Clarified ISAs –The times, they are a-changin’ 1

By Tarryn Wright, CA(SA)

Background
The Clarity Project at a
Following the various accounting scandals of the early glance:
2000s, international regulators became more focused
• 19 ISAs and ISQC1
on the audit of public companies and the quality of
have been redrafted
auditing standards. This led to the “Clarity Project” at an
• 16 ISAs have been
international level. both revised and
redrafted
For year ends on or after 15 December 2010, auditors
• Two new standards
will be required to comply with the Clarified International
have been issued,
Standards on Auditing (ISAs). While the term “clarified” ISA 265
has been used, to a degree this is misleading as the ‘Communicating
standards are not simply “clearer”, but are also more Deficiencies in
prescriptive with some new and many additional Internal Control to
requirements. Those Charged with
Governance and
All of the ISAs have been rewritten and each standard Management’ and
is now structured in a new way, with clear objectives, ISA450 ‘Evaluation of
definitions and requirements, together with application Misstatements
and other explanatory material. This structure makes it Indentified During the
easier for the auditor to understand what is required Audit’
and what is purely guidance. In addition revised • ISA540 ‘Audit of
Accounting
guidance on quality control procedures will also
Estimates’ and
become effective at the same time as the Clarified
ISA545 ‘Auditing Fair
ISAs. Value Measurements
and Disclosures’ have
Clarified ISAs
been combined in
ISA540 (revised and
The clarity project was a comprehensive program which
redrafted) ‘Auditing
the IAASB initiated with the following objectives:
Accounting
Estimates, Including
• Indentifying the auditor’s overall objectives when
Fair Value Accounting
conducting an audit in accordance with ISAs;
Estimates, and
• Setting an objective in each ISA and establishing Related Disclosures’
2

the auditor’s obligation in relation to that objective;

• Clarifying the obligations imposed on auditors by
the requirements of the ISAs and the language used to communicate such requirements;
• Eliminating any possible ambiguity about the requirements an auditor needs to fulfil; and
• Improving the overall readability and understandability of the ISAs through structural and
drafting improvements. 3
Each redrafted standard has the same new structure as follows:

• Introduction
• Objective
• Definitions
• Requirements
• Application
• Other explanatory material

The main areas of audit work that have been changed by the Clarified ISAs are set out below.

ISA 600 (revised and redrafted) The Audit of Group Financial Statements

The revised ISA covers a wider scope and sets out new requirements in respect of the
relationship between the group engagement team and the component auditors. It will affect
audit firms who are not the auditor for the entire group.

ISA 550 (revised and redrafted) Related Parties

The revised ISA has a number of new requirements that place a greater emphasis on a risk-
based approach to auditing related parties. It is now recognised that the risks of material
misstatement are higher when related parties are involved. Related party relationships and
transactions are to be considered explicitly in the team’s fraud discussion and an understanding
of controls relevant to related parties is to be obtained.

In addition, the revised standard requires that the auditor challenges management’s assertions
that transactions with related parties are on an arm’s length basis.

ISA 540 (revised and redrafted) Auditing Accounting Estimates, Including Fair Value
Accounting Estimates, and Related Disclosures

There are new requirements for the auditor to adopt a higher degree of professional skepticism
where accounting estimates, fair value estimates and related disclosures are concerned, with
emphasis on management bias.

This statement now contains new requirements in respect of:

• Specific matters for the auditor to gain an understanding of in order to assess risk
• Evaluation of estimation uncertainty and determining any significant risks
• Requirement to perform substantive procedures to respond to significant risks
ISA 265 Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management

This is a new ISA; designed to address the way in which auditors report control deficiencies to
those charged with governance. This is aimed at improving the quality of the communication to
management and those charged with governance and also, to focus attention on the definition
of a significant deficiency requires notification not only to management, but to those charged
with governance as well.

The auditors’ assessments must include consideration of the types of controls that they would
expect to be present at the audit client, taking into account size, complexity and nature. If
relevant controls are missing, their absence should be reported to the appropriate level of
management or to those charged with governance, even if they do not directly impact on the
planned audit procedures.

Two “letters of comment” or “management reports” may be appropriate to address findings that
may be dealt with by management and those findings which are required to be notified to those
charged with governance.

ISA 450 Evaluation of Misstatements Indentified During the Audit

This is a new standard that has been derived from the revisions to ISA 320 on audit materiality.
It requires the auditor to accumulate misstatements, reassess materiality and specific
documentation.

ISA 530 Audit Sampling (redrafted)

The risk-based auditing approach means that the auditors will plan their procedures using a risk
assessment, which is built on an understanding of the entity and the environment in which it
operates.

The point is emphasised that it is extremely rare for any deviation or misstatement identified in a
sample to be an anomaly and not representative of the whole population. Where the auditor
concludes that the misstatement is anomalous, then the standard requires that the auditor is to
obtain sufficient appropriate evidence to support this conclusion.

Significant difficulties

ISA 260 deals with two-way communication issues and the importance of effective two-way
communication between the auditors and management and/or those charged with governance.
When the auditor encounters significant difficulties during the course of an audit, the auditor is
required to notify the appropriate level of management or those charged with governance.
Should the auditor conclude that two-way communication has been inadequate, then the auditor
should consider their ability to accept reappointment.
ISA 570 Going Concern (redrafted)

While the standard has not been revised, the redrafting has given rise to a significant number of
elevations; in particular where events or conditions cast significant doubt on the entity’s ability to
continue as a going concern. Evidence concerning management’s assertion where they
conclude that the going concern assumption is appropriate for their particular circumstances
must be obtained. This includes evaluating management’s plans for future actions and
considered must be made by the auditor as to whether those plans are feasible.

APB Consultation on Clarified ISAs

Audit of small Audit of listed

and mid-sizes and large private
entities companies

Sample size 14 companies/ 13 companies

Charities
Average increase in recurring cost of the
audit of an individual entity 9.60% 1.90%

Average impact of ISA 600 on group audits 0.50% 3.00%

Total recurring costs for group audits 10.10% 4.90%

Average increase in ‘year one’ nonrecurring

costs 3.80% 0.10%

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Total year one cost 13.90% 5.00%

Impact on Auditors

While a similar study has not been performed in South Africa, the APB in the UK and Ireland
surveyed practitioners to identify what they believed the impact on auditors would be. This
survey could be equally applicable to South Africa, as the changes to the current auditing
standards are going to have an associated cost. The new standards in particular add a host of
additional requirements to what is already required from an audit and the auditor will need to
consider the impact of these costs on their clients, their fees and the economics of their
practices.
In addition, additional training is required, as are changes in the current audit methodologies
and audit tools. Supporting materials and manuals are going to have to be updated for each
revised and redrafted standard.

Fortunately, the auditor and the client, especially those in international group entities, will benefit
due to the enhanced quality and uniformity of audit practice worldwide. It is hoped that the
clarification will assist in the adoption of ISAs around the world, and facilitate international
convergence.

Conclusion

Audit costs are going to increase for the first time adoption of the Clarity ISAs, as the
requirements are more stringent. However, with sufficient planning, training and a good
understanding of the Clarified ISAs, audit firms can keep increases in fees to a minimum.

Sources:

1. Bob Dylan, 1964

2. Steve Collings, Accountancy Students, “The Clarified Auditing Standards”
3. IAASB Website, June 2009
4. APB consultation on whether UK and Irish auditing standards should be updated for the
new Clarified International Standards on Auditing, October 2008