Limited assurance standards: does one size fit all?
The market for limited assurance engagments is segmented and it may be appropriate to segment standards in light of this.
At the beginning of the year the International Auditing and Assurance Board released an exposure draft – Proposed International Standard on Review Engagements: ISRE 2400 (Revised) Engagements to Review Historical Financial Statements.
This exposure draft has been welcomed by the New Zealand accounting profession in light of the recent proposals by the New Zealand Ministry of Economic Development (MED) encouraging the provision of limited assurance or review engagements as alternatives to audits, in particular in relation to the assurance of registered charities’ financial information.
The MED’s proposals tend to favour review engagements as a means of providing a moderate or limited level of assurance on the reliability of charities’ financial information, as distinct from full audits that provide a higher or reasonable level of assurance.
In New Zealand the review engagement has been seen as an alternative to an audit ever since the Companies Act 1993 increased the scope for reviews of financial statements by allowing shareholders of non-issuer companies to elect not to appoint an auditor.
However, it appears that the demand for review engagements mostly comes from entities (such as charities, clubs and societies) that have historically had no mandatory requirements for an audit under any applicable law, but where such entities’ members or constitution stipulate a need for some level of assurance. Funding providers and government agencies also often require some level of independent assurance as a requirement for a grant or as a component in a lending contract.
In 2010, we completed a study to ascertain the extent of the supply of limited assurance engagements by chartered accounting firms in New Zealand, comprising the Big 4 firms and Audit New Zealand (referred to in this article as the “Big 5”) and small/medium firms (referred to as the “Non-Big 5”). An electronic survey was sent to each of the 1,685 Non-Big 5 chartered accounting firms throughout New Zealand and hard copies of a more comprehensive survey were mailed to an office of each of the Big 5 firms. Responses were received from 921 (55%) Non-Big 5 accounting firms and all of the Big 5 firms responded.
PREVALENCE OF LIMITED ASSURANCE ENGAGEMENTS
All of the Big 5 firms in New Zealand provide limited assurance engagements. However, only 10% of the 921 Non-Big 5 respondents provide such engagements and these types of engagements make up less than 10% of these firms’ total assurance engagements, ie they are not provided frequently.
The reasons given by both groups of suppliers for not providing limited assurance engagements or for not providing them often, in order of frequency, are detailed in Table 1.
Most of the Non-Big 5 accounting firms that did not carry out limited assurance engagements did not perform assurance engagements of any type.
It was noted by a couple of Non-Big 5 respondents that there appears to be a lack of awareness by some funding bodies (including government agencies) of the option of a review as an alternative to an audit engagement. A number of Non-Big 5 respondents also suggested that it was actually more cost effective to carry out an audit rather than a review engagement.
One respondent suggested that “the lines between audit and review need better definition”. Another respondent commented that: “An important issue for us is that financial administrators of small entities often do not have a detailed understanding of activities and so testing by enquiry and analytical review may prove fruitless, with the result that we have no alternative but to directly verify. This escalates the cost of review engagements relative to audits for such clients.”
The perceived or actual lack of competence by the Non-Big 5 practitioners to carry out audits or review engagements was another reason provided for not carrying out such engagements. The lack of reward versus the cost and risk of providing assurance engagements was also mentioned as important. When asked what would encourage the respondents to provide limited assurance engagements more often, the Non-Big 5 practitioners suggested that the following additional guidance from NZICA would be useful.
- Audit assistant software programme designed for limited assurance engagements.
- A training course.
- Limited assurance standards similar to auditing standards.
- Work programme templates.
- A handbook summarising different and similar techniques involved in an audit and in a review.
- Standardised working paper templates, checklists and questionnaires.
The Big 5 suppliers suggested that updated and specific standards on limited assurance engagements would be helpful.
TYPES OF ASSURANCE ENGAGEMENTS PROVIDED AND WHO RECEIVES THEM
The most common type of assurance service (other than financial statements audits) provided by the Non-Big 5 respondents are reviews of historical financial information (60% of their non-audit assurance services). These are followed by reviews of prospective information, which are provided by 36% of these respondents.
Other types of assurance engagements include the assurance of a variety of subject matter, such as:
probity audits
- real estate trust audits
- New Zealand Trade and Enterprise audits
- reviews of internal systems and controls
- Ministry of Education private training enterprise reviews
- audits of sub-sets of historical financial information
- reviews of projections for gaming licences (for the Department of Internal Affairs)
- New Zealand Grape Wine Export Code Quality audits.
The Big 5 firms also provide limited assurance on historical financial information as the most common type of limited assurance engagement. This is followed by limited assurance on prospective information and assurance on non-financial information such as environmental disclosure. Audit New Zealand carries out a number of limited assurance reviews of the service performance of certain public sector entities. The Big 5 firms also carry out limited assurance engagements on internal control systems and procedures, and assurance on behaviour, especially compliance with sector specific regulation in the energy sector and with regard to corporate governance.
The Big 4 firms carry out limited assurance reviews of historical financial information, most frequently for companies. Public sector entities, not surprisingly, are the most common recipients of limited assurance engagements supplied by Audit New Zealand. The Big 4 firms perform limited assurance engagement for trusts, partnerships, charities and clubs to a much lesser extent. On the other hand the Non-Big 5 respondents supply limited assurance engagements mostly to clubs, charities, companies, and trusts. They also perform limited assurance engagements for churches, parent teacher associations, community groups, early childhood centres, sports clubs, partnerships and sole traders.
It appears from these findings that the market for limited assurance services in New Zealand is segmented by the size of the suppliers. The larger suppliers of assurance services deal mostly with companies in New Zealand, while the clients of smaller suppliers tend to be mainly small charities and other small enterprises. This market division is very likely to be driven by the cost of supply.
THE LEVEL OF CONFIDENCE
The chartered accounting firms were asked to identify the percentage of confidence that they believe they provide when they give an opinion in a reasonable assurance engagement (such as an audit) and a limited assurance engagement (such as a review). This was measured on a scale of 0% to 100% and the results are shown in Table 2.
COMMUNICATING A LIMITED LEVEL OF ASSURANCE
The majority (91%) of the Non-Big 5 respondents use negative assurance reports to express the limited level of assurance provided. The remaining 9% use different formats of reporting, usually specific formats. Some respondents stated that they prefer to use the standard assurance report as suggested by NZICA’s Review Guideline number 1 (Appendix III) when carrying out limited assurance engagements, and they communicate the limited level of assurance by giving a negative assurance report.
When asked to comment on the understandability of the issued reports over half (56%) of the Non-Big 5 respondents reported that they believe their clients “somewhat” understand the reports issued and another 23% believe that their clients do not at all understand the limited assurance reports they receive. The remaining 21% of the Non-Big 5 respondents believe that they communicated the limited level of assurance successfully and that their clients completely understood the limited level of assurance that they had received.
On the other hand all of the Big 4 firms use negative reports to communicate a limited level of assurance. Audit New Zealand uses specific reports for some of their non-audit assurance engagements, as prescribed by various sectors’ regulations. In spite of that, three out of five respondents in this category of suppliers consider a positive form of reporting would be an improvement on the current negative wording used in limited assurance reports.
The respondents in this group also stated that limited assurance reports should specify both the responsibilities of the reviewer/assurance provider and the responsibilities of the client’s governing body, as well as limitations of limited assurance engagements, and most importantly, an emphasis that a limited assurance engagement is not an audit.
CONCLUSION
The findings from this study show that the suppliers’ market for limited assurance services in New Zealand is well defined. The Big 5 and Non-Big 5 suppliers of limited assurance services have segmented the market with the Big 4 firms tending to supply their limited assurance engagements to mainly companies, with the most common types of engagements being historical financial information reviews. Audit New Zealand tends to supply assurance on compliance with specific public sector legislation to public sector entities. Non-Big 5 suppliers, on the other hand, tend to supply limited assurance engagements to mostly small entities and charities, who most frequently receive reviews of their historical financial information.
In conclusion, it appears that the “one size fits all” approach towards the development and implementation of limited assurance standards may not be the best approach to take when regulating and promoting these types of services. More understanding of the underlying characteristics of the suppliers of limited assurance services and their market segments should be considered when developing new or revised limited assurance standards in New Zealand.
Table 1: Comparison of reasons for not providing limited assurance engagements or for not providing them often
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Non-Big 5
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Big 5
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1. Lack of demand
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1. Limited usefulness of reports
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2. Legal liability issues
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2. Client would not understand the level of assurance provided
|
|
3. Other reasons (eg “outside of area of expertise”, “we have completely exited this work”)
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3. Difficulty with clarity of subject matter/criteria
|
|
4. Cost
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4. Lack of demand
|
|
5. Client would not understand the level of assurance provided
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5. Cost
|
|
6. Limited usefulness of reports
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6. Legal liability issues
|
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7. Lack of adequate standards
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7. Lack of adequate standards
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8. Difficulty with clarity of subject matter/criteria
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8. Other reasons
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Table 2: Mean perceived levels of confidence
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Reasonable assurance engagements
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Limited assurance engagements
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|
Big 5 firm
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80%
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50%
|
|
Non-Big 5 firm
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87%
|
72%
|
REFERENCES
International Federation of Accountants (IFAC) (2011) Revised International Standard on Review Engagements (ISRE) 2400: Engagements to Review Historical Financial Statements, IFAC: New York.
Ministry of Economic Development (MED) (2009) The statutory framework for financial reporting, Discussion document, accessed 23 October 2010 at med.govt.nz.
New Zealand Institute of Chartered Accountants (NZICA) (1989) RS-1, Statement of review engagement standards. NZICA: Wellington.
January
- Dr Nives Botica Redmayne FCA is a Senior Lecturer in Accountancy at Massey University and Sue Malthus FCA is Principal Accounting Lecturer at the Nelson Marlborough Institute of Technology.