ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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Chapter 10: Group audits
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Advantages of joint audits
The reasons why joint auditors might be appointed include the following:
The client company may be so large that it requires the services of more than
one firm of auditors.
After the acquisition of a large subsidiary, using joint auditors may help the
transition process while the group auditors become familiar with the new
subsidiary. The ‘old’ auditors should be familiar with the business of the
subsidiary and should pass their knowledge over to the parent company
auditors. For the parent company auditors, this should accelerate the process
of getting to know the business of the new subsidiary.
Joint auditors may provide a higher level of technical expertise than either
audit firm could provide individually.
Improved geographical coverage may be obtained for the audit, where each
of the joint auditors on its own does not have offices that cover all the
geographical locations of the component companies in the group.
It has been suggested that two medium-sized audit firms might ‘join forces’
and tender for the audit of a company for which the auditors would normally
be one of the ‘Big 4’ audit firms. This is possibly a way in which medium-
sized firms might try to ‘break the monopoly’ of the Big 4 on large company
audits.
Disadvantages of joint audits
Possible disadvantages of joint audits include the following:
The extra cost to the client. It is likely to cost more to use two audit firms than
to use one.
Possible inconsistencies between the two joint auditors in the audit methods
that they use. If so, there may be problems in reaching agreement on whose
audit method to use.
The possible difficulty the two firms may have in agreeing the division of
work.
Additional problems that will arise in monitoring and controlling the audit
work of two different firms.
The two firms may find it difficult to work well together, and each firm may
try to become the leading firm in the joint audit.
If there is a claim against the auditors for negligence in the conduct of the
audit, there may be some difficulty in identifying which of the joint auditors
is potentially liable.
The key to a successful joint audit is good communication between the firms,
including joint planning meetings and regular discussions between the firms at all
key stages of the audit process. The meetings and discussions should be fully
documented.
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Auditing the consolidation process
Role of the group auditor with regard to consolidation
The main audit procedures relating to consolidation
Subsequent events
4 Auditing the consolidation process
4.1 Role of the group auditor with regard to consolidation
As discussed above, ISA 600 requires the group auditor to obtain an
understanding of the consolidation process, including the instructions issued by
management to its components. This will allow an assessment of the risks
involved in the consolidation process.
The group auditor will want to confirm that the following have been done
correctly by the client group.
There has been a full and accurate transfer of information from the individual
financial statements of the components of the group to the final consolidated
financial statements.
Appropriate consolidation adjustments have been made.
However, the amount and type of detailed audit procedures to be carried out
will depend on the group auditor’s assessment of risk in this area.
4.2 The main audit procedures relating to consolidation
The table below sets out the main audit procedures that could be performed in
relation to the consolidation process ie preparing the consolidated financial
statements from the financial statements of the individual components in the group.
Topic Audit procedures
Clerical
accuracy
Confirm that figures have been transferred accurately from
the financial statements of the components (individual
conmpanies in the group) to the consolidation schedules.
Check the arithmetical accuracy of all consolidation
calculations, such as the consolidation total balances and
total transaction values.
Status of
investments
Confirm that the parent company has correctly classified
investments as a subsidiary, associate, joint venture or
simple investment, in accordance with standard accounting
practice.
Confirm that the appropriate accounting treatment has been
adopted for each of these classifications of investment in the
group accounts.
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Table continues
Topic Audit procedures
Changes in the
group
For acquisitions: confirm fair values, the calculation of
purchased goodwill and accounting treatment in
accordance with IFRS 3 and any other relevant standards.
Where there has been an acquisition during the year
involving deferred consideration as part-payment, check
that the amount of the deferred consideration has been
included in the cost of the acquisition at discounted present
value, using a current pre-tax cost of capital as the discount
rate. (Note: The cost of the acquisition affects the amount of
the purchased goodwill.)
Where there has been an acquisition during the year
involving a possible contingent consideration as part-
payment, check the reasonableness of the assumption that
the resent value of the contingent consideration should be
included in the cost of the acquisition.
For disposals: confirm the sale proceeds, and the calculation
of the gain or loss on sale.
Check that the correct accounting treatments of items are
applied in the consolidated income statement/statement of
comprehensive income and the consolidated . For example,
when a subsidiary has been an acquired during the year,
check that the calculation of pre-acquisition and post-
acquisition profit is correct.
Consolidation
adjustments*
Reconcile the inter-company transactions and balances (or
review the reconciliation of the inter-company transactions
and balances that has been made by the client’s staff).
Confirm the inter-company balances.
Check calculations of the adjustments for unrealised profit.
Check the calculations and disclosure of non-controlling
interests.
Check the accounting treatment of inter-company dividends
and other dividends.
Loss-making
investments
Consider whether any goodwill on acquisition has suffered
an impairment.
Consider whether a write down of the investment in the
books of the parent company is needed.
If a subsidiary makes losses consistently, its going concern
status may be in question.
However, the group may take a formal decision to provide
financial support to the subsidiary. This decision, in effect,
would protect the going concern status of the subsidiary,
even if it is making losses. In such a situation, the group
auditor will normally request a ‘comfort letter’ (or ‘support
letter’) to this effect from the directors of the parent
company.
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Related parties
Ensure the provisions of IAS 24 are complied with.
(Most components of the group will be ‘related’ to most
other components.)
Reporting
Reach a conclusion about whether the group financial
statements present a true and fair view.
(The principles relating to group audit reports are dealt
with in a later chapter.)
*(Note: Consolidation adjustments are adjustments that are made after the
financial statements of the individual group companies have been prepared. The
adjustments are needed to consolidate the financial statements of the individual
companies into a single set of group financial statements. Consolidation
adjustments may therefore include adjustments to the financial statements of
individual group companies, to achieve consistency of accounting policies. There
are also adjustments for inter-group balances and closing inventory from intra-
group sales, for goodwill impairment, and so on.)
4.3 Subsequent events
The subsequent events review will need to include procedures to identify events at
components that occur between the dates of the components’ financial information
and the date of the group audit report. These procedures could be carried out by the
group auditor or by component auditors.
Chapter 10: Group audits
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Documentation and communication with management and those
charged with governance
Documentation
Communication with group management
Communication with those charged with governance of the group
5 Documentation and communication with
management and those charged with governance
5.1 Documentation
In addition to meeting the requirements of ISA 230 Audit documentation the
group auditor must also document the following matters.
An analysis of components, identifying significant components.
The type of work performed on the financial information of components.
The extent of the group auditor’s involvement in the work performed by
component auditors on significant components.
Written communications between the group auditor and component auditors
concerning the group auditor’s requirements.
5.2 Communication with group management
The group auditor should make group management aware, on a timely basis, of
the following matters.
Material weaknesses in the design or operating efficiency of group-wide
controls.
Material weaknesses which are significant to the group that the group
auditor has identified at components.
Material weaknesses which are significant to the group that component
auditors have identified at components and have brought to the attention of
the group auditor.
Any fraud or suspected fraud identified by the group or component auditors.
The distinction between management and “those charged with governance” (see
below), who could in fact be the same, is covered in a later chapter.
5.3 Communication with those charged with governance of the group
In addition to the matters required to be communicated by ISA 260
Communication of audit matters with those charged with governance the group
auditor should communicate the following matters to those charged with the
governance of the group.
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The type of work to be performed on the financial information of
components.
The group auditor’s planned involvement in the work to be performed by
component auditors.
Any concerns over the quality of any component auditor’s work.
Any limitations on the group audit (eg a lack of access to information).
Any fraud or suspected fraud involving group management, component
management, or employees with significant roles in group-wide controls
where the fraud resulted in a material misstatement of the group financial
statements.
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Paper P7 (INT)
Advanced audit and assurance
CHAPTER
11
Audit-related services
Contents
1 Review engagements
2 Agreed-upon procedures
3 Compilation engagements
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Review engagements
The distinction between audit and audit-related services
Types of review engagement
Due diligence engagements
International Standard on Review Engagements (ISRE) 2400
Reporting at the end of a review engagement
International Standard on Review Engagements (ISRE) 2410
Procedures for the review of interim financial information
Reporting on the review of interim financial information
1 Review engagements
1.1 The distinction between audit and audit-related services
An audit is a form of assurance engagement. The objective of an audit is to enable
the auditor to form an opinion as to whether the financial statements of an entity
give a ‘true and fair view’.
An audit is designed to provide a high level of assurance to the users of the
financial statements.
In contrast, audit-related services do not provide the same high level of assurance,
and in some cases do not provide any assurance. Audit-related services include
engagements such as:
Reviews of data. Reviews of data are checks carried out on information
prepared by another person. They provide a moderate level of assurance that the
information under review is free of material misstatement.
Agreed-upon procedures. This is an engagement where the party hiring the
accountant specifies the procedures that the accountant should follow when
performing the assignment.
Compilations. The accountant is engaged to prepare information, rather than to
audit information prepared by someone else. For example, an accountancy firm
may be engaged to prepare a tax computation for a client.
1.2 Types of review engagement
In a review engagement, the accountant is engaged to review financial information
or other information, but not to audit it.
The work performed in a review engagement is less detailed than the work for an audit.
As a result, the level of assurance provided is moderate rather than high (as in the case
of an audit).
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A distinction is made between two types of review engagement:
an attestation engagement, and
a direct reporting engagement.
Attestation engagement
To attest to something means to affirm it or vouch for it. In an attestation
engagement, an accountant is engaged to attest to something. For example, an
accountant might be engaged to attest to the fact that certain procedures within an
entity have been performed in a prescribed way. The accountant will not comment
on the quality of the procedures, but will simply attest to the fact that they have
been performed.
Direct reporting engagement
In a direct reporting engagement, an accountant is engaged to provide a special
report on some aspect of the client’s affairs.
The report will provide an expression of opinion (usually providing negative
assurance) that is made in accordance with the agreed terms of the engagement
The report is prepared after the accountant has carried out an independent
examination of financial information or other information that has been
prepared for use by another party.
1.3 Due diligence engagements
One of the most common forms of direct reporting engagement is ‘due diligence’
work. This term refers to any engagement where the accountant is engaged to make
enquiries into the accounts, organisation or activities of an entity.
Due diligence work is most commonly referred to in the context of mergers and
takeovers. The work involves obtaining information about the target company, prior
to the takeover (or merger). The objective should be to find out everything that may
be relevant about the target company’s operations, financial performance, financial
position and future prospects. In addition, information should also be gathered
about the business environment in which the target company operates.
The accountant will also interview the senior management of the target company,
and also other key employees and possibly external third parties. Due diligence
work does not involve tests of controls (unless the client specifically asks for this),
nor does it involve substantive testing. Due diligence work is not a form of audit
work.
The main objective of due diligence is therefore often to provide information that
will allow the client to:
decide whether a takeover or merger is actually desirable, and
if so, whether the proposed cost of the acquisition is reasonable.
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An adverse or critical due diligence report may therefore result in:
abandoning a proposed takeover or merger, or
reducing the offer price for the acquisition.
Items to investigate in a due diligence exercise
Financial performance and financial position. The accountant will look at the
available historical financial information about the target company, such as its
financial statements for the past few years. Ratio analysis will often be used to make
an assessment. The accountant will also look at the target company’s management
accounts, budgets and profit/cash flow forecasts, and at any current business plan.
Operational issues. The accountant should also look for any operational issues in
the target company that may raise questions about its value. For example, the target
company might have important contracts with major customers, and the accountant
should try to find out when these contracts reach their termination date and what is
the probability that the contracts will be renewed. Other operational problems may
be discovered, such as a high rate of labour turnover, or high costs incurred in
meeting warranties or guarantees to customers.
Management representations. Management of the takeover target may have
provided representations to the potential buyer. For example, they might have
given a written assurance that the target company is not subject to any tax
investigation or potential litigation. Due diligence work should seek to establish that
these representations appear to be correct.
Identification of assets. A takeover usually results in purchased goodwill in the
consolidated accounts. However the takeover target may have several intangible
assets that do not appear in its statement of financial position (because they were
internally-generated assets) but which should be recognised for the purpose of
consolidation. Examples are internally-generated patent rights, customer lists and
databases and brand names. These should be identified and valued, for inclusion in
the consolidated statement of financial position after the acquisition. It is also useful
for the management of the potential buyer to be aware of the nature and estimated
value of the intangible assets that they would be acquiring.
Benefits and costs of a takeover. Due diligence may also include an attempt to
estimate the future benefits of the takeover, such as cost savings from synergies
such as economies of scale. Any ‘one off’ expenses such as redundancy costs and
reorganisation costs will have to be estimated – by the potential buyer if not by the
due diligence process.
Benefits of using an audit firm for due diligence
There is no reason why an accountancy firm, such as the frm’s auditors, shouldbe
engaged to carry out due diligence. Management could do some or all the work