Proposed International Standard on Auditing 600 (revised & redrafted) The Audit of Group Financial Statements
Proposed revised and redrafted International Standard on Auditing issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants
Comments from ACCA
July 2006
Executive Summary
ACCA is pleased to comment on the proposed International Standard on Auditing 600 (Revised and Redrafted) The Audit of Group Financial Statements (proposed ISA 600), issued for comment by the International Auditing and Assurance Standards Board (the IAASB) of the International Federation of Accountants.
ACCA supports the issue of an ISA dealing with the audit of group financial statements, as these are an important aspect of financial reporting. The proposed IAS 600 is more comprehensive and hence more functional than the extant ISA 600, which deals only with using the work of another auditor.
We welcome the decision of the IAASB to re-expose proposals first aired in December 2003, redrafted in a form consistent with that in the exposure draft on Improving the Clarity of IAASB Standards (the Clarity Project). In this response we confine our comments to substantial changes in proposed ISA 600, including those identified for comment in the Explanatory Memorandum forming part of the exposure draft.
We provide detailed comments on the whole of the requirements section of proposed ISA 600. Our general conclusion is that the requirements are proposed at too detailed a level. We suggest simplification through the reclassification of certain requirements as guidance and the elimination of ‘essential guidance’ from the requirements section.
We are particularly concerned that proposed ISA 600 seeks to introduce requirements to allocate materiality and assess risk at ‘component level’ when ISAs have hitherto recognised that this is not appropriate. We believe that ISA 330 The Auditor’s Procedures in Response to Assessed Risks already provides appropriate requirements, that there is no theoretical justification for further requirements at an intermediate level, and that, instead, this is rightly a matter for each individual firm’s methodology.
We call for more guidance in proposed ISA 600, to encourage consistent application in relation to:
- the entity preparing group financial statements
- circumstances where there are no other auditors
- very large groups
- other auditors involved in the audit of the financial statements of a single entity
and - audits involving components without group financial statements.
General Comments
ACCA supports the issue of an ISA dealing with the audit of group financial statements, as these are an important aspect of financial reporting. The decision to move to a more comprehensive treatment of the subject than is given in the extant ISA 600 provides for standards and guidance that are more functional.
PRECEDING EXPOSURE DRAFTS AND FOCUS OF OUR COMMENTS
We welcome the decision of the IAASB to re-expose further its proposals following changes made to the approach in earlier exposure drafts. This demonstrable commitment to consultation is important to developing standards of the highest quality. Together with the transparency and oversight of the IAASB standard-setting process, this gives auditors and those who rely on their work considerable confidence in the value of global auditing standards.
We note that the IAASB has considered carefully the responses to earlier proposals and is not seeking further repetition of comments previously made. Accordingly we provide views only on the effect of substantial changes in the final proposals and on the way the text has been prepared in accordance with the drafting conventions adopted for the project to improve the clarity of IAASB Standards (the Clarity Project).
THE ‘INVISIBLE’ HOLDING COMPANY
The text of proposed ISA 600 does not include consideration of the position of the entity that prepares the group financial statements (other than a mention of ‘head office’ as part of the definition of ‘component’). There are several matters that are relevant. In reality, that entity (‘the holding company’) is likely to be audited by the group auditor. Its status as a component is worthy of separate consideration. Its existence should be recognised in the terminology used, for example, ‘those charged with the governance of a group’ are actually better termed ‘those charged with governance of the holding company that prepares group financial statements’ (or simply ‘those charged with governance’). We suggest that application material should deal with the interaction of the audit of the group financial statements and the audit of the holding company.
APPLICATION TO A WIDE RANGE OF CIRCUMSTANCES
The text of proposed ISA 600 (and indeed the thinking underlying it) seems to relate naturally to a group audit where there are other auditors and where the group is neither very small nor very large. We consider circumstances below where this and other circumstances commonly encountered have consequences for the consistent application of requirements.
No other auditors
The scope of proposed ISA 600 includes the audit of group financial statements where there is no involvement of other auditors. Applying it in such circumstances is relatively easy where requirements are clearly relevant only when there are other auditors. This is not always the case, however, as some requirements make no mention of other auditors and there could be inconsistent application. For example, the requirements in paragraph 9 to 13 regarding acceptance and continuance as group auditor only make sense where there are other auditors.
We recommend including guidance in application material to address this overarching issue. As such circumstances may be expected to be more common with small groups, such an approach would be consistent with providing specific material for smaller entities.
Very large groups
Proposed ISA 600 does not address the audit of very large groups, where typically there is more than a single ‘layer’ of components. Subgroup structures may exist for countries and regions and the group auditor may wish to address risk at levels between the group financial statements and components. (The definition of ‘component’ refers to entity.)
The requirements are aimed at component level and it may have been decided that there was no further benefit in having requirements for other layers. We do not favour mandating formal risk assessment at the component level (see elsewhere in this response), so would not suggest it for other intermediate levels.
The omission of consideration of intermediate levels does, however, force the group auditor to carry out work on components that could be both inefficient and ineffective, as its relevance to the opinion on the group financial statements is marginal. We doubt that, in the current regulatory environment, group auditors will feel able to adopt broad brushes and deal with aggregations of components unless application material deals with such matters. Irrespective of the ability of the firms typically carrying out very large audits to author their own internal guidance, we recommend, therefore, that specific guidance be included in proposed ISA 600 for the audit of very large groups.
Other auditors involved in the audit of the financial statements of a single entity
The scope paragraph of proposed ISA 600 states that, ‘This ISA, adapted as necessary in the circumstances, also applies where other auditors are involved in the audit of the financial statements of a single entity.’
Such an approach may work when it is only guidance that is being adapted but as there are 42 paragraphs of requirements, much more needs to be done to specify precisely what requirements are relevant.
There is no guidance in proposed ISA 600 as to how it should be adapted and we recommend that this omission be remedied.
Two typical circumstances arise: either the other auditors are involved to the same extent at a division as they would be if it were a separate group company or they have very limited responsibilities (such as a site visit to observe inventory count). As a minimum, further guidance should deal with the latter.
Audits involving components without group financial statements (a circumstance highlighting a deeper issue)
The scope paragraph of proposed ISA 600 indicates that it applies (with adaption) where other auditors are involved in the audit of the financial statements of a single entity. There is no mention of circumstances where components exist, there are no other auditors and group financial statements are not prepared.
The obvious explanation for this omission is that the existence of components is not itself sufficient justification for requirements over and above those in ISAs generally.
If one accepts this explanation then it calls into question whether the degree to which other auditors are involved is, on its own, an appropriate trigger to bring 42 paragraphs of requirements potentially into operation (though with adaption). This could result in proposed ISA 600 being applicable in cases where there is only minor involvement of other auditors.
One could, conversely, challenge the ‘obvious’ explanation above and query why, if requirements relating to components are appropriate for all audits of group financial statements, they are not also relevant to single-entity audits. Is the mere absence of other auditors sufficient to give exemption from them?
MATERIALITY AND RISK AT THE COMPONENT LEVEL
The difficulties illustrated by the above arguments arise because there is no actual theoretical underpinning of the requirement to determine materiality levels (and assess risk) at the component level.
Paragraph 26 of extant ISA 200 Objective and General Principles Governing an Audit of Financial Statements Under ISAs summarises as follows:
‘. . . In order to design audit procedures to determine whether there are misstatements that are material to the financial statements taken as a whole, the auditor considers the risk of material misstatement at two levels: the overall financial statement level and in relation to classes of transactions, account balances, and disclosures and the related assertions.’
ISAs have not imposed requirements at levels between these two and we do not agree that it is appropriate for an ISA dealing with group financial statements to do so.
Paragraph 7 of ISA 330 The Auditor’s Procedures in Response to Assessed Risks requires the auditor to design and perform further audit procedures that are responsive to the assessed risks of material misstatement at the assertion level. This is a comprehensive requirement which rules out the need for further requirements at any intermediary level.
It is rightly a matter for an individual firm’s methodology to determine how to relate risk (and materiality) at the financial statement level and risk (and materiality) at the assertion level. To comply with the requirement in paragraph 7 of ISA 330, firms adopt differing approaches, some of which may involve allocating combinations of materiality and risk to constituents of the financial statements other than components in order to limit tolerable error overall to an acceptable level.
The requirement to determine materiality levels (and assess risk) at the component level seems to have been developed to justify the division of components into those that are significant and the others, so that differing approaches to the work of other auditors can itself be explained.
We believe that the end result of the approach can be achieved in other ways that are consistent with ISAs and not open to challenge. Moreover, by removing a requirement to make formal assessments of factors that are not actually relevant to the audit of the group financial statement (being an intermediate step) the standard would result in more efficient audits.
For the reasons set out above, we strongly recommend that there be no requirement to determine materiality and assess risk at component level (paragraph 19). As a consequence we also recommend changing the definition of ‘significant component’. In our view it would be better to recast this material as part of the guidance in application material concerning factors that influence the judgement of the group auditor in relation to the nature timing and extent of their work in relation to other auditors.
Comments on Substantial Changes
The Explanatory Memorandum forming part of the exposure draft provides three paragraphs of examples of substantial changes in the final proposals. They contain questions which we have highlighted and answered below.
33(a) The proposal to eliminate the distinction between related and unrelated auditor gave rise to substantial changes to some of the proposed requirements. Respondents are asked to indicate whether they are in agreement with the proposal, and the effect that it has on the procedures that the group auditor performs in relation to the work of other auditors. Respondents are asked also to consider the proposed definitions of “group auditor,” “member of the engagement team under the direct supervision of the group engagement partner,” and “other auditor or another auditor.”
Elimination of the distinction between related and unrelated auditor?
We agree with eliminating the distinction between related and unrelated auditor (and called for this in an earlier response) as this is more in keeping with a risk-based approach to auditing.
The effect that eliminating the distinction has on the procedures that the group auditor performs in relation to the work of other auditors?
We find the proposals generally acceptable, but there will remain difficulties in practice and we are of the view that costs will increase – especially for smaller groups and auditors. We comment in detail on each requirement in the last section of this response where we conclude that many are not necessary.
The proposed definition of ‘group auditor’?
As drafted, the term ‘group auditor’ means the same as the term ‘group engagement partner’ and excludes mention of the firm. Such exclusion may not be workable in conjunction with legislation referring to the firm in the context of the statutory audit of group financial statements. We suggest adding the firm to the definition. We recognise that proposed ISA 600 envisages treating some parts of a firm as ‘other auditors’, but we believe that the dual nature of the terminology is already well understood and is workable.
The proposed definition of ‘member of the engagement team under the direct supervision of the group engagement partner’?
The definition is acceptable. However, it is overly complex and we question whether a separate term is necessary to achieve what we assume is the intention – namely to act as an anti-avoidance measure to counter the creation of artificial ‘engagement teams’ spanning several firms or countries. It would be sufficient to refer to ‘member of the engagement team’ (the latter being defined in extant ISA 220 Quality Control for Audits of Historical Financial Information). The following paragraphs give our reasoning for this conclusion.
Proposed ISA 600 does not supersede extant ISA 220, which continues to apply to all audit engagements, including those that are an audit of group financial statements. ISA 220 defines engagement team as follows: ‘Engagement team – all personnel performing an audit engagement, including any experts contracted by the firm in connection with that audit engagement.’ In this context, ‘personnel’ means ‘partner and staff’, and the letter means ‘professionals, other than partners, including any experts the firm employs’. The definition implicitly limits personnel to those of the firm.
To comply with ISA 220 the engagement partner (in this case the group engagement partner) must direct and supervise all the (group) engagement team to this extent. Thus all members of the engagement team are necessarily under the direct supervision of the group engagement partner and there is no difference between the two terms: ‘members of the engagement team under the direct supervision of the group engagement partner’ and ‘members of the engagement team’.
The proposed definition of ‘other auditor or another auditor’?
The inclusion in the definition of the words ‘for the group audit’ apparently excludes circumstances where other auditors are involved in an audit of financial statements of a single entity. It may be that the definition has to be adapted as well as the rest of proposed ISA 600 in such circumstances, but it may be better to provide definitions that do not need to be adapted.
The words ‘other auditor or another auditor’ would be understood even in their plain language meaning in proposed ISA 600 (because they are contrasted with group auditor) but outside that context a more specific term, such as ‘component auditor’ would be more recognisable and perhaps more useful, as requirements in proposed ISA 600 could differentiate between those relevant to the group auditor, a component auditor (for the group audit) and other auditors (if that distinction was intended).
We suggest using the term ‘component auditor’ instead of ‘other auditor or another auditor’.
The proposed definition of ‘other auditor or another auditor’ is acceptable but is unnecessarily complex because of the decision to refer to ‘the group engagement partner or a member of the engagement team under the direct supervision of the group engagement partner’. Had ‘group auditor’ not been made synonymous with ‘group engagement partner’ (see our comments above) the definition could have been simplified to: ‘An auditor, other than the group auditor, who performs work on the financial information of one or more components [for the group audit].’
33(b) The IAASB is of the view that the proposed revised ISA will enhance the quality of group audits. Where a group auditor takes sole responsibility for the audit opinion on the group financial statements, it will require that the group auditor obtains sufficient appropriate audit evidence on which to base such an opinion. The IAASB recognizes, however, that current group audit practices vary. This is one reason why the IAASB considers it necessary to be reasonably specific about the steps to be taken, and the work effort required, by the group auditor.
Do respondents think that this approach is justified?
In the last section of this response we provide detailed comments on the requirements section. We find that many of the proposed requirements are inappropriate and conclude, therefore, that the proposals are more specific than is appropriate.
33(c) The IAASB is aware that, at this stage of the Project to Improve the Clarity of IAASB Standards there are those who think that further exposure drafts should not be issued until the clarity drafting conventions are finalized. However, the IAASB considers that to avoid further delay in this project it is appropriate, given the changes from the previous exposure draft, to seek views on the proposed revised ISA at this stage. The effect of finalizing the clarity proposals will be taken into account in finalizing the resulting ISA. With regard to the application of the proposed clarity drafting conventions, respondents are asked to respond in particular to the following questions:
(i) Is the objective to be achieved by the auditor, stated in paragraph 6 of the proposed ISAs, appropriate?
(ii) Have the guidelines identified by the IAASB for determining whether a requirement should be specified been applied appropriately and consistently, such that the resulting requirements are at a level that promotes consistency in performance and the use of professional judgment by auditors?
Is the objective to be achieved by the auditor, stated in paragraph 6 of the proposed ISAs, appropriate?
We made extensive comments on objectives in our response to the exposure draft ‘Improving the Clarity of IAASB Standards’ and do not repeat them here.
Proposed ISA 600 serves two main purposes: to replace extant ISA 600 Using the Work of Another Auditor, and to introduce new requirements for an audit of group financial statements. The distinction between the two has not been reflected in the drafting of the objective.
In the last section of this response, our detailed analysis of the requirements in proposed ISA 600 draws attention to the implicit requirements placed on other auditors (comments on paragraph 39). To recognise the fact that requirements relate also to other auditors, we suggest changes to both the objective and the scope of proposed ISA 600.
Have the guidelines identified by the IAASB for determining whether a requirement should be specified been applied appropriately and consistently, such that the resulting requirements are at a level that promotes consistency in performance and the use of professional judgment by auditors?
This question may be analysed into two parts. The first part refers to whether the guidelines identified by the IAASB have been applied correctly (‘appropriately and consistently’). The second part, which is more important, is an implied test on the guidelines themselves: whether their use gives an appropriate result (‘promotes consistency in performance and the use of professional judgment’).
The Explanatory Memorandum issued with proposed ISA 600 indicates that the guidelines for determining whether a requirement should be specified are the same as those used in the exposure draft ‘Improving the Clarity of IAASB Standards’. We do not repeat, therefore, the extensive comments made on the guidelines in our response to that exposure draft.
With regard to the proposed requirements, as set out in our detailed comments in the last section of this response, we consider that the resulting requirements are not at the correct level: many are unnecessary. We also suggest that explanatory material, currently in the requirements section, should be repositioned as application material.
Detailed Analysis of Requirements in Proposed ISA 600
This analysis considers in detail the wording of the requirements section. Two particular issues dominate: many proposed requirements are not necessary and explanatory material should be excluded.
There is no need to duplicate requirements in other ISAs merely to give a narrative flow to the prose – the requirements section should only include such requirements as are necessary.
We are concerned that the current redrafting of clarified ISAs has not fully recognised the feedback from commentators criticising the mixing of requirements and explanatory text. Mixing the two runs a high risk that requirements will be mistaken for explanatory text and vice versa.
A list of requirements should be a simple reference text. There is no need to consider explanatory material ‘essential’ merely to give a narrative flow to the prose – the requirements section need not be a ‘good read’.
References are to paragraph numbers in proposed ISA 600.
Para 9
The requirement duplicates that in ISA 220. Application material could mention that the consolidation process and financial information from components are relevant factors.
Para 10
This requirement amplifies that in paragraph 9 and the same comment applies.
The wording requires an initial determination of which components are likely to be significant even if no other auditors are involved. This is not necessary as it does not determine any subsequent action.
The requirement to determine whether the group auditor will be able to be involved in the work of other auditors is restricted to ‘components likely to be significant’. This is just part of the need to consider relevant factors (when complying with ISA 220) and may mislead auditors into doing too little.
Para 11
This is explanatory and should be excluded from the requirements section.
Para 12 & 13
The requirement duplicates that in proposed ISA 705 Modifications to the Opinion in the Independent Auditor’s Report. Application material could mention the need to comply with that ISA.
Para 14
The wording ‘and of any other factors that may affect the ability of the group auditor to be involved in the work performed by the other auditors’ should not be included.
With an objective-based standard there is no need to include prompts about ‘any other factors’ as the auditor must consider whether the objective has been satisfied and will do this anyway.
The words ‘that may affect’ impose a very low hurdle; almost any factor may affect. Wording should indicate that it is only items of similar significance to those listed (if any) that need be considered.
The wording ‘This requirement does not apply to members of the engagement team under direct supervision of the group engagement partner. Such individuals are subject to the requirements of ISA 220, “Quality Control for Audits of Historical Financial Information.”’ is explanatory and should be excluded from the requirements section.
Para 15
Where the auditor is unable to use the work of another auditor, the group auditor has no option but to take the action mandated in this paragraph. In an objective-based standard it is unnecessary and should be excluded from the requirements section. It could be included in application material.
Para 15
The words ‘serious concerns’ can only be interpreted as concerns that make it inappropriate for the group auditor to rely on the work of another auditor. That being so, it is not necessary to introduce the complication of having a term ‘serious concerns’.
The prohibition on using the work of another auditor is inappropriate. There should be a facility to rely less on such work if that is an appropriate response to the risk.
The word ‘client’ is ambiguous – it should be specified whether this is the group or the component or both.
Para 18
The requirement is unnecessary as it duplicates that in proposed ISA 320 Materiality in Planning and Performing an Audit. Application material could refer to this.
Para 19
There is no research or theoretical underpinning for this requirement.
This requirement is fraught with difficulties because there is no requirement elsewhere in ISAs to assess risk other than at the financial statement level and at the assertion level (with associated materiality levels). Without wishing to enter into a long theoretical debate – it is clear that allocating materiality and making risk assessments at the component level (or other intermediate level) is a matter of methodology for those firms that might choose to do that in circumstances where no other auditors are involved.
Firms differ in the way materiality and risk are manipulated in their methodology in order to design audit procedures to achieve reasonable assurance. In the absence of a common methodology (such as might be employed within a network) there is no common language through which effective communication can be made.
A further problem is that the requirement is apparently predicated on the component being subject to an audit. It is possible that the other auditor is being asked to carry out specified audit procedures relating to the identified significant risks (paragraph 22(c)). In such circumstances, any component level materiality is arguably irrelevant, yet there is no condition precedent in paragraph 19.
Paragraph 20 (see below) does not refer to component materiality when listing factors that determine the work to be performed on a component. This shows the ‘disconnect’ in the logic, and argues strongly that paragraph 19 is inappropriate.
Because of the above difficulties, we strongly suggest treating the topic of component materiality as application material.
Para 20
The requirement to ‘determine the work to be performed by the other auditor’ could be interpreted as requiring very detailed step-by-step instructions to be issued. The implication from the paragraphs referred to is that the determination is between types of work – such as audit or specified procedures. It would be better to be explicit in this regard.
Para 22
The list of matters that shall be performed is unnecessary as they are, in effect, options that could be indicated in application material.
We are uncomfortable with the use of the word ‘audit’ in connection with specified account balances. What is really intended is procedures designed to achieve reasonable assurance.
In reality, 22(b) will be the same as 22(c) where the identified significant risk relates to specific account balances.
The word ‘specified’ is only relevant when the group auditor specifies the account balances to another auditor; ‘specific’ should be preferred, although ‘one or more’ is perhaps even simpler.
Para 23
In the light of our comments on paragraph 22, we are uncertain whether the intention of paragraph 23 is to confine the options available to those set out in 22(a) and (b) or just to 22(a).
If the intention is to preclude work other than an audit of the component, we do not agree with the requirement.
While an audit may be appropriate in many circumstances where the component is individually financially significant to the group, it is out of keeping with a risk-based approach to mandate procedures that might be inefficient in the particular circumstances. This requirement may not satisfy the ‘virtually all’ test of the Clarity Project. It would be better to refer in application material to the factors that might influence the group auditor’s judgement in relation to the work on the component.
Para 22 & 23
These two paragraphs draw attention to the fact that the definition of ‘significant component’ has been complicated so that paragraphs 22 and 23 can be written as they have been. This is not an appropriate way to construct definitions. If retained, the definition should be made simpler: ‘Significant component - a component identified by the group auditor that is likely to include significant risks of material misstatement of the group financial statements’. It is necessary to consider, however, whether there is a need for a separate term, as the wording of ISA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement could be applied directly.
Para 24
The list of matters that shall be performed is unnecessary as they are in effect options that could be indicated in application material.
We are uncomfortable with the use of the word ‘audit’ in connection with specified account balances. In reality, 24(b) will be the same as 24(c) where the identified significant risk relates to specific account balances.
The word ‘specified’ is only relevant when the group auditor specifies the work to another auditor. ‘Specific’ should be preferred, although ‘one or more’ is perhaps even simpler.
Para 25
This requirement is imprecise.
If this is meant to be part of the overall review at the end of the audit, the requirement is unnecessary, as it duplicates that in paragraph 13 of ISA 520 Analytical Procedures.
If it is intended to be an earlier substantive procedure, then it is in conflict with ISA 315 and ISA 330 The Auditor’s Procedures in Response to Assessed Risks, as further audit procedures should be undertaken only in response to a risk assessment at the assertion level.
Para 26
The list of matters affecting the auditor’s determination of involvement in the work performed by the other auditors is explanatory and should be in application material.
The reference to a memorandum or report of work performed is inappropriate. The group auditor may gather information in better ways than reading a report. The proposed ISA has not required that the group auditor obtain one. It is not appropriate to require that one be evaluated.
The list of matters that shall be performed (‘where considered necessary’) is unnecessary, as they are options that should be indicated in application material, with an indication of factors relevant to the choice.
Para 27
The requirement relates only to significant components but the work involved is arguably necessary to be in a position to decide whether the component is significant.
This highlights a difficulty with the definition of ‘significant component’, in that the term refers to a component that is likely to include significant risks of material misstatement. The word ‘likely’ signifies an expectation rather than fact. In paragraph 27, the requirement applies to components expected to be significant and requires involvement in work to identify significant risks.
It is to be anticipated that group auditors will be conservative when deciding whether they expect significant risks of material misstatement and hence that there will be more significant components identified than will objectively be such once detailed risk assessments have been performed.
Given the time-consuming nature of the ‘involvement’ specified in paragraph 27, this could add significant costs to group audits, with little actual benefit.
The sentence ‘The nature, timing and extent of the group auditor’s involvement are affected by the group auditor’s understanding of the other auditor.’ is explanatory and should be presented only in application material. It is inappropriate to emphasise just one matter which will affect the group auditor’s involvement.
The list of requirements would be of little relevance if the other auditor were carrying out specified procedures rather than an audit. Indeed, the other auditor may not even make a risk assessment in such circumstances. Was the intention (not actually effected) to limit such requirements to cases where the significant component was significant due to its individual financial significance to the group? If so, this reinforces our comment about the potential for confusion arising from the complex definition of ‘significant component’.
Para 28
The words ‘based on the group auditor’s understanding of the other auditor,’ unnecessarily limit the matters that the group auditor should properly consider. This ought to be dealt with in application material.
Para 29
The majority of this paragraph is clearly application material describing what the auditor may do. The last part contains a requirement ‘to meet the requirements of this ISA’. Such a requirement is redundant and should be removed.
Para 30 to 34
ISAs do not, in general, deal with the audit of specific processes; it is the outputs of processes that are relevant. For example, extant ISA 540 refers to obtaining evidence regarding accounting estimates as amounts not processes; review and testing of the process of an accounting estimate is one source of evidence.
There are two approaches that could both be an improvement on the list of requirements as proposed.
The first would be to remove them. There is no special reason for treating the consolidation process in this way when, for example, the process of making non-consolidation journal entries is not given special status.
The second would be to conform the approach with that in the current revision of ISA 540. This is appropriate in any case where aspects of the consolidation process result in accounting estimates (or indeed give rise to fair-value considerations).
Para 35 & 36
Unless the definition of ‘significant component’ is changed, at this stage of the audit it would be appropriate to refer to ‘components that were earlier treated as significant components’, as it should be anticipated that they are no longer likely to contain undiscovered material misstatement.
We do not believe that a simple either/or requirement is appropriate; especially when some components that were significant through their nature or circumstances are concerned. The group auditor should plan subsequent events procedures in a way that is properly responsive to risk. As written, the paragraphs might be interpreted as detracting from, or replacing, ISA 560.
We suggest using application material to refer to the requirements of ISA 560 and to suggest how, in a group audit, these might be satisfied.
Para 37
The sentence ‘Communication with other auditors that perform work on the financial information of components in accordance with paragraphs 22-24 takes place throughout the group audit.’ is explanatory and should be in application material.
The requirement to communicate ‘as early as possible’ is inappropriate. It is possible to communicate today about next year’s audit and indeed that of the following year. The requirement should be to communicate no later than is necessary for the communication to be effective in achieving its objectives.
The wording about the form of communication, ‘ordinarily in the form of a letter of instruction’ is suited only for inclusion in application material.
The requirement to set out the ‘form and content’ is inappropriate. Agreement on the form of communication (e.g. a letter on white paper) is a matter of administration; the requirement should relate only to the nature of the expected content.
It should be recognised that the other auditor has some say in the content of a report. Some firms ask for inappropriate representations from other auditors (more than the work would justify) and ISAs should not be written in a way that supports such practice.
Para 38(a)
The requirement beginning ‘where applicable’ is just explanatory and should be in application material. Here, concepts such as ‘clearly trivial’ are introduced and these would also be better explained in application material.
Para 38(b)
The sentence ‘This communication occurs when the group auditor is not involved in the other auditor’s risk assessment procedures.’ is explanatory and should be in application material.
Application material should identify any intended differences between ‘may affect’ and ‘likely to include’ (paragraph 7(j)) as otherwise the level of reported risk may be inappropriate.
Para 38(c)
What is the reason for including the word ‘direct’ in ‘Could have a direct bearing’?
‘Could’ denotes a very low threshold and may provoke extensive listing or ‘catch all’ wording. We suggest including some test of significance.
39 Other related requirements are worded in terms of the group auditor having to request of the other auditor. This requirement is placed on a memorandum or report (i.e. the piece of paper).
If the intention is that requirements be placed on the other auditors they should be explicitly worded as such. In that case the objective of the ISA must include aspects relevant to this. It would also assist users in such circumstances if the scope paragraph identified the fact that requirements related both to group and other auditors.
If the above is not the intention, then the material should be placed in application material.
Para 40
This requirement is placed on a memorandum or report (i.e. the piece of paper).
If the intention is that the requirement be placed on the other auditor it should be explicitly worded as such. In that case the objectives of the ISA must include aspects relevant to this. It would also assist users in such circumstances if the scope paragraph identified the fact that requirements related both to group and other auditors.
If the above is not the intention, then the material should be placed in application material.
Para 41
A group auditor should be able to decide without reference to a memorandum or report that it is necessary to discuss significant matters or take action. This might be the case where the group auditor is involved in the work or because of the significance of the component. The requirement should not be related only to a document that may not be relevant. Action need not always follow discussion.
Para 42
This is unnecessary as a separate requirement. It adds nothing to the requirements in ISAs generally to obtain sufficient evidence. If it is considered to be a useful reminder it should only be in application material.
Para 43 to 50 The proposed ISA deals with matters that are similar to those addressed in ISAs on accounting estimates and fair values. There are some differences, however. For example, the proposed ISA does not mention management representations, and combines communication with those charged with governance with group management.
We believe that it is important to the Clarity Project that a consistent approach be adopted across all ISAs or that explanation be provided where that is not appropriate.
Para 49
It is difficult to comment on the list of matters required to be communicated in addition to those in proposed ISA 260 The Auditor’s Communication With Those Charged With Governance, as the latter has not been finalised. There would appear to be some matters where the level of detail is greater than proposed in ISA 260 (49(a)) and some matters that are just examples of matters that would already be required to be reported under proposed ISA 260 as significant difficulties encountered during the audit (49(d)). When finalising proposed ISA 600 and proposed ISA 260 it is important that they be consistent.
In general, we do not support the introduction of specific requirements that deal with just one aspect of a more general requirement. Not only are such requirements unnecessary but they can divert auditors from addressing other relevant matters. Application material can be used to address matters that auditors consider in group audits in relation to ISA 260.
The introduction of a concept of being charged with the governance of a group is unnecessary because, in reality, the governance is of a company that produces group financial statements, not of a group.
We recommend changing the requirement to refer to communication with those charged with governance.
The condition in the proposed ISA 260 relating to circumstances where all those charged with governance are also involved in managing the entity should be repeated here. This point affects many ISAs and the IAASB should ensure that conforming amendments are made as part of the Clarity Project.
Para 49(c)
There is no need for the requirement to communicate instances of concern about the quality of work of other auditors.
Such information may be relevant to fee negotiations or a desire on the part of the group auditor to have components change auditor to a network firm but is of no significant relevance for governance purposes, unless it results in circumstances that are already required to be reported under ISA 260.
The requirement opens up issues of confidentiality, the expertise of auditors in assessing ‘quality’ as opposed to whether sufficient appropriate evidence has been obtained, obligations to report bad work to professional bodies, intra-firm responsibilities (where the other auditor is not in another firm) and so on. There is also no requirement placed on other auditors to report in relation to the group auditor – arguably of much more interest to those charged with governance.
We strongly recommend deleting this requirement.
Para 49 & 50
There is a lack of consistency as paragraph 49 refers to proposed ISA 260 alone whereas paragraph 50 refers to ISA 230 Audit Documentation and the other ISAs. Either construction could be used, but we recommend that a consistent approach be adopted here, and for many other ISAs during finalisation of the Clarity Project.
Para 50
Given the extensive mention of reports from other auditors, we query whether the retention of those documents should be included. Application material could usefully discuss this and (if requirements relating to the consolidation process are retained) explain documentation-related considerations.