Simplifying Auditing Standards for Small or Non-Complex Entities–Exploring Possible Solutions

May 18, 2018

Published: IFAC

By: Hilde Blomme

Confidence in small business benefits us all. The difficulties of applying the International Standards on Auditing (ISAs) in small or non-complex entity audits are apparent, and as such the status quo is not an option.

With our new publication, we aim to open the conversation to find an efficient way to deal with the small or non-complex entity audits.

Same standards for everyone?

SMEs, including small or non-complex entities, contribute more to the EU economy than large enterprises do, accounting for 66.6% of total employment and 56.8% of value added in the EU28 non-financial business sector.

However, audit regulators and standard setters focus on protecting capital markets. This has made the current ISAs too complex for smaller entities’ needs. An audit of financial statements (hereafter: audit) can instil required trust and confidence as auditors check if historical financial information is reliable.

Should auditing a company with less than 25 employees follow the same standards as a large company with thousands of employees? Smaller entities are major contributors to growth and therefore, regulators and standard setters must not overlook them when dealing with auditing standards.

Possible solutions

For solutions to be workable, they should be global, technology oriented, and ensure a consistent audit comfort and assurance level. In our publication, we explore the following options to overcome the difficulties of applying the ISAs in small or non-complex entity audits:

 1 – Build within the ISAs:This could be one, or a combination of, the following four streams: a) develop guidance to apply the ISAs to small or non-complex entities, b) revise the ISAs applying a ‘think small first’ approach, c) revise the ISAs to deal with complex language, and d) apply information technology to the ISAs.

 2- Develop a standalone standard:This standard could design an audit that achieves the same objectives as the current audit while tailoring it to smaller entities’ circumstances. Considering the difficulties faced when carrying out smaller entity audits, a standalone standard could adapt the current audit approach. It could make more use of professional judgement, moving away from an approach that is too focused on compliance and documentation of non-applicable requirements. A standard with clear and explicit principle-based requirements could also help avoid misunderstandings and unnecessary discussions with oversight authorities.

 

Next to these possible solutions, we identified two other routes that may be part of a solution, but do not fully respond to all issues at stake:

 1 – Include a direct engagement dimension to audit: Under the IAASB assurance framework, providing assurance within a direct engagement is possible, such as an engagement in which the practitioner directly measures or evaluates the underlying subject matter against the criteria.

 2 – It is possible to imagine an audit engagement where the auditor is involved in calculating the closing entries and the measurement of the final estimates. This would result in a combined engagement: a direct engagement on the final estimates and an assertion-based audit on the overall financial statements. While remaining responsible for the financial statements, the general manager will receive added-value from the auditor beyond the usual audit work on the financial statements.

 3 – Make full use of data analytics in audit: This would allow the auditor to use the entity’s data more easily. It could also pave the way for adopting more straightforward controls that could simplify the audit approach.

Experimenting is key

To identify the best solution, experimenting is key. A fruitful example of this is the Financial Reporting Council’s Audit and Assurance Lab, which explores the role of audit committee reporting in promoting audit quality. The IAASB has started setting up advisory panels, for instance on technology. But the mandate of such initiatives should not only be to advise, but also to work collaboratively and test new ideas in practice.

To discover different and potentially better ways of dealing with the audit of smaller entities, the IAASB would need to experiment with possible solutions and set up a safe space to innovate. One example would be to conduct audit pilots using new solutions like those suggested in our publication. Subsequently, practitioners should assess the outcome of these pilot projects. Representatives of audited entities, along with auditors, should also be part of this assessment.

Next steps

At our 30 May event, Accountancy Europe, the IAASB and other stakeholders will pursue the debate on the audit of small or non-complex entities and how auditing standards could help to better respond to the challenges faced. Join us at the event to provide your views on finding a solution on this strategic issue.

Audit is a valuable service to small or non-complex entities. Further research must be done to find a possible solution that serves these entities.

http://www.ifac.org/global-knowledge-gateway/audit-assurance/discussion/simplifying-auditing-standards-small-or-non

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