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GAAS and the small business audit.

GAAS and the Small Business Audit

It has been more than a decade since the accounting profession began to grapple with the problems often faced by auditors of small business enterprises. The profession concluded that while there may be times when special guidance may be necessary to meet the needs of small business auditors, there should be no differences in audit standards based on the size of the entity being audited. (1) This conclusion was reached despite two studies indicating substantial support among members of the profession for a separate set of Generally Accepted Auditing Standards (GAAS) for small business audit clients. (2) Instead, the profession opted to address the needs of small business auditors with what can be called an "advocacy and education" approach. A question remains as to whether the profession's advocacy and education approach has been successful in convincing small business auditors that one set of GAAS is sufficient for all audits, large or small.

The purpose of this article is to discuss the success of the profession's advocacy and education approach. First, typical small business audit problems will be reviewed, then the profession's advocacy and education approach will be examined in more detail. Auditor opinions concerning the applicability of GAAS to small business audits and the profession's response to the problems of the small business auditor will then be analyzed. Finally, several practical recommendations will be made.

Small Business Audit


Typically, the difficulties encountered by auditors of small businesses have been directly related to characteristics common to most small businesses. These characteristics, and the audit problems which they create, have been well documented. They include: 1. Concentration of ownership and

operational control in one, or a

few, individuals. This owner/manager

dominance creates the

potential for management override

of internal controls. 2. Limited segregation of duties

within the accounting system

because of the small number of

employees. This often results in

internal control deficiencies. 3. Limited accounting knowledge

by management and employees

and informally designed accounting

systems, both of which may

result in inadequate documentation

and limitations on internal

control. 4. Easy access to company assets by

management and employees

which causes internal control

problems. 5. An inactive, or ineffective,

policy-making body (e.g., board

of directors) which results in a

lack of effective oversight for the

business. (3)

The audit problems stemming from small business characteristics are generally rooted in the internal control system of the small business audit client. So pervasive are the lack of internal controls in some small businesses that their auditability has been questioned. It has even been suggested that a small business qualification similar to the one permitted under the auditing standards of the Chartered Accountants of England and Wales be adopted in the U.S. (4) British auditors of small businesses are permitted to qualify their opinion with the following middle paragraph:

In common with many

businesses of similar size and

organization, the company's

system of control is dependent

upon the close involvement of

the directors/managing director

(who are major shareholders).

Where independent confirmation

of the completeness

of the accounting records was

therefore not available, we have

accepted assurances from the

director/managing director

that all the company's transactions

have been reflected in the

records. (5)

The Profession's Advocacy

and Education Approach

The first prong of the profession's approach to helping small business auditors cope with their problems gave the small practitioner a stronger voice in the profession. The American Institute of Certified Public Accountants (AICPA) established the Division for CPA Firms in 1977. Under the Division for CPA Firms is the Private Companies Practice Section (PCPS). The objectives of the PCPS are to improve the quality of services to private companies, to establish and maintain an effective system of self-regulation for member firms and to provide member firms with a better means of effectively providing input on professional matters. (6)

Since its inception, the PCPS has been an advocate for the small and regional firm viewpoint in the standard setting process. The Technical Issues Committee (TIC) of the PCPS maintains formal liaisons with the Financial Accounting Standards Board, the Governmental Accounting Standards Board, the Auditing Standards Board and other senior technical committees. As a goal, the TIC wants to ensure that the views of the local practitioner get communicated to the standard setting bodies. It also wants to reduce standards overload for smaller practitioners. It evaluates standards before they are issued and recommends revisions. Since 1980 it has issued more than 100 formal letters of comment, 20 of those in 1988-89 alone. The TIC also takes responsibility for informing the AICPA of problems encountered by local practitioners in implementing or interpreting local standards. (7)

Under the education prong, the profession has worked to improve communication with and services to small firms. This effort includes the development of new continuing education courses and seminars (which address problems peculiar to audits of small businesses) as well as the publication of small business auditing guides by professional and private groups. To strengthen practitioner education, the AICPA has developed a number of continuing education courses (see 1990-1991 AICPA Self Study/Video Catalog) and seminars (see 1990-1991 AICPA Seminar Catalog) designed to enhance the local practitioners' ability to perform small business engagements more effectively and efficiently.

The profession also provides nonauthoritative literature to assist practitioners in small business engagement. Some examples are the Auditing Standards Division's Audit Procedures Study entitled Audits of Small Businesses, which was designed as a practical guide to assist practitioners in small business engagements, and The Practicing CPA, a periodical devoted to local firm issues. In addition, the profession has made an attempt to educate local firm practitioners concerning the availability of centralized professional resources such as the AICPA Library and the Technical Information Service.

Auditor Opinions - The

Applicability of GAAS to

Small Business Audits and

the Responsiveness of the


Ninety-seven auditors indicated their agreement disagreement with four statements concerning the applicability of GAAS to small business audits and with three statements concerning the profession's responsiveness to the needs of the small business auditor. Participants could also indicate that they had no opinion. The participants were either seniors, managers or partners in their respective firms. Forty-nine of the participants practiced in local or regional firms in the midwest (non-national firms) while 48 of the participants practiced in one of four national firms with offices in the midwest. Table 1 presents the results.

The applicability of GAAS to small

business audits

The first four statements shown in Table 1 are concerned with the applicability of GAAS to small business audits. Among all respondents, a sizable majority (64-77% percent) indicated satisfaction with GAAS for small business audits. The degree of satisfaction was higher among the national firm respondents (73-83%), but much lower among the non-national firm respondents (only 53-71%).

Large minorities ( 41 % and 35 % respectively) of the non-national firm respondents (as opposed to only 19% of the national firm respondents) agreed that GAAS are difficult to apply (Statement 3) and disagreed that the field standards of GAAS were written in such a way that they apply equally well to audits of both large and small businesses (Statement 4). This may indicate the level of frustration felt by small business auditors when trying to apply GAAS to actual small business engagements.

The substantial differences in the responses of the national versus the non-national firm practitioners are probably due, in large part, to the dissimilarities in client bases and resource availability among national and non-national practices. Non-national firm practitioners are much more likely to be involved in small business audits than are national firm practitioners. National CPA firms tend to attract and service larger clients who generally have stronger internal control systems and greater segregation of duties than the clients serviced by non-rational firms. As a result, non-national firm practitioners are more likely to have encountered difficulties applying GAAS to small business audit clients on a regular basis than their national firm counterparts.

Resource availability may also be a factor in the response differences among the non-national and national firm practitioners. Typically, practitioners from national firms have infirm technical expertise available. For example, when a national firm practitioner encounters a problem in applying GAAS on a small business audit engagement, he or she may simply refer the problem to the infirm small business experts who provide the practitioner with an appropriate solution. In contrast, a non-national firm practitioner may have to rely on personal experience. The national firm practitioner is aware that he or she encountered a small business audit problem, but may not fully comprehend its magnitude since a solution was quickly provided by the firm's small business experts.

The profession's responsiveness to the needs of the small business auditor

The last three statements in Table 1 are concerned with how well the accounting profession has responded to the needs of the small business auditor. As shown in Table 1, substantial support exists for a renewed effort to help small business auditors with GAAS application difficulties. Sixty-five percent of all respondents would support an immediate review of the adequacy of GAAS for small business audits (Statement 6). Nearly three out of four (74%) of the non-national firm participants would support such a review. [Tabular Data Omitted]

The responses to Statement 7 reveal a large degree of disagreement between non-national and national firm participants. Fifty-seven percent of the non-national firm respondents agreed that the profession needs to consider drafting new GAAS field standards to reflect the audit characteristics of small businesses. Only 19% of the national firm respondents agreed. It appears that the respondents who are closest to the difficulties of applying GAAS to small business audits (non-national firm participants) may feel a more immediate need for addressing small business audit problems. The national firm respondents seem uncommitted on the question of action by the profession. While they generally agree (56%) that a review of GAAS for small business audits would not be objectionable, they express strong disagreement (65%) with the concept of drafting new field standards for small business audits. The non-national firm participants are consistent in their support of action by the profession on the small business GAAS issue.

The responses to Statement 5 may be an indicator of the root of many small business auditor difficulties in GAAS application. Overall, only 17% of the respondents felt that small practitioners had an adequate voice in the development of the field standards of GAAS. Nearly six out of 10 (59%) of the non-national firm participants felt underrepresented in the GAAS development process, whereas only fourteen percent felt adequately represented.

A similar percentage (19%) of the national firm respondents felt that the smaller practitioner was adequately represented in the GAAS development process. However, a full 50% of these participants felt they could not offer an opinion on the issue. This may indicate a lack of knowledge among national firm practitioners about the types of practice problems encountered by their small firm counterparts.

The disparity in resource availability between the national firms and the smaller firms probably contributes to the feeling of inadequate representation among the non-national firm participants. National firms maintain national technical issues staffs that examine and comment on professional exposure drafts. Most small firms simply lack the time, the manpower and the financial resources necessary to actively participate in the standard setting processes.


The national and the non-national firm participants responded quite differently to the seven statements concerning the applicability of GAAS to small business audits and the responsiveness of the profession to the needs of the small business auditor. This may indicate that the small business GAAS application problems encountered by local and regional practitioners are not being adequately communicated to other members of profession. It could also indicate that the profession as a whole is not sufficiently acting upon the small business GAAS application problems that are reported by local and regional firm practitioners.

All members of the accounting profession, whether they practice in a large or small firm, should be alarmed when it appears a group of members feels underrepresented and that their needs are not being adequately addressed. The following is a series of practical recommendations aimed at improving intra-professional communication and alleviating the feelings of underrepresentation expressed by the non-national firm participants.

Find ways to communicate the views of local and regional firm practitioners. If the profession is to help local and regional firm practitioners with the small business GAAS application problems they encounter, those problems must be put on the profession's agenda. Small and regional firm practitioners must make their views known. Doing so will require the commitment of time and effort, two commodities that are scarce in smaller firms. The resource commitment can be kept to a minimum by banding together, however. Information about small business GAAS application difficulties (and other issues important to the small practitioner) could easily be collected and communicated to other members of the profession by special purpose task forces organized by local chapters of state societies. Large local chapters should consider employing a small firm technical expert to comment on professional exposure drafts and to insure that the views of the small practitioner are made known to the profession's standard setting bodies.

Give state societies a more active role. The profession should seriously consider giving state societies a more active role in the standard setting process. Small practitioners tend to be more active in state societies than in the AICPA. If state societies had a meaningful role in the development stage of standard setting process, it is more likely that the needs of the small practitioner would be addressed.

Provide easier access to resources. The AICPA should strive to make the central resources (e.g., AICPA Library and Technical Information Service) more available to the small business auditor. Perhaps regional or state sites could be utilized. It is possible that at least some of the GAAS dissatisfaction shown by local practitioners could be eliminated through the use of these resources.

Revisit GAAS applicability. The profession should revisit GAAS to determine whether they are equally applicable to all audits. Although this question was examined in 1978 by the Review of Existing Auditing Standards Task Force, it is apparent from the non-national firm participant responses that there is considerable dissatisfaction with current GAAS as they relate to small businesses.

Make a renewed effort to solve problems experienced by tall practitioners. The accounting profession must pay attention to the needs of all its members. If the needs of a segment of the profession are not attended to, that segment may become disillusioned. Small practitioners are the backbone of the profession, and the profession must commit additional resources to the study of problems encountered by small practitioners. Once those problems have been identified, real efforts should be undertaken to help the small practitioner.


(1) Commission on Auditor's Responsibilities, Report, Conclusions, and Recommendations (New York: AICPA, 1978), p. 133.

(2) D.D. Raiborn, Auditing Research Monograph No. 5: Audit Problems Encountered in Small Business Engagements (New York: AICPA, 1982), p. 95, and D.T. Anderson, H.I. Dycus and R.B. Welker, "GAAS and the Small Business Audit," The CPA Journal, April 1982, pp. 10-23.

(3) See for example, Raiborn, op. cit., p. 9, F. Marino, "Small Business Audits: A Continuing Problem," The Ohio CPA Journal, Winter 1986, p. 19, Andersen, Dycus and Welker, op. cit., p. 13 and D.D. Raiborn, D. M. Guy and M. Zulinski, Solving Audit Problems in Small Business Audits," Journal of Accountancy, April 1983, p. 53.

(4) Marino, op. cit., p. 20, 23.

(5) Institute of Chartered Accountants in England and Wales, Auditing Standards and Guidelines (St. Albans, London: Staples Printers, 1980) p. 55.

(6) Division for CPA Firms Private Companies Practice Section Peer Review Manual, Rev. ed. (New York: AICPA, 1986).

(7) PCPS Advocate, Annual Report, Vol. 10, No. 6, December 1989 (AICPA-Division for CPA Firms), p. 3.

Allan L. Karnes practiced public accounting for five years prior to his academic career. Graduating third in his class from the Southern Illinois University School of Law, he also obtained a graduate degree in accounting from Ball State University. An author of several tax and accounting articles, he has authored a number of articles in numerous professional accounting journals. He is a member of the American, Illinois and Jackson County, Illinois Bar Associations, the American Institute of Certified Public Accountants and the American Accounting Association. He is licensed to practice law and accounting in Illinois.

James B. King, II is a former budget director at the University of Maryland. He has also worked as a systems analyst and management consultant in both academia and the private sector. He earned his PhD at Indiana University. He has previously published in Controllers' Quarterly. He is a member of the American Institute of Certified Public Accountants, the American Accounting Association and the National Association of Accountants. He is licensed as a certified public accountant in Maryland.

Robert B. Welker has a PhD from Arizona State University. His published research and articles have appeared in a number of professional accounting journals including The Journal of Accounting Research, The Accounting Review, The International Journal of Accounting Education and Research, The CPA Journal, The Ohio CPA Journal, The Oil and Gas Tax Quarterly and Managerial Planning.
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Title Annotation:Generally Accepted Auditing Standards
Author:Karnes, Allan J.; King, James B., II; Welker, Robert B.
Publication:The National Public Accountant
Date:Aug 1, 1991
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