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The proposed new standard for audits of less complex entities is not perfect, but it is progress – and it is needed as there are fewer firms performing small audits.

Audits of less complex entities (LCEs) matter – and so does the international standard for their audit that is being proposed by the International Auditing and Assurance Standards Board (IAASB). The public consultation on this draft new standard (see box) closed on 31 January 2022, so while the IAASB considers the responses, let’s consider the case for why such a standard is needed.

Crisis management

The smaller audit market is facing a long, drawn-out crisis. As the number of firms available to perform small audits is slowly shrinking, small and medium-sized entities, smaller charities and other types of organisation are at risk of losing access in their local communities to high-quality audit services, despite a real need for those services. Some high-street firms are finding it increasingly difficult to justify remaining in the audit market. One of the reasons for this is the increasing complexity of an audit.

The IAASB now has an opportunity to change all that. Its Exposure Draft of a standard for LCE audits provides some much-needed clarity and international leadership regarding such audits, removing them from an increasingly complex web of auditing standards that are difficult to apply to LCEs because they are primarily designed for larger entities.

A solid framework

The proposed standard has significant shortcomings, but it still provides a solid framework for how to undertake an LCE audit and a promising basis for further development. Its current flaws are fixable and are being addressed through responses from a wide range of stakeholders, including ICAEW.

Katharine Bagshaw, Senior Manager, Auditing Standards, says: “There’s been unprecedented interest in this proposed standard from many stakeholders who rarely express an interest in auditing standards. That alone demonstrates the need for a better standard for LCE audits – not just more guidance – and while there’s a long way to go, the IAASB has made a start. That matters.”

Clear and compelling need

There are many reasons why LCEs need access to high-quality audit services in jurisdictions such as the UK, with high audit exemption limits.

Many audits are performed on companies that would be exempt were it not for the fact that they are parts of larger groups. Credit rating agencies and providers of finance look for assurance on the information provided by smaller businesses. In the third sector, where audit exemption levels are lower, many organisations are required to have an audit under their constitutions or for other reasons. There is a clear need for auditing standards specifically designed for these LCEs.

“The availability of audit services to LCEs depends on the willingness of practitioners to provide such services,” says the ICAEW response to the IAASB consultation. “This, in turn, depends on the availability of efficient and effective auditing standards.”

The ICAEW response points to the recently revised International Standards on Auditing (ISA) on risk assessment (ISA 315) and on the audit of accounting estimates (ISA 540) as being the latest in a long line of standards that are difficult to apply to LCE audits – standards many see as compelling reasons for a new, separate auditing standard.

While many firms are enthusiastic about the idea of a separate standard for LCE audits, others are less sure and they are concerned about the potential need to develop and maintain two audit systems. The case for the new standard could and should be made more clearly and convincingly, and the IAASB has a role in doing that.

ICAEW’s Director of Policy, John Boulton, says: “On balance, ICAEW believes this standard is a real opportunity to make it easier to understand auditing standards in an SME environment – principally, by removing redundancy designed for more complex environments.”

The global public interest

A standard for LCE audits should also make it more efficient to audit LCEs. “We face a looming crisis of LCE audit availability and this is an achievable and potentially effective way of heading that off,” says Boulton. “It’s in the public interest that we do what we can to support the market for smaller audits. It’s time for the standard-setters to step up and exercise global leadership.”

ICAEW’s Managing Director of Reputation and Influence, Iain Wright, says: “The audit product provides assurance for third parties such as credit agencies and providers of finance. Without such assurance, less complex entities may find the opportunities to grow and innovate choked off.”

Wright adds: “It’s in the interests of the entire global economic ecosystem, in the context of a post-pandemic push for recovery, that a suitable and relevant standard be made available as soon as possible, to facilitate both audits and opportunities for growth.”

LCE auditing standard: past, present and perhaps

The audit profession has seen both the length and complexity of International Standards on Auditing (ISAs) grow over the past 30 years. This reflects globalisation, increasing sophistication in auditing practices, and massive growth in the complexity of larger entities and global groups. But for smaller LCEs, the increasing length and complexity of the ISAs have brought disproportionate increases in audit work and bureaucracy.

There is no magic bullet solution – and various approaches have been tried. Standard-setters have attempted to make ISAs more scalable and some countries have developed their own LCE auditing standards. Both approaches faced mixed receptions, as did the notion of rewriting existing ISAs to address the needs of both LCEs and large listed entities. The IAASB’s draft standard seeks to respond to these issues, is proportionate to the typical nature and circumstance of an LCE audit, and it offers a global solution.

The next steps

The LCE standard is not universally popular with stakeholders, nor are the ISAs. Work is needed on the new LCE standard to make it fit for purpose and to get regulators on board, as in some jurisdictions they are not keen to adopt it. But ICAEW is urging the IAASB to move forward and finalise the LCE standard as soon as possible, to permit jurisdictions most in need of it to adopt it immediately and to prevent the fragmentation of the IAASB’s hard-won global consensus on auditing standards.

ICAEW looks forward to the finalisation of the standard. This will enable the IAASB to refocus some of its efforts on the audit of entities listed on the world’s capital markets and it will allow LCE auditors and others to work with the new standard to refine and improve it. ICAEW’s response to the IAASB consultation on its draft LCE audit standard is available on the ICAEW website.

Support resources

Adopting this new standard for LCE audits could have a significant impact on many auditors and the work they do across many jurisdictions. LCEs play a critical role in the global economy and represent the majority of audits around the world and in the UK. There is a lot to think about.

To learn more about the proposed new LCE standard and related considerations and implications for auditors, explore some of the articles, webinars and other related resources available from ICAEW and the IAASB.

For insights into the IAASB’s development of the new LCE standard and implications for auditors, watch a recording of ICAEW’s hybrid panel event. Tom Seidenstein, IAASB Chair, discusses proposals for the LCE standard, its background and its development, with a panel of auditors and representatives from the UK’s Financial Reporting Council and the IAASB’s LCE Taskforce.

Additional perspectives from auditors on the proposed LCE standard and associated implications are available in a faculty podcast. 

Stay up to date with progress on the LCE standard for ICAEW news and insights.

Access IAASB resources on the LCE standard, including the Exposure Draft, webinars and other related materials.

Audit & Beyond

This article was first featured in the April 2022 edition of Audit & Beyond.

Audit & Assurance April 2022 cover