Audits of less complex entities at a turning point : Input needed
In September 2021, the AASB issued a Discussion Paper: Exploring Standard-Setting Options for Audits of Less Complex Entities. The discussion paper was issued to gather views on how best to address the challenges practitioners' experience in audits of less complex entities (LCE).
One of the key decisions the board will need to make is whether to pursue a separate standard for audits of LCE modelled after the International Auditing and Assurance Standards Board (IAASB)’s Exposure Draft: Proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ED-ISA for LCE).
The discussion paper is a significant development that will shape the future of LCE audits for many years to come. We need your input!
In this blog, I'll discuss:
- why change is needed
- how the AASB is addressing the need for change
- a potential international solution
- how you can express your views
Why change is needed
Small and micro-entities represent a significant part of business in Canada. Where these entities are less complex, the practitioners' ability to apply Canadian Auditing Standards (CAS) to such entities in a scalable and proportional way is critical to performing high-quality, cost-effective audits.
CAS, adopted from the International Standards on Auditing (ISA) set by the IAASB, are designed to be applied for audits of all entities, regardless of size or complexity. However, the complex and continually evolving operating and reporting environment have contributed to the challenges practitioners face when auditing LCE in accordance with CAS.
Over the last few years, I have led the board's project to understand the challenges practitioners face when auditing LCE in accordance with CAS. I have spoken to practitioners, practice reviewers, practice advisors, developers of audit tools and methodologies, and regulators. They told me:
- The CAS have become complex, lengthy, overly detailed and challenging to navigate.
- The CAS are not explicit enough about when requirements are scalable or proportionate for an entity's less-complex elements.
- Specific requirements in CAS are challenging to apply in LCE audits.
- CAS are unclear on the required documentation when specific audit procedures have not been performed because they are ineffective or do not apply.
For these reasons, practitioners may:
- not consistently apply CAS in LCE audits, which may affect the performance of high-quality audits
- spend unnecessary time and effort performing procedures that may be ineffective or create redundant documentation, which may affect the performance of cost-effective audits
- if conducting audits is not cost-effective, it will become a barrier to engaging auditors
How the AASB is addressing the need for change
The AASB is looking for a solution to help auditors of LCE undertake consistent, effective, and high-quality audits. Unfortunately, there is no simple solution. Your input is critical in informing the AASB on its future course of action. The AASB issued the discussion paper to exchange ideas and encourage you to share your thoughts and views on possible options the AASB should explore.
The discussion paper sets out three possible options for you to consider:
- Option 1: Separate standard for audits of LCE. For example, the AASB could adopt ED-ISA for LCE when issued as final or use it as a basis for developing an equivalent Canadian standard.
- Option 2: Limited, targeted revisions to CAS to support the need for scalability and proportionality. For example, where practitioners experience significant challenges in applying a requirement in a CAS to an entity's less-complex element(s), the AASB could revise the CAS to deal with the challenges. The revision may take the form of application and other explanatory material focused on describing considerations specific to LCE.
- Option 3: Targeted non-authoritative guidance focused on the LCE. For example, the AASB could develop, or support other groups in developing guidance and tools for new or revised CAS focused on LCE, or address challenges specific to LCE. Such guidance would not be part of the CAS and would not impose additional requirements on practitioners.
Some of the possible options will be quicker to progress, while others will take longer, and you may identify other options not in the discussion paper. Your input on the possible options will help the AASB develop a clear direction on what action(s) are needed.
A potential international solution
The IAASB has heard the call for action, not only from Canada but from many of the 130 jurisdictions who also adopt ISA. The IAASB’s response has been to develop ED-ISA for LCE as a global solution to addressing the concerns that the ISAs are too complex and challenging to apply to LCE audits.
The key foundational concepts on which the ED-ISA for LCE is designed are as follows:
- It is developed as a separate standalone and "self-contained" standard, designed to be proportionate to the typical nature and circumstances of an LCE. Therefore, it does not refer to the ISA for requirements not contemplated in the standard.
- It is based on ISA (and CAS) core requirements relevant to LCE audits needed for a reasonable assurance opinion.
- It only contains those requirements relevant to LCE audits. So, if the entity has complex elements, the ED-ISA for LCE cannot be used. That is, a practitioner cannot go to the ISA (or CAS) and "cherry-pick" from the requirements to audit the entity's complex elements.
- It does not include application and other explanatory material like in ISA (and CAS). Instead it contains minimal guidance called "essential explanatory material," where considered crucial to implement selected concepts and requirements.
An important objective in developing ED-ISA for LCE is explaining when it can be used (i.e., the scope). If ED-ISA for LCE is used for engagements for which it has not been designed, the auditor will not be able to obtain sufficient appropriate evidence to support a reasonable assurance opinion.
The IAASB struggled with the definition of an LCE. So, it decided to explain the scope of ED-ISA for LCE through:
- specifically prohibiting the use of ED-ISA for LCE for audits of:
- listed entities
- group financial statements
- entities with public interest characteristics
- entities in a jurisdiction that does not want to adopt ED-ISA for LCE or specifies use of other standards instead
- describing qualitative characteristics of complex matters or circumstances that, if exhibited by an entity, precludes the use of ED-ISA for LCE
- for example, ED-ISA for LCE is inappropriate for auditing an entity with complex accounting estimates
- providing local jurisdictions with an option to set further prohibitions
- for example, for entities that exceed a certain revenue threshold
Additionally, in setting policies or procedures for using ED-ISA for LCE, audit firms may further restrict ED-ISA for LCE for specific clients. Further, for each engagement, the auditor would need to determine whether ED-ISA for LCE standard is appropriate for use initially and during the audit considering the qualitative characteristics.
We need to hear what Canadians think as decision time nears
I believe that we are at a turning point in audits of LCE. The action the AASB takes may have significant implications for the audit profession.
The AASB has a big decision ahead about which possible option(s) to pursue, including which option to pursue as a priority. For the AASB to reach the right decision, it needs to be fully informed by hearing from as many stakeholders as possible, including practitioners, users of audited financial statements, practice advisors, audit inspectors, academics, and those who develop and use firm methodologies.
On the possible options, for example, the AASB wants to know:
- Do you think that Option 1 (a separate standard for LCE audits for use in Canada) is the appropriate solution? If so, do you support the adoption of ED-ISA for LCE?
- Do you think that Option 2 (making limited, targeted revisions to CAS) is the appropriate solution? If so, what revisions to CAS do you suggest to address the significant challenges you believe exist in applying CAS to LCE?
- Do you think that Option 3 (developing targeted non-authoritative guidance) is the appropriate solution? If so, for which areas or specific requirements in the CAS would it be most helpful?
Also, the AASB wants to know your views about ED-ISA for LCE. Whether or not it will adopt ED-ISA for LCE in Canada will depend on whether such a proposed standard will serve Canadians' needs. For example, the AASB wants to know:
- Would you use ED-ISA for LCE on your LCE audits?
- Do you think the AASB should specify the types of entities or industries in Canada that auditors should be allowed to use or prohibited from using ED-ISA for LCE? If so, which ones?
- Do users think that an audit performed using ED-ISA for LCE is a lower level of assurance than an audit conducted using CAS?
- Do you think an audit performed under ED-ISA for LCE is different from an audit performed under CAS? If so, how? Do you anticipate specific efficiencies or benefits from using ED-ISA for LCE?
Comments are due December 10, 2021. The AASB will identify the best option to move forward in Canada based on the feedback received.
How you can express your views
- Write a letter to the AASB. Look for the link to submit your comment letter in the discussion paper.
- Attend a virtual roundtable discussion, which is running November 15-24, 2021:
Keep the conversation going
We need to hear from you by December 10, 2021, so please read the discussion paper and get back to us! If you cannot submit a comment letter or attend a roundtable discussion, email me to set an alternative way to obtain your input.
Stay tuned by following the project page.
Disclaimer
The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.