Following an extensive consultation process the IAASB has issued the ISA for Less Complex Entities (ISA for LCE), a standalone auditing standard which contains all the necessary requirements to allow the auditor to obtain reasonable assurance that the financial statements of an LCE are free from material misstatements. 

Purpose and objectives of the ISA for LCE

The IAASB stated that the ISA for LCE was developed to provide a global solution to the concern about the length, complexity and understandability of the ISAs and their application to the audit of LCEs. Some of main objectives of the new standard are discussed below:

Proportionate and tailored 
While it is based on the principles and objectives set out in the main ISAs, the aim of the ISA for LCE is to provide a standard which is proportionate and tailored to the audit of smaller and less complex businesses. The IAASB has stated that the ISA for LCE has been designed to ensure that the audit procedures to be carried out are appropriate for the size and complexity of the entity under audit. The standard provides practical guidance to demonstrate how audit procedures can be applied in a less complex environment. 

Emphasis on a risk-based approach
The ISA for LCE continues to emphasise a risk-based approach. This ensures that an auditor working on smaller entities is still able to focus on the areas most at risk of material misstatement. Auditors are required to use their professional judgement when applying a relevant audit approach to the engagement. This focus on key risk areas allows for more targeted procedures and should also result in the audit being less burdensome on entities which lack the extensive resources of a larger company.

Audit documentation requirements
Due to the extensive documentation requirements which are set out in the main ISAs, another driver for the standard was the aim of reducing the administrative burden on auditors for LCEs while ensuring that sufficient appropriate audit evidence is still obtained on which to provide an opinion. 

When the ISA for LCE can be used 

Decisions about the required or permitted use of the ISA for LCE is determined by individual jurisdictions. The ISA for LCE should only be used once it has been formally adopted, and the scope of its use confirmed, by the relevant regulatory authorities or standard-setting authority.  

The standard does provide specific guidance on which engagements the ISA for LCE may or may not be applied: 

Regulatory requirements

Specific prohibitions
The standard sets out the entities and circumstances under which it can be applied with some clear prohibitions. The ISA for LCE cannot be used for the audit of:

• A listed entity
• An entity which has public interest characteristics, such as a financial institution or provider of insurance or
• A Group where any of the Group companies fall into to the two categories listed above or where component auditors are involved. The only exception here is when the component auditor’s involvement is limited to circumstances in which a physical presence is needed for a specific audit procedure for the Group audit, such as attending the inventory count (essentially where the involvement of a component auditor is limited to the performance of a specific audit procedure).

Qualitative characteristics 
The standard also sets out key qualitative characteristics which describe what is deemed to be an LCE on the basis that an entity not displaying these would not be a suitable candidate for the ISA for LCE to be applied. These characteristics cover a number of key aspects of the business and include:

• The industry, business activity and model – an LCE is likely to operate in an industry or with a business model which does not give rise to significant pervasive business risks and is not governed by specific laws or regulations which add complexity. The entity’s transactions are also likely to result from only a few revenue streams. As such, even a small entity operating in a highly regulated industry, such as financial services, would not satisfy the criteria for the ISA for LCE to be applied by the auditor. 
• Organisational size and structure – the entity’s structure should be straightforward with minimal reporting lines and a small, key management team. Therefore, an entity with a large management team or multiple individuals involved in managing different areas of the business is unlikely to meet this requirement. 
• Ownership structure – ownership should also be simplistic, and all owners are known and easily identified. Complex group or ownership structures would preclude an entity from being audited using the ISA for LCE.
• Nature of the finance function – the entity should have a centralised finance function and few employees involved in the financial reporting process (the standard suggests five individuals or fewer). Therefore, any entity with a very large or decentralised function where multiple teams are preparing financial information should not be audited using the ISA for LCE.
• Information technology (IT) – an LCE should have simple IT processes and is likely to use commercial, off-the-shelf IT software which has limited ability for changes and configurations. Access to the IT systems is also likely to be limited to one or two designated individuals. Therefore, entities which rely on complex IT systems, reports or sophisticated systems of internal controls would not qualify for the standard to be applied.
• Financial reporting framework and accounting estimates – the entity’s financial statements will require limited management judgement to be utilised when applying the requirements of the financial reporting framework. Therefore, where the entity has financial accounting estimates which rely on complex techniques, assumptions or data, the ISA for LCE should not be used.  

Quantitative thresholds
The ISA for LCE suggests that each relevant jurisdiction should also determine appropriate quantitative thresholds (such as revenue, assets or employee numbers) to help determine for which entities the ISA for LCE can be used.

Benefits of using the ISA for LCE

Simplification of audit and documentation requirements
One of the key benefits of applying the ISA for LCE is the simplification of the audit requirements by ensuring that such audits focus on the most relevant audit requirements. It also eliminates those requirements which are typically not applicable to less complex entities. For example, the ISA for LCE has more tailored requirements around understanding a company’s system of internal control. This is on the basis that such entities will have more simplistic and basic systems in place. Another example is amendments for auditing accounting estimates because companies for which the standard can be used are unlikely to have very complex accounting estimates which rely on detailed assumptions and complex models. 

Standard is scalable and proportionate
As mentioned previously, one of the key aims of the ISA for LCE is to provide a standard which is proportionate and tailored to the audit of smaller and less complex businesses. This angle of the standard should be beneficial for smaller entities, as it will allow the audit firm to tailor their audit approach based on the specific requirements of the client, rather than having to apply and meet the more stringent requirements of the ISAs. 

Efficiency and accessibility
The standard aims to make the audit process for LCEs more efficient and accessible through reducing the complexity of the audit process and the time required to complete the audit. This will make the process more efficient which should result in cost savings for both the audit firm and the audit client. This should also make the audit process more accessible to smaller audit firms and should allow firms or clients with access to fewer resources able to conduct or obtain a high-quality audit.  

Quality assurance and confidence in financial reporting
A focus of the standard was to reduce the burden of the audit process while still ensuring that audits are conducted to a high standard. This ensures that even smaller entities can receive reliable and thorough audits, the results of which can be used by businesses for investment or lending decisions. 

The standard has been designed to be implemented globally and incorporates the flexibility to ensure that local regulations can still be accommodated. This results in effective audit results irrespective of whether IFRS accounting standards or local accounting standards have been adopted by the entity. The aim of which is to ensure confidence in the financial reporting process applied by less complex entities. 

This article has been written by a member of the AAA Examining Team