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SPECIAL
CONSIDERATIONS — AUDITS OF
GROUP FINANCIAL STATEMENTS
(INCLUDING THE WORK OF
COMPONENT AUDITORS)
The objectives in ISA 600 (revised and redrafted) are twofold. First and foremost, the
group auditor needs to establish that it is appropriate to act in the capacity of group
auditor. Secondly, the group auditor also needs to ensure that sufficient appropriate audit
evidence is gathered to support the opinion contained in the consolidated financial
statements of the group. For the purposes of ISA 600:
‘Principal auditor’ means the auditor with responsibility for reporting on the financial
statements of an entity when those financial statements include financial information of
one or more component auditors audited by another auditor.
‘Other auditor’ means an auditor, other than the principal auditor, with responsibility for
reporting on the financial information of a component which is included in the financial
statements audited by the principal auditor. Other auditors include affiliated firms,
whether using the same name or not, and correspondences, as well as unrelated auditors.
‘Component’ means a division, branch, subsidiary, joint venture, associated entity or
other entity whose financial information is included in the financial statements audited by
the principal auditor.
Consider the following illustration:
Illustration
AMG Inc is an entity who is registered in the UK. It has a whollyowned subsidiary in China
who carries a material amount of inventory. As inventory is material to the financial statements
of AMG Inc, attendance at the inventory count is deemed necessary. It is impractical for the
principal auditor to travel to AMG’s subsidiary in China and they have, therefore, requested a
Chinese firm of Auditors to attend their inventory count.
In the above illustration, the principal auditor is using the work of another auditor to
observe the procedures adopted at the inventory count of the Chinese subsidiary. The
principal auditor should, therefore, consider how the work of the other auditor will affect
the audit. In particular to comply with the provisions in ISA 220, the principal auditor
should ensure that component
auditors have the specific levels of skills and competence to carry out the audit work
effectively.
CONSOLIDATION PROCESS
Under ISA 600, the group auditor is required to obtain an understanding of the
consolidation process, including the instructions issued by group management to
component entities. A review of how the group financial statements are produced can be
illustrated as follows.
Stage One
The first stage involves each component entity being audited for the purposes of forming
an opinion on the individual entity’s financial statements. These audits can either be done
by the group auditor or a component auditor. Where component auditors are involved, the
group auditor must consider how much additional work will need to be performed on the
components for the purpose of expressing an opinion on the group financial statements.
Stage Two
The second stage involves the group’s management consolidating the financial
statements of each component entity. The group auditor needs to obtain an understanding
of the consolidation process to ensure that the process has been followed correctly in
accordance with the relevant financial reporting framework. For example, IAS 27
‘Consolidated and Separate Financial Statements’ governs the consolidation process for
subsidiaries for those entities reporting under IFRS. The group auditor shall communicate
clearly with component auditors about the scope and timing of their work on the financial
information related to components and their findings [ISA600.8(b)(i)].
Stage Three
The third and final process involves the group auditor obtaining sufficient appropriate
audit evidence regarding the financial information of the components as well as the
consolidation process with the objective of forming and expressing an opinion on
whether the group’s financial statements are prepared, in all material respects, in
accordance with the applicable reporting framework [ISA600.8(b)(ii)].
ACCEPTANCE AS GROUP ENGAGEMENT PARTNER
ISA 315 requires auditors to gain an understanding of an entity and the environment in
which it operates. Group audits are no exception and invariably involve obtaining a
greater depth of understanding because of the component parts of the group. ISA 220 is
particularly relevant and should be applied by the group engagement partner in
determining whether sufficient appropriate audit evidence can reasonably be expected to
be obtained in relation to both the consolidation process and the financial information of
the components on which to base the audit opinion [ISA600.12]. For these reasons, the
group engagement team needs to obtain an understanding of the group, its components
and the environment in which they operate. It follows, therefore, that it is vital the group
auditor has a good understanding of the structure of the group and the materiality of each
of its components. If the group engagement partner concludes that sufficient appropriate
audit evidence cannot be obtained due to the limitations imposed by group’s
management, which will result in a potential disclaimed opinion being expressed, then
the group engagement partner must decline acceptance of the engagement. If the
engagement is a continuing engagement then the auditor shall resign [ISA600.13].
In situations where domestic legislation or other regulation prohibits the auditor from
resigning from a continuing engagement, the auditor shall express a disclaimed opinion
on the group’s financial statements [ISA600.13].
OBTAINING AN UNDERSTANDING OF THE GROUP, ITS COMPONENTS
AND THE ENVIRONMENT IN WHICH THEY OPERATE
The group engagement team must gain a thorough understanding of the group, its
component entities and the environment in which they operate in order to ensure that they
can identify areas where material misstatement is likely to arise and undertake their risk
assessment. Obtaining such an understanding involves the engagement team
understanding the group wide internal control systems which can be obtained either at
the initial engagement stage or by reviewing prior year working papers. The engagement
team is also required to understand the consolidation process and the instructions from
group management to component entities.
An understanding of the consolidation process is a fundamental aspect of group financial
statements and as such the group engagement team shall also obtain an understanding of
the instructions issued by group management to its components. The auditor should
undertake tests of groupwide controls to ensure their operating effectiveness where the
auditor has concluded internal controls operate effectively, or where the auditor has
concluded that substantive procedures alone would not provide sufficient appropriate
audit evidence at the assertion level.
The group engagement team are compelled to approach and undertake the group audit
assign ment with a degree of professional scepticism. This is particularly the case when
the group engagement team considers the consolidation adjustments and any associated
reclassifications, which may give rise to material misstatement in the group financial
statements due to fraud or error.
In obtaining an understanding of the group, its components and the environment in which
they operate, the auditor needs to identify and assess the risks of material misstatement.
Obtaining an understanding of such groups and their components will often be more in
depth than with a ‘standalone’ audit client because the auditor needs to consider the
controls in place across the whole of the group. The auditor shall also gain an
understanding of the consolidation process and the instructions issued to management.
The group engagement team shall establish an overall group audit strategy and develop a
group audit plan in accordance with ISA 300 [ISA600.15]. In addition, the group
engagement partner shall review the overall group audit strategy and group audit plan
[ISA600.16].
In a lot of cases, the principal auditor will use the work of other auditors in auditing the
group. Where principal auditors use the work of other component auditors, the principal
auditors shall consider the professional competence of the other auditor in the context of
the specific assignment. Specifically the auditor will consider whether the component
auditor has the necessary skills and technical competence in order to carry out the audit
work effectively. Professional qualifications on their own may not necessarily mean that
a component auditor has the necessary technical competences that are required to carry
out the assignment. Moreover, a technically competent and qualified component auditor
may also not possess the degree of skills and knowledge which the component entity
requires, and in some instances the auditor may also require the use of experts.
Where principal auditors employ the services of other component auditors, the principal
auditor shall perform procedures to enable the principal auditor to conclude whether, or
not, the work of the other auditor is adequate for the principal auditor’s purposes. Factors
which the principal auditor needs to address with the other auditor are:
Independence issues.
- Whether the other auditor will comply with ethical guidelines.
- How the work of the other auditor will be used.
- The accounting and auditing requirements of the component entity — in particular
areas requiring special consideration (key risks, control environment).
- Timescales for performing and completing the work.
- Whether the other auditor has the resources available to enable an effective audit to be
carried out.
Component auditors have sole responsibility for their audit opinion on the financial
statements of the component they audit. They must not rely on the principal auditors
informing them of matters which might have an impact on the financial statements of the
component. If they wish to do so, they shall seek representations directly from
management, or, where applicable, those charged with governance of the entity audited
by the principal auditors.
The principal auditors have no obligation to provide information to other auditors.
Where, during the course of their audit, they discover matters which they consider may
be relevant to the other auditors’ work; they shall discuss and agree on the appropriate
course of action with those charged with governance. This may involve the principal
auditors communicating directly with the other auditors, management or those charged
with governance.
If the circumstances are such that the information cannot be passed to the other auditors,
for example, due to sensitive commercial considerations, the principal auditors should
take no further action. To divulge such information in these situations would be a breach
of client confidentiality.
In situations where the component auditor is deemed not to be independent or where
there are concerns about the component auditor’s technical competence or understanding,
the group engagement team will obtain sufficient appropriate audit evidence on the
component’s financial information without requesting the other auditor to perform work
on the financial information of the component entity.
At all stages during the audit assignment, the component auditor must cooperate with the
principal auditor and advise the principal auditor as soon as is reasonably practicable of
any limitations on their work which they encounter. In addition, where the component
auditor encounters issues which may require reporting to legal or regulatory bodies, they
should communicate these matters to the principal auditor as soon as is reasonably
practicable.
MATERIALITY
Materiality must be assessed where audit opinions are to be expressed and group audits
will require materiality to be determined for the group financial statements as a whole at
the time the audit strategy is being developed. In addition, component materiality shall
also be determined by component auditors having regard to the risk assessment. In order
to ensure the aggregate of uncorrected and undetected misstatements in the group’s
financial statements does not exceed the materiality level for the group financial
statements as a whole, component materiality levels must be set lower than the
materiality level for the group financial statements as a whole. In audits where
components are deemed ‘insignificant’ the audit engagement partner shall undertake
analytical procedures at group level [ISA600.21].
In situations where the engagement team conclude that sufficient appropriate audit
evidence cannot be obtained from the work performed on the financial statements of
components that are deemed ‘insignificant’ components, the work undertaken on the
internal controls of insignificant components and the analytical procedures performed at
group level, the auditor shall:
Perform, or request a component auditor to perform, an audit on the component’s
financial information using component materiality.
Perform an audit of one or more account balances, classes of transaction or disclosure.
Undertake a review of the financial information of the component using component
materiality.
- Devise specific procedures that will allow sufficient appropriate audit evidence to be
obtained.
For all entities within the group, the group auditor shall review a report of the work done
by the component auditor, regardless of materiality. After reviewing the work of the
component auditor, the group auditor will then ascertain the extent of any further actions
which need to be taken, or any further work which needs to be carried out, in order to
ensure that the financial statements are free from material misstatement. Factors that the
group auditor will ordinarily consider are:
A review of the component auditor’s working papers.
- Performing a risk assessment at component entity level.
- Participating in closing meetings with the component auditor and the management of
the company.
- Reviews of the relevant parts of the component auditor’s audit working papers.
Where the group auditor considers that additional work is necessary, the group auditor
should determine the nature of the work necessary, and whether the work should be
carried out by the group or component auditor.
SUBSEQUENT EVENTS
The group engagement team must consider any events that have occurred between the
reporting date and the date of approval of the financial statements and the signing of the
auditor’s report, and as such the auditor is required to design and implement audit
procedures that are designed to identify such events. In addition, where the principal
auditor uses the services of component auditors, the principal auditor should request that
the component auditor notifies the group engagement team if they become aware of any
subsequent events that may require adjustment or disclosure within the financial
statements.
Illustration Group Audit with Going Concern Issue
Sarvonia Group owns three subsidiary entities all of which trade in the same industrial sector.
One of the subsidiary’s in the group has suffered a significant loss during the year and this is
now the second year in which the same subsidiary has reported a heavy loss. The loss has been
sustained due to the loss of two key customers. The subsidiary company in question has been
deemed a going concern by management on the basis that the group will continue to support the
subsidiary financially until such time as the entity returns to profit.
The above illustration would ordinarily require the auditor to obtain a ‘support letter’ from the
group’s management. It is sometimes the case that a subsidiary, when considered in isolation,
does not appear to be a going concern. In the context of group financial statements, the parent
and the subsidiary are seen to be a complete, single reporting entity, so if the group as a whole is
a going concern, that is sufficient. However, the component auditor will need assurance that the
subsidiary, in isolation, is a going concern. In such a case, the component auditor may request a
support letter (also referred to as a ‘comfort letter’) from the management. This letter states that
the intention of the parent is to continue to support the subsidiary, which makes it a going
concern.
CONSOLIDATING SUBSIDIARIES REPORTING UNDER ALTERNATIVE
GAAP
Consolidating a subsidiary from a developing country may be a problem for host
countries as the basis of preparation of the subsidiary’s financial statements may be so
different to the parent’s GAAP that the principal auditor will not be able to conclude that
the financial statements present the entity’s financial statements fairly. This is only a
problem if the financial statements, or the differences caused by the basis of preparation
are material to the group.
The problem can be averted by asking management and those charged with governance
to restate the accounts under the parent’s GAAP. The principal auditors might require
that this restatement process is audited to ensure that it is accurate. However, the modern
auditing profession is finding such difficulties easier to overcome with the increased
internationalization of accounting practices.
COMMUNICATION
Timely communication of the group engagement team’s requirements to the component
auditor shall take place. This communication must set out the work to be performed, the
use to be made of that work and the form and content of the component auditor’s
communication with the group engagement team. It must include:
A request that the component auditor will communicate with the group.
The ethical and independence requirements relevant to the group.
In the case of an audit or review of the financial information of the component, com
ponent materiality and, where applicable, materiality level(s) for particular classes of
transactions, account balances or disclosures, together with the threshold above which
misstatements cannot be regarded as ‘clearly trivial’.
Significant risks of material misstatement that have been identified in the group’s
financial statements due to fraud or error that is relevant to the work of the component
auditor. It is also a requirement that the group engagement team will request the
component auditor to communicate on a timely basis any other identified significant risks
of material misstatement of the group financial statements, due to fraud or error, in the
component, and the component auditor’s responses to such risks.
A list of related parties prepared by the group’s management plus any related parties of
which the group engagement team are aware. The group engagement team shall also
request the component auditor to communicate to them, on a timely basis, related parties
that have not previously been identified by the group engagement team. The group
engagement team must also determine whether to identify such additional related parties
to other component auditors. [ISA600.40]
At the conclusion of the group audit, the group engagement team will request the
component auditor to communicate:
Whether the component auditor has complied with all ethical and independence
requirements as well as professional competences relevant to the group audit.
Whether the component auditor has complied with the group engagement team’s
requests.
Identification of the financial information of the component which the component
auditor is reporting.
Information on instances of noncompliance with laws and regulations that could give
rise to material misstatement of the group’s financial statements.
A list of uncorrected misstatements of the financial information of the component which
need not include misstatements which are below the threshold for clearly trivial
misstatements.
Indicators of possible management bias.
- A description of identified significant deficiencies in internal controls at component
level.
- Other significant matters that the component auditor has communicated, or expects to
communicate, to those charged with governance of the component, including fraud or
suspected fraud involving component management employees who have significant roles
in internal control at component level, or others where fraud resulted in material
misstatement of the financial information of the component.
Other matters which may be relevant to the group audit or that the component auditor
wishes to draw to the attention of the group engagement team.
The component auditor’s overall findings, conclusions or opinion. [ISA600.41]
PROCEDURES FOR PLANNING AND UNDERTAKING GROUP AUDITS
Establish if consolidated financial statements are required.
- Obtain and document an understanding of the group, its components and their
activities.
Ensure adequate documentation of the consolidation process is present.
- Agree the terms of the group audit engagement and issue a letter of engagement.
Ensure the group engagement letter states that restrictions on:
the group auditor’s access to component information, management or other
auditors; or
the work to be performed which are imposed after the group auditor’s acceptance
of the engagement constitute a scope limitation that may affect the group audit opinion.
Send out a group letter of instruction to each component auditor advising group auditors
of all necessary requirements.
- Ensure letter of instruction to component auditors includes timetable for completing
audit and details and dates for meeting with group auditors and management.
Request confirmation from component auditors that they will:
Cooperate with the group engagement team.
- Confirm their compliance with ethical and independence requirements.
- Notify group auditor of any ethical or independence problems.
- Advise the group auditor of materiality levels.
- Advise on a timely basis of the risk of any fraud and error and its impact and
also
details of any fraud and error discovered.
Provide details of any related parties not previously identified.
- Confirm the group engagement team’s requirements will be complied with.
- Provide information on instances of noncompliance with laws or regulations.
Provide a list of uncorrected misstatements and errors.
- Provide indicators of possible management bias.
- Provide indicators of going concern problems.
- Provide a description of any identified material weaknesses in internal control.
Ensure that an appropriate materiality level has been set for the group as a whole and
for the individual components in the group.
- Ensure that there is adequate documentation of risk and the internal controls within the
group.
Establish and document which components within the group are significant and which
are not.
- For nonsignificant components ensure that as a minimum, analytical procedures have
been undertaken. Consider if further work is necessary.
For significant components decide what further audit procedures are needed to be
carried out including review of working papers if appropriate.
- Assess whether audit evidence obtained at components is adequate and document how
this assessment has been carried out.
If audit evidence is deemed insufficient, document and perform additional procedures
necessary to provide sufficient and appropriate audit evidence.
- Agree figures in the financial statements to the consolidation workings.
- Check arithmetical accuracy of consolidation and workings.
Consider if basis for prior year consolidation entries is still appropriate.
Verify reconciliation of the movements in:
reserves;
- noncontrolling interests;
investments; and
- deferred tax.
Ensure that all intragroup balances and transactions have been eliminated during the
consolidation process.
Ensure that any unrealized profit in inventory and noncurrent assets has been
eliminated.
Ensure any investments in subsidiaries have been eliminated, including the provision for
losses.
Ensure that consistent accounting policies have been adopted throughout the group.
- Ensure that if dividends have been passed between entities within the group, that the
preacquisition element has been correctly treated.
PROCEDURES FOR COMPLETION OF GROUP AUDITS
Ensure appropriate work is carried out on the consolidation process. This should involve
reviewing the instructions issued by group management to the components.
Communicate any weaknesses identified in internal controls to group management.
Ensure that there is communication with those charged with governance of the group.
This should cover all the matters required by ISA 260 (revised and redrafted) and each of
the following:
Overview of the type of work to be performed.
- Overview of group auditors’ planned involvement in work of component
auditors.
Concerns over quality of any component auditor’s work.
- Any limitations on the group audit.
- Any fraud or suspected fraud identified.
Evaluate the adequacy of the work performed by the component auditor.
- Establish impact of any matters arising on the group audit report and group financial
statements.
- Consider the effect of each component auditor’s memorandum or report of work
performed on the group audit.
- Ensure each component auditor’s letter has been received and follow up nonreplies.
- Ensure appropriate subsequent events work has been performed for all group
components and the group as a whole.
- Ensure appropriate going concern work has been performed for all group components
and the group as a whole.
- Ensure no evidence has come to light which would impact on the firm continuing as
group auditors.
Chapter Roundup
The group auditor needs to establish that it is appropriate to act in the capacity of group auditor.
The group auditor also needs to ensure that sufficient appropriate audit evidence is gathered to
support the opinion contained in the consolidated financial statements of the group.
Principal auditors should ensure other auditors comply with the provisions of ISA 220 as well as
ethical and independence requirements, and that other auditors have the specific levels of skills
and competence required to carry out the audit work effectively.
An understanding of the group and the environment in which it operates by the group
engagement team, including groupwide controls, and the consolidation process is required.
In obtaining their understanding of the group, the group engagement team needs to identify and
assess the risks of material misstatement.
Principal auditors have no obligation to provide information to other auditors. Where principal
auditors discover matters relevant to other auditor’s work, the principal auditors will discuss and
agree on an appropriate course of action with those charged with governance.
Where component auditors are deemed not to be independent, or where concerns are present
about the component auditor’s technical competence, the group engagement team will obtain
sufficient appropriate audit evidence on the component’s financial statements.
Component materiality must be assessed by component auditors.
Where components are deemed ‘insignificant’, the audit engagement partner must undertake
analytical procedures at group level.
For all entities within the group, the group auditor shall review a report of the work done by the
component auditor, regardless of materiality.
The group engagement team must consider subsequent events and design and implement audit
procedures which are designed to identify such events.
Various communications should take place between the group engagement team and the
component auditor.