05 September 2011

FEE Briefing Paper on proportionality and ISAs

FEE published the Briefing Paper to answer some common questions about the suitability of ISAs for SME audits and for use by SMPs. It demonstrates that clarified ISAs can be used to audit very small entities in a proportionate way.

The Briefing Paper argues that ISAs were not originally developed by the IAASB for use primarily in auditing large public interest entities, that the ‘clarified’ ISAs’ additional requirements and ISQC 1 are not more onerous for SMEs, and that SMEs and SMPs were involved in the development of the standards.

FEE’s response to the Green Paper, “FEE fully supports the adoption of ISAs for all statutory audits in the EU without further delay”, summarised FEE’s more detailed response to the Commission’s 2009 consultation on the adoption of ISAs. FEE explained their reasons for adopting ISAs for all statutory audits of all companies, including small companies for which an audit is required. The rationale for this response is repeated in the FEE Briefing Paper on European Passport for Auditors and Audit Firms of June 2011.

FEE also believes that the ISAs do provide a proportionate response to the needs of SMEs and SMPs. ISAs are designed by the IAASB to be usable for entities of all sizes, of all types, in all jurisdictions. Their application to audits of SMEs is clearly demonstrated in the 'IAASB Staff Questions & Answers on Applying ISAs Proportionally with the Size and Complexity of an Entity' of August 2009. The IAASB consulted publicly on their standards and includes in each standard a specific section 'Considerations specific to smaller entities'. This forms part of the application guidance and sets out specific ways in which the relevant standard might be applied to an SME. This can be both indicating a simpler approach or a particular challenge. For example, ISA 315 on risk assessment points out both that in a smaller entity the active involvement of an owner-manager may mitigate certain risks, for instance risks arising from a lack of segregation of duties in a small entity, but equally that it may increase other risks, for instance the risk of override of controls.

Whilst it is true that the new ‘clarified’ ISAs do include some additional requirements, it is unfair to assume that this will make all audits more time consuming and expensive to perform:

• Firstly, the majority of “new” requirements resulting from the clarity project are in more complicated areas, such as fair values, accounting estimates, the use of experts and audits of group financial statements. In many cases, these will simply not be relevant to SMEs. Where they are relevant, the additional complexity is normally driven by more complex accounting (for example, SMEs that choose to move to IFRS may have to fair value more things, which in turn will mean that auditors have to audit those fair values);

• Secondly, the new “clarified” standards make it clearer what is required and what is application guidance. In some cases, this will make it clearer that something does not need to be done in a particular circumstance, for instance in the considerations specific to smaller entities;

• Thirdly, in a small number of areas, additional work may be needed even on smaller audits. This should, however, help the auditor deliver increased value and insights about the audited entity to management and directors. For example, considering the appropriateness of the internal controls on the collection of debt gives those running a company an insight into the longer term sustainability of their business.

FEE considered all of these issues when responding to individual draft ISAs and to the EC consultation on adoption of ISAs.

FEE’s comment letters to the IAASB on the exposure draft of ISQC 1 and to the EC on the application of ISAs stated their belief that it was possible to apply ISQC 1 as drafted in a proportionate manner for SME audits and by SMPs. FEE is, however, aware of concerns from some SMPs that local regulators have not taken a proportionate approach and are expecting a degree of complexity disproportionate to the size and nature of their audit firm and their client base. In FEE´s comment letter on the IAASB’s strategy for 2012-2014, FEE has called on the IAASB to work on a project to demonstrate how a proportionate approach can be taken to establishing and documenting an appropriate quality control system, which local regulators could use.

Full paper

© FEE