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Simplifying financial statements audit of less complex entities

Updated: May 17, 2023

SMALL and medium enterprises (SMEs) account for more than 90 percent of businesses globally. About 60 to 70 percent of jobs globally are from the SMEs and represent the majority of audits around the world.

Currently, the audits of financial statements in most of the jurisdictions across the world, whether for large, medium or small entities are governed by the International Standards on Auditing (ISA). ISA are professional standards for the performance of financial audits of financial information. These standards are issued by the International Federation of Accountants through the International Auditing and Assurance Standards Board (IAASB). The Philippines has also adopted the use of ISA and renamed it to Philippine Standards on Auditing.

Compliance with ISA seems to be disproportionate to the audits of SMEs due to the increasingly lengthy and complexity of the full requirements of ISA. It is also not scalable to the nature and existing conditions of the SMEs. This led to the call to have a separate auditing standard that will suit the audit of the financial statements of SMEs.

In response to this call, the IAASB issued the draft International Standards on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE). The IAASB did not use the term "SMEs" but instead adopted the term "less complex entities" (LCE). The IAASB is of the view that ISA for LCE should focus on the complexity of the entity rather than its size. Accordingly, ISA for LCE, by design, does not address complex matters or circumstances and is not permitted to be used for audits other than LCE. The proposed ISA for LCE has included specific prohibitions and qualitative characteristics that will make the ISA for LCE inappropriate for use in an audit of the financial statements of entities other than LCE.

The basis for the design of the draft ISA for LCE is a separate standalone standard for an audit of the financial statements of an LCE that:

– Is proportionate to the nature and circumstances that would be typical of an audit of a less complex entity;

– Is able to be used effectively and efficiently in audits of entities embodying common characteristics of being less complex to be able to obtain sufficient appropriate audit evidence to support reasonable assurance audit opinion; and

– Utilizes principle-based requirements using a risk-based approach to an audit so that it can be applied to entities with a wide range of circumstances that embody common characteristics of being less complex.

The draft ISA for LCE has not been designed to obtain sufficient appropriate audit evidence for complex matters or circumstances. Hence, limitations for the use of the draft standard are designated in two categories:

– Specific classes of entities for which the use of the draft standard is prohibited for audits of a listed entity; in a jurisdiction which prohibits the use of the draft standard; entities with public interest characteristics; and group audit.

– Qualitative characteristics that, if exhibited by an entity, preclude the use of the standard for the audit of the financial statements of that entity because they are indicators of, or proxies for, matters or circumstances for which the standard has not been designed.

Where an entity is not restricted by the limitations of the two above categories, the draft ISA for LCE is appropriate to use for an audit engagement.

For example, the use of draft ISA for LCE is appropriate for entities that have simple straightforward organizational structure, and their business services do not give rise to a pervasive risk of technological obsolescence, legal liability or reputational risk.

In designing the draft ISA for LCE, the IAASB took the approach of starting with all the requirements of the full suite of ISA, then removed those requirements typically expected of a complex operation and then what remained is the ISA for LCE. The following requirements for a full ISA are excluded from the requirements of ISA for LCE:

– Excluding areas specific to listed entities such as "segmental information" in gathering audit evidence and "Communicating Key Audit Matters in the Independent Auditor's Report";

– Excluding areas arising from complexities or structure of operations not typical of LCE, such as the requirements to perform procedures in accordance with using the work of internal auditors;

– Excluding the requirements in the audit of complex accounting estimates and related party disclosures;

– Excluding the requirements of group audits;

– Excluding the requirements for audit considerations relating to an entity using service organizations; and

– Excluding detailed requirements in relation to management amendments to the financial statements after the date of the auditor's report as this is expected to be rare for audits of LCE.

The auditor is required to determine that the audit engagement is an audit of LCE in order to use the draft standard when accepting or continuing an engagement. The auditor should also stay alert throughout the audit for further information that could come to the auditor's attention that may change the judgment as to the use of the draft standard.


Wilfredo A. Baltazar is the 2021 President of the Association of CPAs in Public Practice (ACPAPP).

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