By Dato’ Lock Peng Kuan and Johnny Yong
The long-awaited, separate, standalone, proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE) which is based on the core requirements of the International Standards on Auditing (ISAs) was issued by the International Auditing and Assurance Standards Board (IAASB) for comments on 23 July 2021.
The term Less Complex Entities (LCE) was adopted as the IAASB is of the view that ISA for LCE should focus on the complexity of an entity rather than its size. Accordingly, ISA for LCE, by design, does not address complex matters or circumstances and is not permitted to be used for audits other than LCE. The proposed ISA for LCE has included specific prohibitions and qualitative characteristics that will make the ISA for LCE inappropriate for use in an audit of the financial statements of entities other than LCE.
Following the publication of the proposed ISA for LCE, questions arose as to whether the proposed ISA for LCE will significantly change the way auditors perform their audits of financial statements of LCE. An example of questions is whether auditors of LCE are still required to use the systematic sampling approach when performing the substantive testing of transactions or to comply with the ISQC 1¹ which is going to be replaced by the ISQM 1.
Hence, it is important to set the scene right at the outset. As mentioned by the Technical Director of the IAASB, Willie Botha, this standard is not a license to do less audit but a set of standards that will guide you to do a more efficient audit, i.e., to do a “right audit”.
Doing the Right Audit
How is this proposed ISA for LCE able to guide the auditors to do the right audit? The proposed ISA for LCE takes the full suite of ISAs, strips it of those requirements typically expected of a complex operation and calls whatever that is left the ISA for LCE. The IAASB has adopted different approaches to keep the ISA for LCE concise and succinct as much as possible by:
- Excluding areas specific to listed entities such as “Segmental Information” in ISA 501 Audit Evidence – Specific Consideration for Selected Items and “Key Audit Matters” in ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report as ISA for LCE can never be used for listed entities due to their being subject to significant public interest.
- Excluding areas arising from complexities or structure of operations not typical of LCE, such as the requirements to perform procedures in accordance with ISA 610 Using the Work of Internal Auditors.
- Excluding the requirements in ISA 540 Auditing Accounting Estimates and Related Disclosures simply because it is not envisaged that LCE will have complex estimates in the preparation of their financial statements.
- Excluding the requirements of group audits in ISA 600 Special Considerations – Audits of Group Financial Statements (Including the work of Component Auditors) as group audits are deemed to inherently exhibit characteristics of complexity within an entity.
- Excluding the requirements in ISA 402 Audit Considerations Relating to an Entity Using a Service Organisation relating to an auditor’s ability to rely on reports on the operating effectiveness of controls from the service organisation as it is anticipated that where transactions are less complex, the auditor would be able to obtain the necessary audit evidence without difficulty from records available; and
- excluding detailed requirements in relation to management amendments to the financial statements after the date of the auditor’s report as this is expected to be rare for audits of LCE.
Recently, the IAASB produced a document mapping and detailing the differences between the ISAs and ISA for LCE and the rationale for the inclusions or exclusions in the proposed ISA for LCE. ISA for LCE is not exactly a think-small-first approach but, in the current situation, may be the only palatable option for an interim solution whilst another work stream known as CUSP² progresses.
In addition, to enhance the readability and understandability of the proposed ISA for LCE, the IAASB had focused on:
- Articulating the requirements in a clearer and simpler way.
- Avoiding the use of long or multiple layers of bulleted lists, where appropriate, since this may be perceived as a “checklist approach” rather than a principles-based approach.
- Summarising or excluding entirely explanatory materials that are lengthy or background in nature, as per what is presented within the existing ISAs. Only explanatory material that is crucial to support the requirements or concepts used (Essential Explanatory Material) will be included in the ISA for LCE;
- Using simpler numbering and the “one thought per paragraph” approach; and
- Avoiding repetition by combining requirements from various ISAs where appropriate, a welcomed relief as most Small and Medium Practices (SMPs) have requested for this approach over the years.
The IAASB expects that the auditing process will become more effective and efficient once the ISA for LCE is in force. Auditors of LCE will not need to dwell upon the identification of applicable standards as in the case of the ISAs, since core requirements are clearer when the nature and circumstances of the entity and audit engagement are less complex. The auditor would thus be able to invest more time executing appropriate procedures that more effectively target the risks of material misstatement when used for audits of LCE.
On the other hand, the ISA for LCE may not necessarily reduce the number of core procedures the auditor is required to perform to support the overall quality of the audit, A strong message received from one of the IAASB’s stakeholders opined that this separate standard should be based on the ISAs and retain the robustness of an audit using the ISAs. Accordingly, the ISA for LCE would present the requirements for audits of LCE based on the core requirements of the ISAs and thus, auditors using this ISA for LCE will be able to provide reasonable assurance in the audits of LCE.
The Standalone, No Top-Up Approach
One of the more controversial viewpoints by the IAASB is the “No Top-Up” approach when it comes to the adoption and implementation of this proposed ISA for LCE.
IAASB has developed the ISA for LCE as a standalone, self-contained standard, separate from the ISAs with no intended need for direct reference back to the requirements or application material in the ISAs. This means that if there is a circumstance that has not been contemplated in the design of the ISA for LCE, ISA requirements cannot be used to “top-up” the ISA for LCE to address the circumstance.
Accordingly, as depicted in the flowchart below, the overall decision for the audit engagement is whether the ISA for LCE is appropriate for use, given the nature and circumstances of the entity. As an example, consider a situation where a less complex entity has a complex accounting estimate that is not contemplated by the proposed ISA for LCE; the auditor should apply the full ISAs instead of using the ISA for LCE together with the requirements from ISA 540 (Revised) to supplement those requirements not addressed in the ISA for LCE when planning and performing the audit of that entity. In fact, in case of any doubt, the auditor should revert to the use of the full ISAs. This is because it could be disruptive and burdensome to switch to the full ISAs at the later stages of audits of purported LCE.
As mentioned earlier and from the diagram above, group audits have been excluded from the proposed ISA for LCE. The baseline assumption is that all group audits are essentially complicated and hence, should not be included in the proposed ISA for LCE.
The Exposure Draft (ED) has solicited firms to “estimate” the number of group audits that would inevitably be excluded, following the IAASB’s current position. Since the implication could be significant, MIA members are requested to read Paragraph 158 of the ED as to why group audits are deemed more complex and then provide their views for the IAASB to make an impact assessment on the overall audit market.
The present length of the ED at 115 pages is fairly reasonable. However, if group audits are included, the length of the standard may potentially expand significantly as the principles and work efforts for group audits will be embedded into various parts of the standard, from planning and risk assessment to auditor’s reporting. Therefore, a possible approach suggested by the IAASB is to have a separate section called ISA for LCE – Applicable to Group Audits. Such compartmentalisation may facilitate navigation of the ISA for LCE, either for a single company audit or a group audit but this could pose a burden on the IAASB in terms of maintenance of the standard, going forward.
ED-ISA for LCE: Your View Matters
The ED is now open for feedback – with more than 180 days for MIA members and network firms to respond. Ensure your voices are heard, either by forwarding your comments to MIA (e-mail: [email protected]) or writing directly to the IAASB. The closing date is 31 January 2022. MIA had organised a few outreach activities (including the SMP Forum on 16 November 2021) with the intention that these will provide the necessary input for the Auditing and Assurance Standards Board’s submission to IAASB before the due date of submission.
The proposed ISA for LCE may not be a panacea for effective audits of LCE locally but a better understanding of the standard will benefit the profession in the overall by focusing more effort into performing appropriate audits for LCE. The simpler more straightforward proposed ISA for LCE will also enable firms to better train their junior staff and eliminate “over-auditing” of certain areas of the financial statements.
By promoting a better focused approach on auditing, small and medium-sized audit practitioners may perhaps be able to provide more ancillary value-added services that come with better understanding of their clients and their operations as opposed to merely conducting checklist-driven, tick-the-box exercises called audits.
Please click here to complete the Survey which will enable the Institute to compile further statistics in responding to the IAASB’s recent LCE Exposure Draft. All responses will be kept confidential.
¹ ISQC 1 is a new set of standards issued by the International Auditing & Assurance Standards Board that will be coming into effect on 15 December 2022. It deals with the firm’s responsibility for having a system of quality management that creates an environment that enables and support engagement teams in performing quality engagements on a consistent basis.
² CUSP is a mid to long term project to address the complexities, understandability, scalability and proportionality of the current ISAs. You can read more of this here: Complexity Understandability Scalability Proportionality (CUSP) | IFAC (iaasb.org)
Dato’ Lock Peng Kuan is a Member of the MIA Auditing and Assurance Standards Board & Johnny Yong is the Head, Capital Market & Assurance, MIA