Group audits

The audit of group financial statements is an area frequently examined in the Advanced Audit and Assurance examination (AAA). It can be tested at any stage of the audit cycle and therefore in any section of the examination. It is important that candidates are able to identify risks arising from aspects of group audits and the responsibility of auditors in this regard. This article will focus on the key areas of group audit, highlighting sections of ISA 600, Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors). Candidates should be familiar with the standard prior to sitting the AAA exam.

The group auditor is responsible for providing the audit opinion on the group financial statements. Components of the group financial statements can include subsidiaries, associates, joint ventures and branches. The components may be audited by the group auditor or may be audited by a different firm of auditors known as the ‘component auditors’. In addition, the group auditor will form an opinion on the parent company’s individual financial statements.

ISA 600 states that the objectives of the auditor are:

(a) To determine whether to act as the auditor of the group financial statements; and

(b) If acting as the auditor of the group financial statements:

(i) To communicate clearly with component auditors about the scope and timing of their work on financial information related to components and their findings; and

(ii) To obtain sufficient appropriate audit evidence regarding the financial information of the components and the consolidation process to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework

The group auditor cannot simply rely on another auditor’s opinion on the financial statements of the company and assume that the figures taken from the company’s financial statements into the consolidated financial statements are appropriate. A material misstatement in the financial statements of a company could become a material misstatement in the financial statements of the group.

Determining whether to act as the auditor of the group financial statements

Prior to acceptance of a new engagement as group auditor, the group engagement partner must determine whether they can reasonably expect to obtain sufficient appropriate evidence in relation to the consolidation process and the financial information of the components of the group in order to form their audit opinion.      

As part of this process, it is necessary to obtain an understanding of the group, it’s components and the environments of the components in order to identify significant components of the group. A significant component is one which is of individual financial significance to the group or, due to its specific nature of circumstances, is likely to include significant risks of material misstatement of the group financial statements. Where a significant component is audited by another party, it must be evaluated whether the group audit team will be able to be involved in the work of the component auditors to the extent necessary to obtain sufficient appropriate audit evidence.   

Exam focus


The acceptance and continuation aspect of group auditing could be examined in several ways. Examples include questions which require a candidate to analyse whether to accept a new group audit client or to identify issues which may require the group auditor to resign from an existing client. It could also be examined in the context of quality control and professional issues if, for example, a group audit had been performed and there had been an indication that the firm might reasonably have expected a difficulty obtaining evidence with respect to a component auditor.   

The concept of a significant component is something which impacts many areas of the syllabus. For example, identifying significant components could be examined in a planning question for a group of companies or may be part of an evaluation of evidence at completion.

ISA 600 provides guidance on what might constitute a significant component however that guidance stresses that this is a matter of professional judgement, rather than a set of definitive rules. The standard states that depending on the nature and circumstances of the group, a group engagement team may decide to apply a percentage such as 15% to an appropriate benchmark to identify components which are financially significant (for example, group assets, cash flows, profits or turnover).   

An example given of a significant component through specific circumstances might be a component responsible for international trading which could expose the group to significant foreign currency risk despite not otherwise being of financial significance to the group.   

In the AAA examination, candidates are expected to apply judgement to the scenario given in a question rather than simply assume that 15% of a given benchmark is appropriate in all circumstances.

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

Exam focus

Questions set at the planning stage which ask for consideration of risks of material misstatement/audit risk arising from a scenario are often set in the context of a group. As such, candidates would be expected to identify specific risks arising as a result.

Candidates could be expected to recognise and justify whether a component is significant, consider the classification risks arising from a component or other unusual/ significant risk arising in relation to a component. In addition, candidates might be expected to identify specific weaknesses or risks arising in the consolidation process. For example:
 

  • - differences in reporting dates which could cause a risk of inappropriate figures being included in the consolidation for a component
  • - a client producing group accounts for the first time may have increased inherent and control risk arising from a lack of experience
  • - trading difficulties in a subsidiary which may indicate an impairment adjustment is required for goodwill held in the consolidated financial statements.   


Candidates may also be expected to describe the procedures to be performed or evidence which should be obtained in relation to the risks arising in a group which could be examined at any point in the audit cycle.

Candidates could also be required to evaluate whether sufficient appropriate audit evidence has been obtained with regards to the financial statements of a group of companies in order to determine an appropriate audit opinion. Candidates may also be asked to identify matters to communicate to management or those charged with governance or to assess ethical and professional issues in a group context.

Conclusion

Group audits are frequently examined in the AAA exam and are examinable in a variety of ways across many syllabus areas. Candidates are expected to have strong knowledge of the underlying accounting issues arising in a group context in addition to the audit implications. Practice of past questions on the issues arising in groups should be performed in order to enhance understanding of the syllabus content and what the examining team are expecting from candidate responses.   

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