The 47-year-old has been selected by Smith ahead of a large pool of high-calibre applicants following Richard O'Kelly's move to Bristol City last week, and he will remain at the Banks's Stadium on an initial deal until the end of the season.
Kelly joined the Saddlers as a youngster in 1981 before turning professional two years later. The striker's goalscoring exploits earned a big-money move to West Ham in 1988 and he went on to enjoy an established career at the top level.
Kelly has since enjoyed coaching stints with the likes of Sheffield United, Preston, Derby and Nottingham Forest.
"I am delighted to come back to the club to help Dean," Kelly said. "I've seen three or four games this season and I've been really impressed with the style of football that Dean has implemented here.
"There is plenty of good young talent that has been developed through the ranks and I am really looking forward to the challenge of helping the club progress.
"The supporters here will accept you if you do your best and work hard for the badge. It is something that I'd like to think I did as a player and will be doing as assistant manager."
Smith added: "I am really pleased to have Ned on board. He was one of the four names that came into my head straight away upon Richard's departure.
"He's a bubbly character who possesses a lot of coaching experience, knowledge of the game and contacts. He is still a well-respected figure at the club for his achievements as a player, and his return is sure to give the supporters a lift.
"I've known him since I was an apprentice here and I am looking forward to developing a working relationship with him."
