Entity Spotlight: Audit Challenges for SMEs, Charities and Start-Ups

A practical comparison of audit obligations, common pitfalls, and tailored strategies for smoother audits across three different types of organisations.

Audit is not a one-size-fits-all obligation. The legal framework, regulatory expectations, and practical challenges that apply to a growing technology start-up are fundamentally different from those facing an established SME or a registered charity. Yet too often, audit is treated as a standardised compliance exercise, when in reality it demands a sector-specific approach to be effective.

This article compares the audit landscape across three distinct entities – small and medium-sized enterprises (SMEs), charities and not-for-profit organisations, and early-stage start-ups – examining the regulatory obligations each faces, the pitfalls that most commonly arise, and the practical strategies that lead to smoother, more productive audits.

It is also a timely moment to consider these differences. The UK’s audit and reporting landscape is undergoing significant change. New company size thresholds came into force in April 2025, charity audit thresholds are set to rise in October 2026, FRS 102 has been updated with effect from January 2026, and revised auditing standards on going concern and fraud came into effect in March 2026. Across all three sectors, the compliance environment is shifting, and understanding those changes is essential to navigating them effectively.

SME audit spotlight

The regulatory framework

The audit obligations of SMEs in the UK are governed primarily by the Companies Act 2006, which sets out the size thresholds that determine whether a statutory audit is required. A company must exceed at least two of three criteria – turnover, balance sheet total, and employee headcount – to fall within the mandatory audit regime.

Following the Companies (Accounts and Reports) (Amendment and Transitional Provision) Regulations 2024, new thresholds came into force for financial years beginning on or after 6 April 2025. These represent the first upward revision to size thresholds since 2016 and reflect the cumulative effect of inflation over the intervening decade. Under the revised regime, a company qualifies as small – and is therefore potentially exempt from a statutory audit – if it meets at least two of the following criteria:

• Annual turnover of no more than £15 million (previously £10.2 million)
• Balance sheet total of no more than £7.5 million (previously £5.1 million)
• No more than 50 employees (unchanged)

The government estimates that these changes will result in approximately 113,000 companies moving from the small to the micro-entity category, 14,000 from the medium-sized to the small category, and around 6,000 from the large to the medium-sized category. For many businesses, this means a material reduction in compliance obligations, and, in many cases, the option to claim an exemption from statutory audit altogether.

However, certain categories of company remain ineligible for the small company audit exemption regardless of size. These include public companies, authorised insurance companies, firms regulated under the Financial Services and Markets Act 2000, and companies that are members of ineligible groups. Additionally, shareholders representing at least 10% of shares can require the company to obtain an audit under section 476 of the Companies Act 2006.

A further relevant development is the update to FRS 102, effective for accounting periods beginning on or after 1 January 2026. The revised standard introduces significant changes to lease accounting, with most operating leases now required to be recognised on the balance sheet, and updates to revenue recognition, bringing UK GAAP closer to IFRS in both areas. For SMEs approaching the balance sheet threshold, the impact of bringing operating lease liabilities onto the balance sheet could be material, and may affect whether a company breaches the audit threshold under the new rules.

Common audit pitfalls for SMEs

1. Assuming audit exemption without checking group status

One of the most common errors made by SMEs is assuming that, because the company itself qualifies as small, it is automatically exempt from audit. This overlooks the group provisions in the Companies Act. A company that is part of a group must consider the size of the group as a whole. If the group is not small, the company cannot claim the small company audit exemption, even if it would otherwise qualify on a standalone basis.

2. Leaving financial records in poor order

SMEs that have not previously required a statutory audit sometimes find their financial records inadequate when they grow into the audit threshold. Inadequate bookkeeping, unreconciled accounts, missing supporting documentation, and informal treatment of director loans or related party transactions are among the most common issues identified at the outset of a first audit. These problems do not just slow the audit down; they can result in qualified opinions or require significant additional work to resolve.

3. Underestimating the impact of FRS 102 changes

The 2026 changes to FRS 102 have particular implications for SMEs with significant leased assets. Bringing operating leases on-balance-sheet will increase total assets for many businesses, potentially affecting loan covenants, banking arrangements, and – as noted above – the audit threshold itself. SMEs should model the impact of these changes on their financial statements well in advance of the effective date.

4. Failing to consider the voluntary audit

The increase in size thresholds means that many SMEs will newly qualify for audit exemption. However, exemption from a statutory audit does not always mean that an audit is unnecessary. Banks and lenders frequently require audited accounts as a condition of financing. Investors, trade partners, and prospective acquirers may place greater confidence in audited financial statements. For growing businesses, a voluntary audit can provide assurance that supports commercial relationships and facilitates access to capital.

Strategies for smoother audits of SMEs

• Maintain clean, well-organised financial records throughout the year — do not treat year-end as the moment to reconcile accounts.
• Engage with your auditor early, particularly in the first year of a statutory audit or following significant business changes.
• Model the impact of FRS 102 lease changes on your balance sheet and assess the effect on threshold status, covenants, and reporting obligations.
• Review your group structure to confirm whether group provisions affect your audit exemption eligibility.
• Consider whether a voluntary audit is commercially beneficial, even where a statutory audit is not legally required.

Charity audit spotlight

The regulatory framework

The audit and reporting requirements for charities in England and Wales are governed by the Charities Act 2011 and the Charity Accounts and Audit Regulations, rather than the Companies Act. This creates a distinct regulatory environment, with different thresholds, different types of scrutiny, and a different regulatory body – the Charity Commission for England and Wales – rather than Companies House.

Under the current regime, a charity must have its accounts fully audited if its gross annual income exceeds £1 million, or if its income exceeds £250,000 and its gross assets exceed £3.26 million. Charities below the audit threshold that have an income of more than £25,000 are required to have an independent examination instead – a lighter-touch form of scrutiny that provides negative assurance rather than the positive assurance of a full audit.

Significant changes to these thresholds are on the horizon. Following a government consultation, the Department for Culture, Media and Sport confirmed in late 2025 that the charity audit threshold will rise by 50%, from £1 million to £1.5 million, and the asset threshold for mandatory audit (where income exceeds £500,000) will increase from £3.26 million to £5 million. The independent examination income threshold will rise from £25,000 to £40,000. These changes are expected to come into force from 1 October 2026, and the government estimates the reforms will generate annual savings of approximately £23 million across the sector.

Charities in Scotland are regulated separately by the Office of the Scottish Charity Regulator (OSCR), which announced plans in 2025 to raise its own audit threshold from £500,000 to £1 million, though an implementation date has not yet been confirmed.

It is also important to note that charity audit thresholds operate differently from Companies Act thresholds. Under company law, a company must breach two of three size criteria for two consecutive years before its classification changes. Under the Charities Act, there is no equivalent two-year rule. This means that a charity whose income spikes in a single year due to a large legacy or one-off donation may find itself subject to mandatory audit in that year, even if it falls below the threshold in surrounding years.

Common audit pitfalls for charities

1. The one-year audit trigger

As noted above, the absence of a two-year rule in charity law can cause charities to yo-yo in and out of the audit requirement. A significant legacy receipt or fundraising campaign that pushes income above the threshold in a single year will trigger the need for a statutory audit for that year, even if the charity has not previously been audited and does not expect income to remain at that level. Trustees should be aware of this risk and plan accordingly – in some cases, it may be possible to seek a dispensation from the Charity Commission to substitute an independent examination for a statutory audit.

2. Related party transactions and trustee remuneration

The Charity Commission expects a high standard of transparency around related party transactions. Payments to trustees, transactions with organisations in which trustees have an interest, and loans to or from connected parties are all areas of heightened scrutiny. Auditors are required to consider whether these transactions have been properly disclosed and approved in accordance with the charity’s governing document and Charity Commission guidance. Failure to manage related party transactions correctly – or to disclose them adequately – is a recurring finding in Charity Commission regulatory action.

3. Restricted fund accounting

Many charities receive income that is restricted to specific purposes i.e. grant funding tied to particular projects, donations made for designated activities, or legacies subject to conditions. Managing and reporting restricted funds accurately is a significant compliance challenge, particularly for charities with complex funding arrangements. Misclassification of restricted income as unrestricted, or failure to demonstrate that restricted funds have been used for their intended purpose, is a common audit finding and can expose charities to regulatory scrutiny.

4. Governance and internal controls

The Charity Commission places significant emphasis on good governance, and auditors are required to consider whether a charity’s internal controls are adequate. Smaller charities which may rely heavily on volunteer trustees and limited administrative resource are particularly vulnerable in this area. Weak controls over cash handling, inadequate segregation of duties, and insufficient oversight of subsidiary trading companies are among the most common issues identified.

5. FRS 102 and SORP 2026 changes

Charities applying the Charities SORP (FRS 102) will be affected by the changes to FRS 102 effective from January 2026, including the new lease accounting requirements. For charities with significant property or equipment leases – including those operating care homes, schools, or community facilities – the recognition of right-of-use assets and lease liabilities on the balance sheet could be material. Trustees and finance teams should begin modelling these changes well in advance of their effective date.

Strategies for smoother charity audits

• Monitor gross income carefully throughout the year, particularly if a significant legacy or major donation is anticipated – and plan for the audit threshold implications.
• Maintain clear records of all restricted funds, including evidence of how funds have been applied in accordance with donor or funder conditions.
• Ensure all related party transactions are properly identified, approved in accordance with the governing document, and disclosed in the financial statements.
• Review internal controls regularly, particularly if the charity has grown or changed its operating model.
• Begin assessing the impact of FRS 102 and SORP 2026 changes, focusing particularly on lease accounting and revenue recognition.
• Engage with your auditor or independent examiner early in the year, rather than waiting until after the year end.

Start-up audit spotlights

The regulatory framework

Early-stage businesses occupy a distinctive position in the UK audit landscape. In their first years of trading, most start-ups will be well below the statutory audit thresholds and will have no legal obligation to commission a statutory audit. The new size thresholds effective from April 2025 – which raise the small company turnover limit to £15 million and the balance sheet limit to £7.5 million – mean that start-ups will remain exempt from mandatory audit for longer as they grow.

However, the regulatory environment for start-ups is far from straightforward. Many will be required to commission a voluntary audit as a condition of investment – venture capital funds, private equity investors, and institutional lenders frequently require audited financial statements before committing capital or extending credit. Start-ups in regulated sectors – including financial services, healthcare, and defence – may face sector-specific audit or assurance requirements regardless of their size.

Start-ups that have been established as subsidiaries of larger groups should also note that the group provisions in the Companies Act may require an audit even where the subsidiary would not otherwise qualify as a mandatory audit entity on a standalone basis. Conversely, subsidiaries of qualifying groups may be eligible for audit exemption under section 479A of the Companies Act, provided the parent company guarantees the subsidiary’s outstanding liabilities and files consolidated accounts at Companies House.

Common Pitfalls for Start-Ups Subject to Audit Obligations

1. Going concern uncertainty

Going concern is among the most significant audit risks for early-stage businesses. Many start-ups operate at a loss in their formative years, rely on external funding to sustain operations, and face genuine uncertainty about their future cash flows. Auditors are required to assess whether the going concern basis of accounting is appropriate and, where material uncertainties exist, to ensure these are adequately disclosed.

The FRC published updated guidance on going concern reporting in February 2025, consolidating requirements from company law, accounting standards, auditing standards, and the UK Corporate Governance Code into a single reference document. Separately, the FRC issued revised auditing standards on going concern (ISA (UK) 570, Revised March 2026), effective for audits of financial statements for periods beginning on or after 15 December 2026, which reinforce how auditors must assess and report on an entity’s ability to continue as a going concern. For start-ups approaching their first audit, understanding what evidence the auditor will need to support the going concern conclusion – including cash flow forecasts, funding commitments, and management’s plans for the business – is essential preparation.

2. Revenue recognition complexity

Revenue recognition is a particular challenge for start-ups, especially those with subscription-based models, multi-element contracts, long-term service agreements, or complex software licensing arrangements. The updated FRS 102, effective from January 2026, introduces a five-step revenue recognition model more closely aligned with IFRS 15, which requires a more rigorous analysis of when and how revenue should be recognised across different contract types. For start-ups that have historically adopted informal or simplified approaches to revenue recognition, the new standard may require a fundamental reassessment of their accounting policies.

3. Share-based payments and equity structures

Start-ups frequently use share options, warrants, and other equity instruments to attract and retain talent. The accounting treatment for share-based payments under FRS 102 is complex, and errors in this area – including failure to recognise a share-based payment charge, incorrect valuation of options, or inadequate disclosure of equity arrangements – are a common audit finding. Businesses operating Enterprise Management Incentive (EMI) schemes should also ensure their schemes have been correctly structured and approved by HMRC.

4. Related party transactions and founder arrangements

Start-ups with founder-led structures frequently have informal financial arrangements between the business and its founders – loans, expenses, services provided by connected parties, and equity arrangements that do not reflect arm’s-length terms. These arrangements need to be properly documented, accounted for in accordance with FRS 102, and disclosed in the financial statements. Auditors will scrutinise related party transactions carefully, and undisclosed or improperly accounted-for transactions can result in audit qualifications.

5. R&D tax credit claims

Research and development tax credits are a significant source of cash for many UK start-ups, and their treatment in the financial statements requires care. Changes to the R&D tax relief regime introduced in 2023 and 2024 have significantly altered the landscape, merging the SME and RDEC schemes for accounting periods beginning on or after 1 April 2024 and introducing an enhanced rate for R&D-intensive loss-making companies. Start-ups should ensure their R&D claims are well-evidenced and consistently treated in their financial statements, as HMRC scrutiny of R&D claims has increased materially in recent years.

Strategies for smoother audits of start-ups

• Prepare detailed, board-approved cash flow forecasts that extend at least 12 months beyond the balance sheet date; these will be central to the going concern assessment.
• Review your revenue recognition policies in light of the updated FRS 102 and ensure your accounting reflects the new five-step model where relevant.
• Document all related party transactions and founder arrangements clearly, and ensure these are captured in board minutes and supporting records.
• Engage a specialist adviser to value share options and other equity instruments, and ensure share-based payment charges are properly recognised.
• Review R&D tax credit claims carefully, ensuring the expenditure claimed is well-documented and that your financial statement treatment is consistent with your tax return.
• Engage with your auditor before the year end, particularly in advance of a first audit, to understand what evidence will be required and to identify any areas of potential difficulty early.

Conclusion: One framework, but three different conversations

SMEs, charities, and start-ups all operate within the UK’s audit and financial reporting framework – but the conversation each needs to have with its auditor looks very different.

For SMEs, the key questions in 2026 relate to the impact of the new size thresholds, the effect of FRS 102 lease changes on balance sheet position and threshold status, and whether the benefits of a voluntary audit outweigh the cost of exemption.

For charities, the immediate priorities are managing the one-year audit trigger risk, maintaining robust governance and restricted fund accounting, and preparing for the threshold changes due in October 2026.

For start-ups, the focus must be on building the financial infrastructure that supports a credible audit from the outset: reliable records, a defensible going concern assessment, compliant revenue recognition policies, and properly documented equity and related party arrangements.

In all three sectors, the common thread is the same: early engagement, good record-keeping, and proactive planning consistently produce better audit outcomes than reactive compliance. The regulatory landscape is changing across all three sectors in 2025 and 2026, and businesses that understand those changes early will be better placed to navigate them effectively.

If you would like to discuss your organisation’s audit obligations or preparation strategies in more detail, please contact the audit and assurance team at UHY Williamson Croft.