Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Audit provisions for small entities: PASE explained

by
19th Mar 2012
Save content
Have you found this content useful? Use the button above to save it to your profile.

The way audits are conducted by firms of professional auditors has become more regulated over the years, with the overarching objective of this regulation being to ensure that audits are conducted, not only to the highest standards befitting a professional firm, but also in accordance with strict ethical guidelines, explains Steve Collings.

The Ethical Standards (ESs) issued by the Auditing Practices Board (APB) are compulsory for firms that undertake audit work for their clients. Specifically, the ESs outline matters such as:

  • How audit firms set policies and procedures to ensure that all those in the firm that carry out audit work do so with integrity, objectivity and independence
  • Financial, business, employment and personal relationships
  • Long association with the audit client
  • Fees, remuneration and evaluation policies, litigation, gifts and hospitality
  • Non-audit services provided to the audit client

It is worth mentioning that the ESs are as vital as the International Standards on Auditing (ISAs) themselves and must be fully understood and implemented within the firm.

Smaller audits

In the UK, many smaller clients fall into the audit regime, either by choice, or because they fail the audit test on either turnover or balance sheet total. When this happens, there are some areas of the ESs that, in practice, are difficult to apply insofar as auditing a small entity. As a consequence, the APB has given certain ‘dispensations’ so that a smaller audit can become cost effective. These ‘dispensations’ are covered in the Provisions Available for Small Entities (PASE).

The PASE was revised in December 2010 (as were all the other ESs) and audit firms need to ensure they are complying with the correct version. The revised PASE and other ESs are effective from 30 April 2011. So what exactly is ‘PASE’?

PASE is an ethical standard which outlines alternative provisions for audit firms that have small audits (the eligibility criteria is set out in the PASE at paragraph 4). The alternative provisions relate to threats arising from economic dependence and where the audit firm may also provide non-audit services to the audit client (e.g. tax/accounting services); it also covers the circumstances of advocacy threats and audit partners joining the audit client. PASE allows an auditor of a smaller audit client to take advantage of exemptions from certain requirements of the ESs 1 to 5 for a small audit.

The alternative provisions

Economic dependence

When an audit firm undertakes an audit for a small audit client, the requirement to comply with ES 4 paragraph 39 is not required. This particular section requires an external independent quality control review to be performed where it is expected that the total fees for both audit and non-audit work which are expected to be received by the audit firm from a non-listed audit entity (and its subsidiaries which are audited by the audit firm) will regularly exceed 10% of the annual fee income of the audit firm, or the part of the firm from which the audit engagement partner’s profit share is calculated, but will not exceed 15%. 

A point to note is that although an external independent quality control review is not required, the audit engagement partner must still disclose the expectation that fees will amount to between 10% and 15% of the firm’s annual fee income. The partner makes this disclosure to the firm’s ethics partner as well as to those charged with governance at the audit client.

Self-review threat – non-audit services

When doing a small audit, the audit firm need not apply safeguards to address a self-review threat, provided that:

  • The client has ‘informed management’; and
  • The audit firm extends the cyclical inspection of completed engagements that is performed for quality control purposes

The term ‘informed management’ means that the client is aware, and has a knowledge of, the financial statements and can make relevant judgements and decisions needed in relation to the presentation and disclosure of information in the financial statements.

Audit firms must ensure that where they adopt the use of the PASE that they extend the number of audits inspected under ISQC 1 (UK and Ireland) requirements and include a random selection of audit files where non-audit services have been provided. 

Management threat – non-audit services

Paragraph 14 of the PASE confirms that an audit firm auditing a small client is exempted from the requirements of ES 5, specifically:

  • Para 63(b) ‘internal audit services’
  • Para 73(b) ‘information technology services’
  • Para 97 ‘tax services’
  • Para 131(c) ‘corporate finance services’
  • Para 140(b) ‘transaction related services’
  • Para 145(a) ‘restructuring services’
  • Para 160 (b) ‘accounting services’

In circumstances when there is no ‘informed management’ provided that the audit firm discusses objectivity and independence issues related to the provision of non-audit services with those charged with governance. The audit firm must also obtain confirmation from the audit client that management accept responsibility for any decisions taken and discloses the fact that it has applied this standard in accordance with paragraph 24 of the PASE.

Advocacy threat – non-audit services

Paragraphs 104 and 145(b) prohibits an audit firm providing tax services to an audit client where providing such services would involve acting as an advocate for the client, before an appeals tribunal or court to resolve an issue that is material to the accounts, or where the outcome of a tax issue is dependent on a future or contemporary audit judgement. In addition, paragraph 145(b) also prohibits the audit firm undertaking an engagement to provide ‘restructuring services’ for an audit client where such an engagement would require the auditor to act as an advocate for the entity in relation to matters material to the financial statements.

When auditing a small audit client, paragraph 15 to the PASE does not require the audit firm to comply with paragraph 104 or 145(b) in ES 5 provided that it discloses the fact that it has taken advantage of this dispensation in accordance with paragraph 24 of the PASE.

Partners joining an audit client

ES 2 at paragraph 49 requires the audit firm to resign as auditors if a former partner is appointed as a director (including a non-executive director), or takes up the role of a key management position with the audit client, where the former partner has acted as audit engagement partner (or as an engagement quality control reviewer, key partner involved in the audit or a partner in the chain of command).  ES 2 provides a time lapse of two years prior to the former partner’s appointment at the audit client.

The PASE, at paragraph 20, states that an audit firm of a small client need not comply with such a provision provided that:

  • The audit firm takes appropriate steps to determine that there has been no significant threat to the audit team’s integrity, objectivity and independence; and
  • It discloses the fact that it has applied this standard in accordance with the provisions in paragraph 24 to the PASE

Disclosures

Within the main body of the auditor’s report (specifically under ‘Respective responsibilities of directors and auditor’), the audit firm is required to disclose the fact that the audit firm has taken advantage of certain exemptions within the PASE which are illustrated in the Appendix to the PASE, specifically:

‘..... Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland).  Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standard for Auditors, including “APB Ethical Standard – Provisions Available for Small Entities (Revised)”, in the circumstances set out in note X to the financial statements.’

Certain disclosures are also required in certain circumstances within the financial statements themselves which can also be found in the Appendix to the PASE, specifically:

  • Where the exemption relating to management threat in relation to non-audit services is provided
  • Where the exemption in relation to advocacy threats and tax services is applied
  • Where the exemption relating to partners joining an audit client is applied

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘The Interpretation and Application of International Standards on Auditing’ and ‘The AccountingWEB Guide to IFRS’). He is also the author of ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

Tags:

Replies (2)

Please login or register to join the discussion.

avatar
By deltaforceaccountant
20th Mar 2012 11:39

Am I right in thinking...

that the "PASE paragraph" referred to  in either the audit report or in the notes to the accounts is frequently incorrectly used by auditors, in that it is only required with reference to accounts and taxation work undertaken by auditors where there is no "informed management" and that to include the paragraph in a set of accounts implies the absence of "informed management".

Thanks (0)
collings
By Steven Collings
20th Mar 2012 13:43

Yes

Where an exemption has been taken advantage of in respect of paras 12, 15 or 20 with respect to a lack of informed management, the audit firm should make brief reference to the fact that the firm's compliance with Ethical Standards also include the PASE together with a general reference to the nature of the exemption in either the accounts themselves or in the auditor's report.

I think the link supplied in the article above takes you directly to the ES-PASE itself (the 2010 revised version) where you can find some suggested wording if this applies to you.

Regards

Steve

Thanks (0)