ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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Paper P7 (INT)
Advanced audit and assurance
CHAPTER
10
Group audits
Contents
1 Introduction to group audits
2 Group audits: preliminaries
3 Working with component auditors
4 Auditing the consolidation process
5 Documentation and communication with
management and those charged with governance
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Introduction to group audits
Group audits and the audit of individual group companies
Possible problems with group audits
Terminology in group audits
1 Introduction to group audits
A group audit is the audit of group financial statements. For this topic, you need to
be aware of the requirements of the following accounting standards:
IFRS 3 Business combinations
IAS 27 Consolidated and separate financial statements
IAS 28 Investments in associates
IAS 31 Interests in joint ventures
In addition, IAS 24 Related party disclosures is also of particular relevance, because
companies within a group are related parties.
1.1 Group audits and the audit of individual group companies
Much of the basic audit work for groups of companies consists of auditing the
financial statements of the individual companies in the group. The parent
company and subsidiaries are referred to (for audit purposes) as the
‘components’ of the group.
The audit work on the financial statements of the components of a group will
follow normal auditing principles and practice.
This chapter is concerned with the additional audit considerations that arise in
connection with the preparation of the group financial statements.
1.2 Possible problems with group audits
The organisation and planning of a group audit is usually more complex than
the planning of the audit of a single company, for the following reasons:
Groups may include a large number of companies. Some group companies
may be foreign subsidiaries that report in their own currency and perhaps
use their national accounting practices to prepare their financial statements,
rather than international financial reporting standards.
Some companies in the group may have a different year-end accounting date
from other companies.
It will be necessary to make or audit adjustments that are made to the
financial statements of individual group companies, for consolidation
purposes.
Some group companies may be audited by an audit firm that is not the
auditor of the parent company.
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1.3 Terminology in group audits
Some special terms from ISA 600 (see below) are used for group audits.
Group auditor. The group auditor is the audit firm responsible for the audit of
the group financial statements (and will usually also be the auditor of the parent
company). ISA 600 in fact refers to the ‘group audit’, the ‘group engagement
partner’ and the ‘group engagement team’ but the term ‘ group auditor’ is
useful and well understood.
The group engagement team will:
establish the overall group audit strategy
communicate with component auditors (see below)
perform work on the consolidation process, and
evaluate the conclusions drawn from the audit evidence obtained in order to
form an opinion on the group financial statements.
Each of the above stages is considered in more detail in the remainder of this
chapter.
Component auditor. A component auditor is an auditor who, at the request of
the group auditor, performs work on the financial information of a component.
For example, the audit of an individual subsidiary, associate or joint venture
may be performed by Audit firm A, when the group auditor is Audit firm B.
Audit firm A is a ‘component auditor’.
Component. A component is an entity or business activity for which group or
component management prepares financial information that should be included in
the group financial statements.
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Group audits: preliminaries
Audits of group financial statements: ISA 600
The relationship between the group auditor and component auditors
Accepting an appointment as group auditor
Understanding the group, its components and component auditors
Materiality
Planning and controlling a group audit
2 Group audits: preliminaries
2.1 Audits of group financial statements: ISA 600
ISA 600 Special considerations – audits of group financial statements (including the work of
component auditors) was issued in October 2007 as a revised and redrafted ISA as
part of the IAASB’s Clarity Project, but also represented the result of a long
consultation process on group audits. The revised ISA 600 contains much more
extensive guidance than the original ISA 600.
2.2 The relationship between the group auditor and component auditors
ISA 600 regulates situations where group financial statements include financial
information of components that are audited by other audit firms. The group auditor
is required to determine how the work of the component auditors will affect the
audit of the group financial statements.
The group engagement partner is responsible for:
the direction, supervision and performance of the group audit, and
issuing an appropriate group audit report.
The group auditor is solely responsible for the audit report on the group
financial statements (although ISA 600 does not in fact use this term). The group
audit report does not therefore refer to any component auditors, unless such a
reference is required by local law. If it is required, the group audit report must
indicate that such a reference does not reduce the group auditor’s responsibility
for the opinion on the group financial statements.
Because of this sole responsibility, ISA 600 contains very specific guidance on:
the direction that the group auditor should give to the group audit, and
the group auditor’s involvement in the work of component auditors.
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2.3 Accepting an appointment as group auditor
It is normal practice for the auditor of the parent company to act as the group
auditor. However, this is ‘technically’ a separate appointment. As in the case of all
appointments, the audit firm should consider whether it is in a position to accept
the appointment as group auditor.
Before accepting appointment as group auditor, the audit firm should ensure that
all the procedures relating to acceptance of an engagement per ISA 220 are met and
that they have a ‘reasonable expectation’ of obtaining sufficient appropriate audit
evidence about the consolidation process and the financial information of
components to reduce audit risk to an acceptable level.
The firm does this by obtaining an understanding of the group and its
components and their environment sufficient to determine:
which components are significant to the group
which significant components are audited by others, and
whether, as group auditor, the firm will be able to be sufficiently involved in
the audit of significant components to obtain sufficient appropriate evidence
about them.
If the group auditor is not able to be involved in the audit of a significant
component, then it is unlikely that the group auditor can obtain sufficient
appropriate evidence in respect of that component and it should not accept (or
should resign from) the engagement. If the auditor is prevented from resigning
from the engagement by the law, he should issue a disclaimer of opinion on the
group financial statements.
Significant components are those that:
are of individual significance to the group (ie individually material in a
group context), or
have been identified as likely to include significant risks of material
misstatement of the group financial statements.
2.4 Understanding the group, its components and the component auditors
In accordance with ISA 315, the group auditor must identify and assess the risks of
material misstatement through obtaining an understanding of the entity and its
environment. This will mean:
enhancing the understanding of the group, its components and their
environments, obtained at the acceptance or continuation stage, and
obtaining an understanding of the consolidation process, including the
instructions issued by management to its components.
This will enable the group auditor to confirm or revise its initial assessment of
components which are likely to be significant.
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When the group auditor plans to request a component auditor to perform work
on the financial information of a component, he must assess the following.
Whether the component auditor understands and will comply with the
ethical requirements that are relevant to the group audit (in particular that he
is independent).
The component auditor’s professional competence.
Whether the group engagement team will be able to be involved in the work
of the component auditor to the extent necessary to obtain sufficient
appropriate audit evidence.
Whether the component auditor operates in a regulatory environment that
actively oversees auditors.
The group auditor cannot simply rely on the work performed by the
component auditor without assessing the likely quality of that work.
If the component auditor is not independent or there are serious concerns about
any of the other matters above the group auditor will need to obtain evidence
relating to the financial information of the component without requesting the
component auditor to perform any work.
2.5 Materiality
The group auditor will need to set:
group materiality for the group financial statements as a whole, and
component materiality for those components where component auditors will
perform an audit or a review for the purposes of the group audit.
Component materiality will usually be lower than group materiality. If a
component has been audited in its own right (because of local laws or
regulations) and the group auditor decides to use that audit to provide audit
evidence for the group audit, the materiality threshold used on that audit will
need to be assessed. If the threshold was too high, then additional work may be
needed.
2.6 Planning and controlling a group audit
The principles and guidelines for planning and controlling a group audit are similar
to those for the audit of an individual company. However, additional considerations
arise, in regard to the complexities of a group audit.
These additional considerations will require the group auditor to do the following:
Familiarise himself with the client’s procedures for preparing group financial
statements (for example, the client may use standard consolidation
schedules).
Ascertain the client’s timetable for the preparation of the group financial
statements.
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Establish an audit strategy and audit plan for the entire group audit,
including the audit of components. This should include:
− staffing requirements for the group audit
− a timetable for the audit of the compamnt financial statemetns and the group
financial statements
− an action plan for possible problem areas (for example, foreign subsidiaries)
− arrangements for communication and co-operation with component
auditors.
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Working with component auditors
Determining the type of work to be performed on components
Communication with component auditors
Involvement of the group auditor in work performed by component auditors
Joint auditors
3 Working with component auditors
3.1 Determining the type of work to be performed on components
Where a component is of individual financial significance to the group, the group
auditor or a component auditor must perform an audit using component
materiality.
Where a component is significant because of likely significant risk of material
misstatement, the group auditor or a component auditor must perform one or more
of the following.
An audit using component materiality.
An audit of one or more account balances, classes of transactions or
disclosures (depending on where the risk of material misstatement lies).
Specified audit procedures to address the risk of material misstatement.
For non-significant components the group auditor should perform analytical
procedures at a group level.
If the group auditor does not consider that sufficient appropriate audit evidence
will be obtained from the sum of the above work then additional work should be
performed on non-significant components (similar to that for significant
components). The selection of such components should be varied from year to
year.
3.2 Communication with component auditors
If there is not effective communication between the group auditor and the
component auditor, there is a risk that the group auditor may not obtain sufficient
appropriate audit evidence on which to base the group audit opinion.
It is therefore vital that there is clear and timely two-way communication between
the group auditor and the component auditor. The group auditor’s requirements are
usually communicated in a letter of instruction. The component auditor’s
communication with the group auditor will usually be in the form of a
memorandum or report of work performed.
However, such communication may not necessarily be in writing. For example, the
group engagement team may visit the component auditor to discuss identified
significant risks or review relevant parts of the component auditor’s audit
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documentation. In such cases, matters must be properly documented in accordance
with ISA 230.
In co-operating with the group auditor, the component auditor will provide the
group engagement team with access to relevant audit documentation provided this
is not prohibited by law or regulation.
The group auditor’s letter of instruction to the component auditor should set out:
the work required
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 should also include:
a request for co-operation
ethical requirements
component materiality
identified significant risks
a list of known related parties.
The component auditor’s report of work performed should include:
a statement of compliance with ethical and group auditor requirements
identification of the financial information on which the component auditor is
reporting
any instances of non-compliance with laws or regulations which could lead to
a material misstatement of the group financial statements
a list of uncorrected misstatements of the financial information of the
component
indicators of possible management bias
any identified material weaknesses in internal control
any other significant matters the component auditor expects to communicate
to those charged with governance of the component
any other matters that may be relevant to the group audit
the component auditor’s overall findings, conclusions or opinion.
3.2 Involvement of the group auditor in the work performed by component
auditors
It is the group auditor’s responsibility to decide what work is to be performed on
the financial information of the component by the component auditor.
The group auditor then has to decide the extent of his involvement in that work. For
significant components he must, as a minimum:
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discuss with component management or the component auditor the business
activities of the component that are significant to the group
discuss with the component auditor the risk of material misstatement of the
financial information of the component, and
review the component auditor’s documentation of identified significant risks
of material misstatement of the group financial statements.
Where significant risks of material misstatement of the group financial
statements have been identified at a component the group auditor should:
evaluate the further audit procedures to be performed to address such risks,
and
consider whether it is necessary to be involved in those procedures.
Such involvement might include:
meeting with component management/auditors to obtain an understanding
of the component
reviewing the component auditor’s overall audit strategy and plan
performing risk assessment procedures at the component
designing and/or performing further audit procedures
participating in closing/other key meetings between component
auditors/management
reviewing other relevant parts of the component auditor’s documentation.
For other components, the extent of the group auditor’s involvement will depend
on his understanding of that component auditor. If he has concerns about that
particular component auditor’s competence, or a lack of local regulation, he may
decide that he needs to be involved in that component auditor’s risk assessment.
In all cases the group auditor is required to evaluate the report of the work
performed by the other auditor. If, after such evaluation and after discussion with
the component auditor/management, the group auditor concludes that the work is
insufficient he should:
determine what additional procedures are needed, and
whether such procedures should be performed by the component auditor or
himself.
3.3 Joint auditors
A joint audit involves two (or more) audit firms being appointed to audit the
financial statements of an entity.
Joint audits may occur in other situations, but they are most commonly found in
group audits. In particular when a group acquires a new subsidiary, it is not
unusual to appoint the group’s auditors jointly with the subsidiary’s existing
auditors, at least for a period of time after the acquisition.
The joint audit provides a joint opinion on the financial statements of the subsidiary.