Across the world, it is estimated that 90% of businesses are small and medium-sized entities. These smaller, less complex entities (LCEs) make a critical contribution to the global economy and comprise the great majority of audits globally. Currently, approximately 130 jurisdictions of the International Federation of Accountants (IFAC) have adopted or partially adopted the International Standards on Auditing (ISAs). The ISAs are designed to be applied to a wide variety of entities, including those whose nature and circumstances are simpler and more straightforward (i.e., LCEs) and those with complex structures and transactions. The International Auditing and Assurance Standards Board (IAASB) recognized that this complexity arising from the application of the ISAs may pose challenges in the audit of LCEs.
Based on the feedback from the IAASB’s 2019 Discussion Paper titled Audits of Less Complex Entities: Exploring Options to Address the Challenges in Applying the ISAs and other inputs gathered from the outreach conducted, the IAASB developed the Exposure Draft of Proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ED-ISA for LCEs). This is a standalone “self-contained” standard, separate from the ISAs which will not need to directly reference back to the requirements or application material in the ISAs for its application. This will address the challenges currently faced by the stakeholders under LCEs and is considered as a global solution. The proposed standard contains requirements for the auditor to obtain sufficient appropriate audit evidence that is intended to enable such auditor to provide reasonable assurance in the audit of the financial statements of an LCE.
Although the ED-ISA for LCEs is based on the core requirements from the ISAs, it does not contain requirements relating to prohibited entities, or where there are matters or circumstances that would have been deemed more complex as described in the Authority of the proposed standard. Accordingly, for example, the proposed standard does not include any requirements:
(a) Specific to listed entities, including procedures related to reporting on segment information (ISA 501) or key audit matters (KAMs) (ISA 701);
(b) When the auditor intends to use the work of internal auditors (ISA 610, Revised 2013); and
(c) With respect to group audits (the requirements of ISA 600 on group audits have been omitted).
There are many differences between the ISAs and ED-ISA for LCEs. Three significant areas where the requirements are broadly different include the following:
(a) Accounting estimates – Specific procedures, in relation to the use of complex modelling and detailed requirements to address situations where there are higher estimation uncertainty, have not been included (e.g., the estimate is not calculated using recognized or common measurement techniques or there is a highly specialized entity-developed model for which there are no observable inputs) as they are not expected to be relevant for the types of accounting estimates in an audit of a typical LCE
(b) Where the entity uses a service organization for processing transactions – Because the requirements in the proposed standard have been designed for the typical nature and circumstances of an LCE, basic requirements for circumstances where an entity uses a service organization for processing transactions have been included (because, for example, many LCEs may have payroll processed by a service organization). However, situations that are deemed more complex relating to the entity’s use of a service organization have not been addressed within the proposed standard. For example, requirements relating to an auditor’s ability to rely on reports on the operating effectiveness of controls from the entity providing the services (e.g., ‘Type 1’ and ‘Type 2’ reports) are not included 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 (including, if applicable, in relation to controls at the service organization).
(c) Management amendments to the financial statements after the date of the auditor’s report – Detailed requirements, relating to the reporting on and distribution of previously issued financial statements when these are amended, are not included because in most jurisdictions, this is expected to be rare.
The public consultation on this new draft standard is open until January 31, 2022. Once final, the standard will meet the growing global need while reducing the emerging risk of jurisdictional divergence.
As published in Mindanao Times, dated 24 September 2021
