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LCE audits: a promising start with work to be done

Author: ICAEW Insights

Published: 19 Nov 2021

At a recent ICAEW event, the IAASB outlined its approach to a standard for less complex entities, and a panel discussed its implications.

Auditing standards have become significantly longer and more complex over the last 30 years. This is, in part, in response to globalisation and the increasing sophistication of auditing practices. 

This has meant an increase in audit complexity for smaller, less complex entities. The International Auditing and Assurance Standards Board (IAASB) and the standard-setters have tried to make standards scalable, with mixed results. 

Creating an auditing standard that relates equally to a complicated international entity and a smaller, owner-managed business is extremely difficult. So in June, the IAASB issued an exposure draft of a new audit standard for less complex entities (LCEs). Like the less complex accounting standards for smaller entities, the LCE auditing standard is based on a simplified risk-based approach. 

The IAASB is currently seeking views from auditors worldwide on their proposals, and are looking for ICAEW members’ views on what they think works and doesn't work in the exposure draft. A recent ICAEW event, chaired by Alex Peal, managing partner at James Cowper Kreston, outlined the progress so far, giving members the opportunity to ask questions about the standard. 

Tom Seidenstein, chair of the IAASB, spoke about the process of creating the draft standard. For example, the IAASB created an international reference group to get real-time feedback as the standard was developed to make it as workable as possible in the first instance.

Seidenstein emphasised the fact that the LCE audit standard isn’t a deregulatory effort. “We are not in the frame of mind to reduce quality or necessarily reduce the amount of work that goes into the audit. We want the audit of LCEs to reflect the right work for the nature and circumstances of the entity.” 

The team tried to determine the core procedures and requirements to drive reasonable assurance in the context of an LCE audit. “One of the areas where we spent quite a lot of time coming up with different alternatives was the big question: what is an LCE and who can use this standard?”

Seidenstein and his colleague Kai Morten Hagen were joined by Katherine Hardinge, compliance partner at Price Bailey; Mark Babington, executive director of regulatory standards at the Financial Reporting Council (FRC); and Rachel Davis, MD at Just Audit. This panel answered questions from the audience and discussed the implications of the standard. 

It is understandable that audit standards have become more complex, said Hardinge. The environment is more complex, and regulators have to respond when large and public corporate failures occur. 

“The problem is that actually for your privately owned companies or less complex entities, it's very difficult to scale the standards back because the standards include a large number of requirements.”

The IAASB had done a good job in creating the standard, but felt it didn't go far enough, she said. “I think that there are still requirements in the standard which aren't necessarily going to add anything to the quality of an audit of less complex entities.”

Babington highlighted the differences in the UK compared to other jurisdictions. “We have the audit exemption threshold that takes out around 85% of entities from actually needing an audit.”

Davis agreed with that sentiment, but highlighted that a lot of small businesses still have audits in the UK. “Two thirds of my client base are actually small clients…There are a few volunteers but most of them are required because of the size of the group. Most of my clients are Section 1A. Therefore, there is a significant need for the standard.”

The panel discussed what the standard might mean for charities. Hardinge says that there is a huge amount of value to be taken from an audit. “We've got some clients who still decide to have a voluntary audit because all their funders require it. 

Raising the audit threshold is not the answer to solving the issue with LCEs for that reason, she said. “Audits are valuable and they do make a huge difference and these companies are important to the economy.”

One of the big questions around the LCE audit, said Babington, was whether it would be determined to have a lower threshold than an ISA audit. “I believe that actually, the gold standard that the ISAs provide is one that we should be proud of and one that we should defend. And one of the things that I don't really want to see is a two tier market.” 

The FRC is working to address the need to expand the number of firms that are able to participate throughout the audit market, rather than one part of it. “I believe that the ISAs are a way of doing that. I believe that they can be applied proportionately and deliver really high quality work.” 

Morten Hagen recognised that more work is needed to get the standard ready. “There's more we need to do, especially around accounting estimates; how do you describe what is complex or not? There might be different views from different practitioners. But getting the feedback through the consultation on what exactly is needed…is very helpful.”

The IAASB are seeking feedback on:

  • the content, flow and structure of the standard
  • The authority and scope of the standard
  • Exclusion of procedures for audits of group financial statements
  • Transition and implementation guidance
  • Maintenance of the standard

They are asking for feedback on the proposals by 31 January 2022. To find out more about the proposals, watch the on-demand recording here.

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