ACCA Audit and Assurance (F8) Practice Exam

What is a defining characteristic of a "Small Entity" in auditing?

1. High employee count

2. Complex financial structures

3. Owner-managers with no agency problem

4. Extensive external audits

The correct answer is: Owner-managers with no agency problem

A defining characteristic of a "Small Entity" in auditing is the presence of owner-managers with no agency problem. In small entities, the owners often take on managerial roles within the organization, which means that there is typically a direct relationship between ownership and management. This alignment reduces the incentive for actions that may conflict with the interests of the owners, unlike larger organizations where management and ownership can be more separated, leading to potential agency problems. In smaller entities, the personal investment and direct oversight by owner-managers helps ensure that the entity is managed in the owners' personal interest, resulting in less complexity and fewer layers of governance. This structure can influence auditing approaches, as auditors may need to consider less formalized controls and a closer relationship between auditors and management in these environments. The other options do not align with the characteristics typically ascribed to small entities. For example, high employee count and complex financial structures are more associated with larger organizations, while the concept of extensive external audits is generally not prevalent among small entities, as they may rely more on internal reviews or less formal audit arrangements due to lower resource availability.