5 December 2024

We started to hear about a new audit standard for Less Complex Entities way back in 2019.

The NZ XRB have now released a consultation document for feedback from NZ auditors and other stakeholders concerning the new LCE standard. The consultation closes on 27 February 2025. So it is important that if you support this that you make your voice heard, as adoption is not a foregone conclusion.

  • We made a submission to IFAC back in 2019 in support of the idea and passing on some of the ideas we had heard from our users.
  • The proposed standard was released in 2021, and we added further commentary in this article.
  • Then in 2023 the glacier moved a few more centimetres as the changes made by ISA 315 (revised 2019) were adapted into the proposed standard.
  • The international version of the standard has at last been approved, IFAC stating that: The ISA for LCE is set to be effective for audits of financial statements of less complex entities starting from December 15, 2025, with early adoption permitted. However, before the standard can be used in jurisdictions, each jurisdiction must decide whether to adopt it.

Relevant points about the draft NZ standard (followed by our comments):

  1. The standard includes content adapted from NZ AS1 (revised) concerning Service Performance Information (SPI) in NZ special section 11. This makes sense.
  2. It may be applied to General Purpose, Special Purpose or an audit of a single financial statement or of a specific element, account or item of a financial statement. So all our NZ small charities, ECEs, special purpose for-profits are included – good.
  3. It may not be used for listed entities, deposit takers, insurance providers, FMC reporting entities considered to have a “higher level of public accountability”, and any specifically prohibited entities. I am surprised that the cut-off was not set lower (e.g. excluding all Tier 1 and 2 entities).
  4. The audit report and engagement letter will state compliance with ISA (NZ) for LCE. This makes sense – who reads this stuff anyway apart from auditors?
  5. The standard covers both fair presentation frameworks, and compliance frameworks. This means that the standard may be used for Tier 4 PBEs and any special purpose reporting that is not fair presentation. Great.
  6. The level of assurance is reasonable assurance – the same as using ISAs. Makes sense.
  7. Essential explanatory material (EEM) is included in blue boxes throughout the text. This is kept to a minimum and seems helpful.
  8. The standard may be used by Public Sector entities. I’m not convinced that any Public Sector entities are ever actually less complex.
  9. The standard may be used for groups unless any parts of the group are prohibited, and where component auditors are involved beyond a specific procedures such as attending a physical inventory count or physically inspecting assets or documents. This is a common sense approach. At one time it was proposed that groups might be excluded altogether.
  10. Whether an entity qualifies depends on assessing some qualitative and quantitative characteristics, including things like size of management team (5 or less), clear transparency of ownership and control, 5 individuals or less involved in financial reporting, commercial software rather than bespoke systems, lack of complex estimates or judgements required, 5 or less entities or business units, and a simple consolidation process where applicable. This all seems reasonable and sensible, if perhaps on the low side. No doubt there could be a questionnaire developed that guides the auditor through their decision.
  11. When the auditor intends to use a report provided by a service auditor of a service organisation either as audit evidence about the design and implementation of controls at the service organisation (i.e., a type 1 or type 2 report), or as audit evidence that controls at the service organisation are operating effectively (i.e., a type 2 report), as this would ordinarily exclude the organisation from being regarded as an LCE. This seems a bit over the top. Many firms use SOC1 or IOS 27001 reports from Xero as part of their audit file. So are all entities using Xero not LCE? I’m sure this is not what the standard drafters intended.
  12. The body of the standard manages to encompass the gist of entirety of the ISAs into 10 sections, plus section 11 dealing with Service Performance. This is a remarkable but wonderful feat.

Australia and Canada decide not to adopt – why?

The consultation document says:

Practitioners in Australia did not support the adoption of the standard, as they considered that current guidance is sufficient for their needs. The view in Australia was that while the ISA for LCE may be a valuable educative and training tool and may allow some practitioners to focus on requirements relevant to the typical nature and circumstances of the audit of an LCE, these benefits are outweighed by public interest considerations including:

  • the perception that an LCE standard is a lesser quality or scaled down audit product,
  • a possible expectation of reduced work effort, despite the level of assurance being the same, and
  • the time lag in updating the LCE standard.

They also state that:

We understand that in Canada, other services, such as reviews or compilations are commonly used in lieu of an audit for many less complex entities. When audits are performed and specific to adoption of the ISA for LCE, there were concerns:

  • regarding transitioning from the ISA for LCE to the ISAs, and
  • that the ISA for LCE does not include requirements when the auditor intends to use a report provided by a service auditor of a service organisation as audit evidence. This was considered to restrict the use of the ISA for LCE in Canada.

Now we are progressing towards a decision for NZ. This has been delayed somewhat by the welcome development of Service Performance component. Are the objections made by the Canadians and Australians valid here?

Let’s address the objections raised by our cousins over the waters to see if they are applicable to NZ.

  1. The perception that an LCE standard is a lesser quality or scaled down audit product. Is a Ford Ranger Ute lesser quality than an 18 wheeler Kenworth truck? It depends on the job required. We will not impress a builder client turning up with the Kenworth to deliver a few sheets of ply and some nails and glue. The LCE is fit-for-purpose for certain entities so the audit quality should be higher as the auditor will not be lost in the irrelevant details.
  2. A possible expectation of reduced work effort, despite the level of assurance being the same. To carry on the metaphor, what is the best tool for the job? What was the purpose making the standard if it was not about a more focussed job? This should result in more efficient job with savings (or at least returning some profit). This is exactly what is needed – like bringing a 1 tonne excavator to dig up granny’s broken sewage pipe rather then a 55 tonne excavator.
  3. The time lag in updating the LCE standard. This is valid concern – if an ISA is updated there will be a corresponding need to update the LCE component. It’s hardly a deal-breaker though.
  4. In Canada reviews or compilations are commonly used in lieu of an audit for many less complex entities (implying that the standard is not needed). This is not the case in NZ with our low thresholds for audit. We have a vast number of entities requiring statutory audit that are ideal candidates for LCE. In fact, in the NZ audit climate it is likely that LCE will become the go-to standard for 80% of our jobs, and the ISAs used only in special cases.
  5. Concerns about transitioning from the ISA for LCE to the ISAs. I assume this concerns an organisation growing and becomes more complex. Auditors would need to be aware of this, just as they must be aware when an entity needs to transition into a higher financial reporting category. This would be part of the planning meeting discussion each year.
  6. That the ISA for LCE does not include requirements when the auditor intends to use a report provided by a service auditor of a service organisation as audit evidence. As noted above, I’m sure it was not the intention of the standard writers to include off -the shelf software in this restriction. If the entity is using a complex third party bespoke service provider maybe it will be caught by some of the other restrictions.

What are the benefits?

Remember how the ISA’s were written in a piecemeal fashion and released in a series of ‘tranches’ over a couple of years?

Auditors have slowly come to terms with how the ISAs fit together. We have attempted to do with Audit Assistant – but because of how they were developed it hasn’t always easy to piece them into a cohesive workflow – even for us who have given it a lot of time and thought. As a result, many just continued to audit as they always have, and still do to this day, with a bit of reluctant adaptation to the standards when someone reviews their workpapers.

Now with the LCE standard the drafters have had to think about how the ISAs all fit together into a modern risk-based audit. We have always attempted to do this with Audit Assistant – to make the ISAs our basic methodology and reference point. So I see the ISA for LCE as a great way of resetting auditors, ironically, back to what the ISAs were supposed to achieve – a cohesive, focussed audit.

Hopefully what auditors learn from this skeleton approach will enhance the quality of their more complex work as well. Using the LCE standard as a training tool, as the Australians noted, may also attract more talent to the auditing profession because graduates can get their heads around the LCE approach and then branch into the nuances of more complex work later if they wish. They get to learn to operate the little digger before progressing to the big one, or driving the Ranger on their way up to the Kenworth.

I believe the benefits of adopting the LCE standard will far outweigh the costs, because audit work will become fit-for-purpose for the majority of NZ entities requiring audit. For all our user firms the vast majority of their jobs will fit within the standard, and many of the steps that are inapplicable in their current jobs will not need to be there, making audit files less cluttered and more focussed .