5 November 2020

Following on from the IAASB discussion paper on the audit of Less Complex Entities (that we have previously discussed), the IAASB recently released some good news – a new single standard is being developed for these entities.

The IAASB Glossary defines these as entities which typically possesses qualitative characteristics such as:

a. Concentration of ownership and management in a small number of individuals (often a single individual – either a natural person or another enterprise that owns the entity provided the owner exhibits the relevant qualitative characteristics); and

b. One or more of the following:

i. Straightforward or uncomplicated transactions;
ii. Simple record-keeping;
iii. Few lines of business and few products within business lines;
iv. Few internal controls;
v. Few levels of management with responsibility for a broad range of controls; or
vi. Few personnel, many having a wide range of duties.

In other words, this encompasses the majority of work carried out by our Charity and SME auditors. We made a submission to that discussion, back in August 2019 (remember 2019?)

In that submission I made the point that:

“…in New Zealand, we have had many provincial firms that carried out perfectly adequate audit work at a scale appropriate to LCEs drop out of auditing because they do not have the time, staff, or resources to carry out compliant ISA audits. In turn, the entities they previously audited have had to either pay much higher fees to large city firms, stop being audited voluntarily (if under the threshold for compulsory audit), or potentially close because they are already financially pressed and dependant on overstressed volunteers. So the social cost of inappropriate audit standards may well be an overlooked factor in this discussion. At a social level, it is critical that small charities and clubs and not-for-profits remain viable and accountable, as these entities create a disproportionate amount of social cohesion which flows down into all sorts of positive social outcomes.”

In the wake of the COVID-19 experience, it becomes even more important to find ways to help smaller businesses, charities, and other not for profits remain viable, and to address the growing time/cost of auditing using unnecessarily complex standards.

The IAASB approach

The approach that the IAASB is taking seems a sensible one. In fact, it is a two-pronged approach. On one hand, they are producing a more accessible and appropriate audit standard for LCEs. On the other hand, they are undertaking a review of the ISAs addressing Complexity, Understandability, Scalability, and Proportionality (CUSP for short).

The work on the ISAs themselves is welcome and sensible, and addresses issues around plain language, avoiding duplication, and so on. But the real good news to me is the development of a separate standard for LCEs. What might this standard be like?

In a worthwhile interview by Tom Ravlic, (the first 18 minutes) Professor Roger Simnett, the chairman of the Auditing and Assurance Standards Board, (as well as Chair and CEO Australian Auditing and Assurance Standards Board and Scientia Professor, UNSW Sydney) explains the key features:

  • This will be a new separate ISA for Less Complex Audits
  • It will maintain a “reasonable assurance” level (i.e. not be regarded as inferior quality to a full ISA audit)
  • There will be a draft of the new standard presented at the December 2020 meeting of the IAASB
  • It will contain chapters or sections that follow the process of the audit (acceptance, understanding the entity, gaining evidence, risk, reporting, etc.)
  • It acknowledges that the audit process is iterative and interrelated
  • The definition of LCE will be clarified, as it is essential that the reduced standard is only applied in appropriate cases
  • There will be little application material in the standard
  • This is not a “checklist” approach (shudder), but real auditing that requires professional judgement to be exercised
  • The standard will be framework-neutral and apply worldwide
  • It also must be broad enough to encompass changing technologies and innovative audit approaches
  • And of course, for us in NZ and Australia, adoption will require approval by the appropriate bodies.

Is this good for the profession?

The interviewer infers that this new standard could be a good “entry-level” teaching tool for those new to auditing. And this is a good point.

The bar is set so high academically in teaching auditing (even back in my experience at the University of Auckland in the late 1970s) that most graduates theoretical understanding of auditing standards and processes (or lack thereof) does not translate well into the actual auditing understanding needed in our average CA firms.

Maybe this standard will not only help LCE audits be more efficient but will actually help make the audit process more accessible and practical to new entrants into the world of audit?

Maybe they learn the basic patterns here then layer the deeper understanding that the ISAs require on top of these basics as their experience and exposure to more complex entities grows?

Finally, the issue is raised in the interview as to whether this could lead to another designation of audit practitioner? A two-tier profession.

This is open for discussion. I would argue that at least in NZ this is de facto what has emerged. We see quite a clear split in our Audit Assistant clientele between firms that carry out the full suite of work from large listed companies all the way down, and firms that just carry out work for charities and not-for-profits exclusively.

Effectively many of our user firms could probably carry out all their work under the new LCE standard. And in my opinion that specialisation is probably a good thing.