South Africa has adopted the International Standards on Auditing (ISAs) published by the International Auditing and Assurance Standards Board (IAASB) which consist of 36 standards each with a number of requirements. These requirements all contain the words “the auditor shall…”, indicating that the auditor has no choice but to apply the requirements to each audit conducted in terms of the ISAs, irrespective of the size and complexity of the entity.
Although the ISAs are designed to be applied to a wide variety of entities with differing circumstances and complexities, they are continually revised to address the operating and reporting environment that is becoming more and more complex. These revisions are also undertaken to address the recent high profile corporate failures, which are more commonly associated with complex entities. However, it is estimated that more than 90% of the entities across the world are small and medium-sized entities (SMEs).
The frustration therefore comes from the requirement for auditors to apply the ISAs that are designed to address the complex circumstances found in large entities to the 90% of entities that are classified as SMEs.
In response to this frustration various jurisdictions have undertaken initiatives targeted at audits of less complex entities, leading to an increase in fragmentation in standards applied for a large section of the audit market. Since 2017 the IAASB has been investigating a solution to this and from July 2020 they focused efforts on the development of a separate standard for use in the audits of less complex entities (LCE). The proposed standard was issued for public comment on 23 July 2021 with comments due to the IAASB by 31 January 2022.
Authority of the proposed standard
As the name of the proposed standard suggests, it is intended to be applicable to audits of financial statements of less complex entities (LCE). The IAASB steered away from the size of an entity being a deciding factor on whether this proposed standard can be applied or not. Smaller does not always equate to less complex and thus the complexity, rather than the size should be considered.
Less complex entities are also not defined in the proposed standard. The IAASB rather approached the scope and applicability thereof by indicating for which entities it is not intended, as opposed to for which entities it is.
The specific classes of entities for which the proposed standard is prohibited will include:
- Where law or regulation specifically prohibits the use of the proposed standard; or specifies the use of auditing standards other than the proposed standard for an audit of the financial statements.
- Listed entities.
- Entities other than listed entities with public interest characteristics, such as insurance brokers, banks, pension funds, etc.
- Where the audit is an audit of group financial statements.
The IAASB refrained from setting any quantitative or other exemption thresholds or more specific criteria to scope the proposed standard as it would not be practicable for them to define the thresholds that would be capable of consistent global application. However, they do recognise that each jurisdiction could set such thresholds for consideration. For application in South Africa, the Independent Regulatory Board for Auditors is likely to determine the thresholds to be applied.
The IAASB has included qualitative characteristics to be applied in determining whether the proposed standard can be applied. The proposed standard cannot be applied if the entity exhibits the following:
- 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 the presence of, complexity, such as those relating to ownership, corporate governance arrangements, policies, procedures or processes established by the entity.
Professional judgement will thus have to be applied to determine whether the proposed standard can be applied to a specific audit engagement.
Key principles used in developing the proposed standard
The intended outcome of an audit performed using the proposed standard is consistent with that of an audit in terms of the ISAs – an audit opinion resulting from a quality audit engagement that would enhance the credibility of the financial statements.
To achieve the consistent outcome, many of the basic concepts used in the ISAs to support a risk-based approach have also been incorporated in the proposed standard, including
- The use of objectives to focus the auditor on understanding what needs to be accomplished and deciding whether more work is required to achieve the stated objective.
- Using the core ISA requirements and concepts such as professional scepticism and professional judgement as a base for establishing the work effort to be performed.
- The need to obtain sufficient, appropriate audit evidence to support the audit opinion.
- The use of materiality to focus the auditor’s efforts and to evaluate misstatements.
- Using the audit risk model (inherent risk, control risk and detection risk).
In developing the proposed standard, it was considered which ISAs in its entirety will not be applicable to LCE. These ISAs, including those specific to listed entities and group audits, were omitted from the proposed standard in its entirety.
For all other ISAs, each requirement thereof was considered and incorporated into the proposed standard as follows:
- The requirements have been included “as is”.
- The wording of the requirements has been modified or adapted to the nature and circumstances of the audit of an LCE. Such requirements are expected to deliver a similar outcome as the ISA requirement in the context of an audit of an LCE.
- Specific requirements within an ISA have been omitted. These include requirements that address matters that would relate to entities specifically excluded from the scope of the proposed standard or matters that are complex.
The proposed standard is thus just a shortened, more understandable and succinct version of the ISAs that are specifically applicable to LCEs.
Timeline
The proposed standard is out for public comment until 31 January 2022 and the IAASB expects the final standard to be approved in December 2022. The IAASB expects that there will be a period of at least 18 months between the date of final issue of the standard and the effective date of the standard. It can therefore be expected that the standard will only become effective soonest June 2024. Until then, an audit is an audit is an audit.
For more information on this, please contact your local Moore firm.