Communication with component auditors
ISA 600 requires the group audit team to communicate its requirements to the component auditor on a timely basis. This will include the work to be performed by the component auditor and the use to be made of it. It will set out the form and content of the information to be provided by the component auditor.
Such communication is required to set out:
- The ethical requirements relevant to the group audit, and in particular the independence requirements.
- Component materiality level (the materiality for a component determined by the group) and the threshold, above which misstatement cannot be determined to be clearly trivial to the group.
- Significant risks of material misstatement identified for the group financial statements which are relevant for the component auditor and a request that the component auditor will notify the group auditor on a timely basis of other identified risks along with their response to those risks.
- A list of related parties identified by group management and any other related parties the group auditor is aware of along with a request that the component auditor communicates any further related parties not identified by the group management or the group engagement team.
The component auditor is required to confirm that they will cooperate with the group engagement team and provide information on a timely basis. The information expected to be provided to the group engagement team by the component auditor includes:
- Confirmation of their compliance with the group auditor’s requirements and ethical standards.
- Any non-compliance with laws and regulations by the component.
- Uncorrected misstatements of the financial information of the component.
- Indicators of possible management bias.
- Description of any significant deficiencies identified in internal controls.
- Other significant matters such as those they expect to communicate to those charged with governance; written representations requested of component management.
- Their overall findings and audit opinion or conclusions.
Obtaining sufficient appropriate audit evidence regarding the components and the consolidation process
Stage one – Gathering evidence on the components
Planning and risk assessment
When formulating the audit strategy and plan, the group auditor has a good understanding of the structure of the group, the significance of each component of the group, the mechanics of the consolidation process, and the risk of material misstatement presented by each of the company’s financial statements. Materiality levels should be established for the group in aggregate, and for the individually significant components.
The group auditor is required to be involved in the component auditor’s risk assessment and the determining of the nature, extent and timing of procedures to address the identified risks of material misstatement for all significant components.
Regardless of whether the company is exempt from audit due to its size, if a component has been determined to be significant due to its specific nature or circumstances (rather than its size) then either the group audit team or a component auditor on its behalf must perform one or more of:
- An audit of the financial information of the component using component materiality.
- An audit of one or more specific account balances, transactions or disclosures relating to the significant risks of material misstatement.
- Specific audit procedures relating to the likely significant risks of material misstatement.
For components not significant to the group, the group engagement team must carry out analytical procedures at the group level.
Involvement in the work of component auditors
For all companies within the group, regardless of materiality, the group auditor should review a report of work done by the component auditor and evaluate significant matters arising. Such maters will be discussed with the component auditor, the component management or the group management as appropriate.
It may be the case that, having performed the actions outlined above, the group auditor concludes that further audit work is required on the financial statements of a component. For example, the group auditor may consider that an element of the financial statements of the component could be materially misstated and that further audit evidence is necessary.
The group auditor should determine the nature of the work necessary and whether the work should be carried out by the group auditor or the component auditor.
Having taken the actions outlined above, the group auditor should now have obtained sufficient evidence to show that component financial information is free from material misstatement and are a sound basis for the preparation of the consolidated financial statements.
Stage two – Auditing the consolidation
The consolidation process
The group auditor must plan the audit procedures to be performed on the consolidation process. For some groups, the consolidation will be complex and is likely to involve some areas of judgement and so there is a high degree of audit risk. Thorough planning will be essential to ensure that audit risk is minimised.
The group auditor will require an understanding of the group-wide controls relevant to the consolidation process, for example the instructions issued to components by management. The group auditor will need to assess the adequacy of such controls and their operating effectiveness in determining whether reliance can be placed upon those controls in determining the nature, extent and timing of procedures on the consolidation.
The types of audit procedures which could be performed include:
- Confirming that figures taken into the consolidation have been accurately extracted from the financial statements of the components and that all components are included.
- Evaluating the classifications of the components of the group – for example, whether the components have been correctly identified and treated as subsidiaries, associates or joint ventures.
- Reviewing the disclosures necessary in the group financial statements, such as related party transactions and minority interests.
- Investigating the treatment of any components which have a different financial year end or accounting policies from those of the rest of the group.
- Gathering evidence appropriate to the specific consolidation adjustments made necessary by financial reporting standards, including, for example:
- the calculation of goodwill and its impairment review
- cancellation of intra-group balances and transactions
- provision for unrealised profits as a result of intra-group transactions
- fair value adjustments needed for assets and liabilities held by the component
- retranslation of financial statements of components denominated in a foreign currency.
Some of the evidence required to meet the above objectives will be gathered by the component auditor, and it is the group auditor’s responsibility to communicate to the component auditor the evidence which they are expected to gather. This communication ideally occurs at the audit planning stage.
The group auditor must have a sound knowledge of the relevant financial reporting standards, which include:
- IFRS® 3, Business Combinations
- IAS® 28, Investments in Associates and Joint Ventures
- IFRS 9, Financial Instruments
- IAS 32, Financial Instruments: Presentation