Proposed International Standard on Auditing for Audits of ...

1 International Standard on Auditing Proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE) Exposure Draft July 2021 Comments due: January 31, 2022 Page 2 of 170 About the IAASB This Exposure Draft was developed and approved by the International Auditing and Assurance Standards Board (IAASB). The objective of the IAASB is to serve the public interest by setting high-quality Auditing , assurance, and other related standards and by facilitating the convergence of International and national Auditing and assurance standards, thereby enhancing the quality and consistency of practice throughout the world and strengthening public confidence in the global Auditing and assurance profession. The IAASB develops Auditing and assurance standards and guidance for use by all professional accountants under a shared Standard -setting process involving the Public Interest Oversight Board, which oversees the activities of the IAASB, and the IAASB Consultative Advisory Group, which provides public interest input into the development of the standards and guidance.

2 The structures and processes that support the operations of the IAASB are facilitated by the International Federation of Accountants (IFAC). For copyright, trademark, and permissions information, please see page 169. 3 REQUEST FOR COMMENTS This Exposure Draft, Proposed ISA for LCE, Proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities, was developed and approved by the International Auditing and Assurance Standards Board (IAASB ). The proposals in this Exposure Draft may be modified in light of comments received before being issued in final form. Comments are requested by January 31, 2022. Respondents are asked to submit their comments electronically through the IAASB website, using the Submit a Comment link. Please submit comments in both a PDF and Word file. First-time users must register to use this feature. All comments will be considered a matter of public record and will ultimately be posted on the website.

3 This publication may be downloaded from the IAASB website: The approved text is published in the English language. Page 4 of 170 EXPLANATORY MEMORANDUM CONTENTS Page Executive Summary .. 5 Section 1 background .. 6 Section 2 Introduction .. 11 Section 3 Guide for Respondents .. 13 Section 4 The Proposed Standard and Specific Matters for Comment .. 14 Section 4A Overarching Positioning of ED-ISA for LCE .. 14 Section 4B Authority of the Standard .. 17 Section 4C Key Principles Used in Developing ED-ISA for LCE .. 23 Section 4D Overall Design and Structure of ED-ISA for LCE .. 27 Section 4E Content of ED-ISA for LCE .. 30 Section 4F Other Matters .. 38 Section 4G - Approach to Consultation and Finalization .. 42 Section 5 Group Audits .. 44 Appendix 1 Summary of Relevant Local Initiatives .. 50 Appendix 2 Request for Comments: Summary of Questions .. 52 Exposure Draft Proposed International Standard on Auditing for Auditis of Financial Statements of Less Complex Entities.

4 56 Conforming Amendments to the Preface to the International Quality Control, Auditing , Review, Other Assurance, and Related Services Pronouncements .. 166 Proposed International Standard ON Auditing FOR Audits OF FINANCIAL STATEMENTS OF LESS COMPLEX ENTITIES Page 5 of 170 Executive Summary Smaller, less complex entities (LCEs) make a critical contribution to the world economy and account for the great majority of Audits globally. At the same time increasingly complex structures and transactions need to be addressed through the development and revision of the International Standards on Auditing (ISAs). The IAASB recognizes that reflecting this complexity in the ISAs could pose challenges for Audits of less complex entities. Based on the feedback from the IAASB s 2019 Discussion paper , Audits of Less Complex Entities: Exploring Options to Address the Challenges in Applying the ISAs and other input from outreach, the IAASB committed to addressing complexity, understandability, scalability and proportionality in the ISAs, and the specific needs of LCEs and the users of their financial statements, and agreed that: A global solution is preferred to increasingly fragmented solutions.

5 A Standard that has been designed to be proportionate to the typical nature and circumstance of an audit of an LCE would be responsive to those stakeholders who have identified challenges with applying the ISAs in Audits of LCEs. There is an urgent need for action. For this reason, the IAASB developed the Exposure Draft of Proposed International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ED-ISA for LCE) on an accelerated basis. The IAASB approved ED-ISA for LCE in June 2021. This explanatory memorandum (EM) provides background to, and an explanation of, ED-ISA for LCE. This EM sets out the background to the development of the Proposed Standard , the Board s direction on the scoping of the Proposed Standard (in the Authority of the Proposed Standard ), the broad principles used to develop a new Standard that provides reasonable assurance and an explanation of the content of the Standard , which is presented in Parts and follows the flow of an audit.

6 The Board s consideration of issues, deliberations and position with respect to key areas in developing the Proposed Standard are addressed in Sections 4 and 5, with specific questions to respondents included at the end of each of sections 4A through 4G, and at the end of section 5 in relation to Group Audits . Appendix 2 includes a full list of all questions for respondents to ED-ISA for LCE. EXPLANATORY MEMORANDUM TO ED-ISA FOR LCE Page 6 of 170 Section 1 background background to the Development of a Separate Standard 1. It is estimated that more than 90% of entities across the world are small and medium-sized entities (SME),1 with some regions estimating that the percentage could be higher,2 such as in the European Union where it is estimated that over 99% of entities are 2. Audits are undertaken for a variety of reasons. Some jurisdictions mandate an audit through law or regulation ( , a statutory audit), which may be done for example by setting audit exemption thresholds (often on a size characteristic) to limit those entities to which statutory audit requirements apply, with changes to these thresholds regularly being ,5 Even when there is not a statutory requirement for an audit, many SMEs are either required to have an audit for another reason or may choose to have an audit for management purposes.

7 3. At present, approximately 130 jurisdictions6 have adopted or partially adopted the International Standards on Auditing (ISAs). The ISAs are designed to be applied to a wide variety of entities with differing circumstances and sizes, ranging from those whose nature and circumstances are simpler and more straightforward ( , LCEs), to those entities whose nature and circumstances are more complex (for example, entities with more complex structures, more complex information systems or controls, or more complex transactions). 1 There is no global definition for a small- or medium-sized entity, and the use and meaning of the term may differ in different jurisdictions. As the discussions about the challenges of applying the ISAs has historically been around the difficulties experienced in SMEs, this term is used in the introduction to the project to explain the background to the project. However, the IAASB is of the view that it is appropriate to focus on the complexity of the entity rather than its size, and therefore uses the term less complex entities (LCE).

8 2 Reference: Edinburgh Group: Growing the global economy through SMEs & World Trade Report 2016: Levelling the trading field for SMEs ( ) 3 Reference: Europa: Statistics on Small and Medium Enterprises 4 For example, in Europe, member states can impose an exemption for audit for entities that are not public interest entities, medium or large entities (and the thresholds for exemption vary across the various member states). In India, there is a statutory requirement for all public and private limited companies to have an audit under their Companies Act annually. In Canada, business corporations that are privately owned are exempted from an audit if all shareholders consent in writing to the exemption in respect of that year. In Australia, there is a size threshold that exempts certain entities from a mandatory audit. In New Zealand, companies with under 10 shareholders may opt out of an audit if they meet other size and regulatory provisions.

9 In the US private companies (with some limited exceptions) are not subject to a statutory audit. 5 In 2010 in Sweden, the regulatory requirement for an audit was abolished for small limited liability companies. However, in 2017, the Swedish National Audit Office published a report, Abolition of audit obligation of small limited companies a reform where costs outweigh the benefits, where it cites numerous downsides to abolishing the SME audit obligation. 6 Reference: Global Impact Map | IFAC EXPLANATORY MEMORANDUM TO ED-ISA FOR LCE Page 7 of 170 4. The IAASB has always been mindful of the need for the ISAs to be scalable in order to be used for Audits of all entities, regardless of size or complexity. However, the operating and reporting environment is becoming more complex and is continually evolving. In addition, there has been a spotlight on the quality of Audits through the results of audit inspections and recent high profile corporate failures, more commonly associated with more complex entities.

10 This has contributed to the recent revision of ISAs such as ISA 540 (Revised)7 and ISA 315 (Revised 2019),8 as well as revisions to the IAASB s quality control standards, ISQM 19 and ISA 220 (Revised)10, and the development of new ISQM 2,11 These revisions had the objective of making the International Standards more relevant in the evolving environment, and are intended to support the consistent performance of quality Audits . However, with these revisions there has been growing concern about the length, complexity, and understandability of these Standard and their application to Audits of LCEs. Some stakeholders have therefore questioned whether the ISAs remain relevant and can be applied in a cost-effective manner to all Audits . 5. In response to these and other similar concerns, various jurisdictions or regions have undertaken initiatives targeted at Audits of less complex (or smaller) Furthermore, some jurisdictions have announced the intention to develop a Standard (s) or solutions for Audits of LCEs within their jurisdictions, or have already developed a pronouncement.