Small firms may need to consolidate to arrest a decline in audit quality, the accounting watchdog has indicated.

With the introduction of new accounting rules for small to medium-sized enterprises (SMEs), small firms are struggling to maintain audit quality and many have given up audit registrations, figures show.

The suggestion made by Paul George, director of the Professional Oversight Board, could herald concerted regulatory pressure on the smaller firms to merge to increase their levels of audit specialisation.

'There's been deterioration in the grading [on the quality of audits]. Year on year, there's a different population but I think it's an interesting trend, which illustrates the challenge that many firms have of keeping up to date with all of the many regulatory demands that are placed on them,' said George.

While most firms perform an average of 20 audits, smaller firms at the lower end of the audit market conduct few or no audits at all.

Increasing complexity in undertaking those audits 'make it less attractive for very small firms to concentrate on this part of the marketplace', he said.

'We've got this project going to help alleviate the risk associated with concentration at the top end of the market.

'I think the lack of concentration at the bottom end is equally a risk and something we're increasingly talking to the professional bodies about and seeing how they can help their members meet the challenges that they face,' George said.

The body's report to the secretary of state said that all the institutes' audit monitoring units witnessed a downward shift in the quality of audits. Professional bodies challenged the idea that quality was declining this week. ICAS executive director David Wood said: 'The regulatory approach is getting slightly harsher. I'm not sure the figures should be interpreted to conclude a deterioration.'

UK 200 Group president Jonathan Russell said audit quality was not deteriorating: 'I would challenge that the quality of audit is reducing. We are not feeling that.'

He added that compliance issues were a problem.

'If you've only got five audits, the cost of maintaining an audit registration will outweigh the value of those audits, which is the issue small firms are dealing with,' Russell said.

View the full interview with Paul George at AccountancyAgeTV