Tag: less complex entity audit

18 August 2021

The IAASB has now issued its proposed standard on less complex entities (ED-ISA for LCE) for feedback.

A standard around LCE’s is long overdue, and their proposal comes with the hope of easing unnecessary requirements placed on auditors.

The standard is expected to come into effect around 2023/2024 and should be a game-changer for the audit of most of our client entities. This article follows on from prior commentary and summarises some of the critical changes the LCE standard will have on an audit engagement.

Relationship to ISAs

The IAASB has decided that the proposed standard is to be separate from the ISAs with no intended need to directly reference back to their requirements or application material. However, the proposed standard does not address complex matters or circumstances so is not permitted to be used for audits that are not audits of financial statements of LCEs.

As a consequence, when a firm is auditing an entity with transactions and accounts deemed less complex, they cannot supplement by using other auditing standards concerning a more complex account or transaction (like an accounting estimate calculated using a bespoke, complex model). In this instance, the auditor may not use ISA for LCE together with requirements from say ISA 540 (Revised) to supplement what may not be addressed in ISA for LCE when planning and performing the audit. They would need to carry out the whole audit using ISAs (see Explanatory Memorandum para 26-28).

Therefore, it will be critical in the planning stage to ensure the LCE standard is applicable for every aspect of the audit engagement. The standard provides good guidance around the applicability of LCE for an audit engagement. See table below:

from Explanatory Memorandum para 50

What Qualitative Characteristics might make the standard inappropriate?

Outside of the specific prohibitions in the table above, an entity may be prohibited from using the LCE standard where an entity exhibits:

  • Complex matters or circumstances relating to the nature and extent of the entity’s business activities, operations and related transactions and events relevant to the preparation of the financial statements.
  • Topics, themes and matters that increase or indicate complexity, such as those relating to ownership, corporate governance arrangements, policies, procedures or processes established by the entity.
    (from Explanatory Memorandum para 67)

What about groups?

At this stage, the standard is unlikely to allow group audits; however, the board is open to changing their minds and has proposed options to incorporate group audits into the standard.

General flow of the proposed standard

The content of ED-ISA for LCE have been grouped into nine “Parts” that follow the flow of an audit engagement (rather than by subject matter or topic like the ISAs):

from Explanatory Memorandum para 92

Each part follows the same structure, a preface, authority (circumstances in which the standard is prohibited or limited), broad concepts, key requirements, and appendices.

Potential Grey areas in the application of the standard

Accounting estimates – Specific procedures concerning the use of complex modelling and detailed requirements to address situations where there is higher estimation uncertainty have not been included as they are not expected to be relevant for the types of accounting estimates in an audit of a typical LCE. While the presence of one complex characteristic exhibited by an entity does not necessarily exclude the use of ISA for LCE this is a tricky area which would lead to a judgement call for the auditor about whether it is still appropriate to continue performing the audit under the proposed standard. The auditor would need to determine if the complex matter or circumstance identified is not in the spirit of what standard intended to be allowed as an accounting estimate.

Service Organisations – The standard is designed for the typical nature and circumstances of an LCE. The prime example is with LCEs that have payroll processed by a service organisation. However, situations deemed more complex relating to the entity’s use of a service organisation 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 organisation.

Planning the Audit

One of the areas where the IAASB has modulated the proposed standard is to not distinguish between the overall audit strategy and the audit plan required by the ISAs. The auditor is still required to plan the audit in the same manner, however, the relevant outcomes of what the auditor would need to do about establishing the overall audit strategy and audit plan have been incorporated together (i.e., there is still a requirement to establish and plan the audit’s scope, timing, and direction).

IAASB Video

The IAASB has released a video explaining the draft standard:

Audit Assistant response

We think that the approach taken appears sensible, but are yet to get into the deep details. We may make a submission on behalf of our users if there are any particular issues that are brought to our attention.

Our goal over the next year or so is to make a new template from scratch incorporating the requirements of the new standard, in anticipation of its adoption. As a clean-slate build, we will be looking at ways to make this as efficient as possible, without having to retain backwards compatibility. Please contact us if you would like to add to our submission on the ED, or make suggestions for the new template.

15 July 2020

For many auditors of smaller entities (small charities and clubs for example), a major difficulty is how to adhere to auditing standards which are designed primarily for larger entities.

Given the time and budget constraints that auditors face this can cause some auditors to go into autopilot and tick-off checklists rather than clearly identifying, assessing, and addressing audit risks. We have identified these issues in previous articles, and although at a global level nothing has yet emerged to tackle this problem, we have designed a new series of audit templates specifically addressing this.

With our templates for less complicated entities (LCEs), we have set out to reduce the compliance burden that the current ISAs create and to focus on what is relevant to smaller organisations. We have done this in part by referencing the suggested application material for small entities within the existing standards, and leaving out the content that will only be relevant in larger entities (e.g. internal audit).

We also aim to improve audit quality, evidence and documentation by reducing the number of pages and work items, and instead we ask questions that prompt qualitative answers with solid evidence, rather than ticking “yes” or “no” answers. We have also tried to reduce the heavy and complex language of the standards to use brief, plain English wherever possible to ensure auditors can understand the true essence of the requirements laid out by ISAs. To carry on the aircraft metaphor – to spend more energy on looking at the view (the client) and less time fiddling with the controls.

Use of the new LCE series templates

While many standards have specific clauses for considerations for smaller entities (we refer to these in the new LCE templates), the standards do not define what “small entities” are. This is left to the auditor’s judgement. We would suggest as a rule of thumb that in most cases in NZ non-Tier 1 and 2 entities will probably be classed as small, and so they will fit our LCE templates unless they have controls that must be tested due to non-transparent processes or have complex operations or ownership structures.

We made the templates primarily with locally owned entities in mind, however often with smaller companies, the trigger for audit is that they have some overseas ownership. When these companies themselves are small and simple, the LCE template will be entirely adequate. We will try to give some guidance around this in future articles, but it is our estimate that 80% of the jobs carried out using Audit Assistant will probably be LCE, either not-for-profit or for-profit entities.

What key changes are included in the LCE templates?

We have conducted an in-depth update of the whole audit process incorporating overall usability review and user suggestions. Based on these changes have been made that include the following.

  • Move from a checklist-style that has mainly yes/no or multi-choice answers to a narrative style that prompts descriptions and attachments of work performed to ensure that the auditor is documenting what they have done and why – designed to get the job done in a thorough but not over-the-top way.
  • Rather than including every detail of the requirements of the standards, complex and detailed points of the standards are summarised and deliberately made into plain English (we are assuming that the auditor has a good grasp of the standards, and will refer to the actual standards by hyperlink to XRB website if required).
  • ISA application material has been chosen so that the template focuses on requirements that are the most applicable to small entities.
  • Remove detailed compliance testing – templates assume a substantive-based approach, without reliance on systems testing.
  • Leave out detailed checklists for what is unlikely to apply to small entities, for example, internal auditors.
  • Make the process more transparent by bringing important work “to the top”, removing duplication and streamlining workflow.
  • Add hyperlink references to specific work performed in other parts of the workbook that is relevant to another section e.g. E1-1.2 of the Entity and Environment.

What auditing standards are not included?

  • ISA 600 – Special Considerations – Audits of Group Financial Statements (limited mention)
  • ISA 610 – Internal Auditor
  • ISA 701 – Communicating Key Audit Matters in the Independent Auditor’s Report (limited mention)
  • ISA 805  – Audits of Single Financial Statements and Specific Element, Account or Item of a Financial Statement 
  • ISA 800 – Reporting Considerations for Special Purpose Framework (no specific mention as the requirements are met by other standards)

New standards included in LCE templates

  • NZ AS1 – The Audit of Service Performance Information (although effective for periods beginning on or after 1 Jan 2021 we have included this content in the new Tier 3 and 4 PBE LCE templates)
  • ISA 540 – Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures (workpapers based on the substantially updated version are included)

Templates available

The following are available for use now, or will be released by the end of July 2020:

  • Audit – Special Purpose Reporting (LCEA-SP-2020)
  • Audit – NZICA SPFR for FPE (LCEA-NZSP-2020)
  • Audit – Tier 3 Charity (LCEA-T3-2020)
  • Audit – Tier 4 Charity (LCEA-T4-2020)

Review and feedback

As the LCE templates are new, we are welcoming feedback on the content. To create a job, go to the “new job” area and select the appropriate version. Note that jobs can be switched from existing templates, but we recommend that this is only done after the annual rollover to avoid loss of work.

We have created a dummy client (“Little and Quick Ltd”) to test the basic special-purpose version. We have been sharing this job with interested users to review. If you would like to have a copy please contact us and we can send through a PDF of the completed job, and/or attach the live job to your account. Happy flying!