Group audits and component auditors

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Group audits and component auditors

MODULE 3 | 3.6.1 | STUDENT COMPANION

The group engagement partner is responsible for the whole group audit, including directing, supervising

and reviewing the work of component auditors. The group auditor decides where work is needed by risk,

not just size; expects access to information and people from the start; evaluates and instructs component

auditors and understands their work; sets component performance materiality below group performance

materiality; and audits the consolidation in its own right.

The standard and its terms

Group audits follow the revised international standard on group audits (ASA 600 in Australia), which applies to

periods beginning on or after 15 December 2023 and takes a risk-based approach. A component is whatever

unit the group auditor chooses for planning and performing the work. A component auditor is any auditor who

performs work on a component for the group audit, whether from the same firm, a network firm or an unrelated

firm.

Who's who in a group audit

Group engagement

partner and team

Responsible for managing and

achieving quality on the whole

group audit, including directing,

supervising and reviewing the

component auditors' work

Group management

Prepares the consolidated

financial statements

Those charged with

governance

Oversee the group's financial

reporting

Component auditors

Same firm, a network firm or an

unrelated firm

Component management

Prepares each component's

financial information

Communicates Communicates

Instructions,

review

Findings

reported back

Access to

people and

information

Component auditors work on each component's financial information

What counts as a component?

Whatever unit the group auditor chooses for planning and performing the work: a subsidiary, a division, a shared function such as a central payroll centre,

or a combination

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.1 | STUDENT COMPANION

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Deciding where work is needed

The group auditor first understands the group, its components and the consolidation process, then works out

where the group financial statements could be materially misstated, and only then decides which components

need work, and what kind.

Kind of work When it suits

An audit of the component's financial

information

Components that are large, or that carry risks across many of their

balances

Audit procedures on specific balances or risks Components where the risk sits in particular items, such as stock in

transit or balances between group entities

No further work there, beyond the group

auditor's own risk assessment at group level

Small, low-risk components

Access comes first. When deciding whether to accept the engagement, the group auditor considers whether it

can reasonably expect sufficient appropriate evidence, including access to information and to people at the

components. Serious restrictions can make that evidence unobtainable, leading to a declined engagement or a

disclaimer of opinion.

Scoping the Voltana group

Voltana group: one set of consolidated financial statements

New Zealand subsidiary

Installs batteries in New Zealand; revenue

about $30 million

Component auditor: audited by a New

Zealand firm, working to Linden Ridge's

detailed instructions

Parent: Voltana Energy Ltd

Brisbane; assembles and sells the batteries;

most of the group

Audited by Linden Ridge itself

Singapore procurement company

Small. Buys cells from overseas suppliers

and sells them to the parent; holds stock in

transit; large balances owed between group

entities

Targeted procedures by Linden Ridge

itself: stock in transit, prices charged

between group entities, balances eliminated

on consolidation

cells

Size alone doesn't decide the scope. Risk does. At group level: consolidation adjustments, eliminations, currency translation and

events after year end at each component

Why Singapore gets attention. It is the smallest component, but stock in transit, the prices charged between

group entities and the balances to be eliminated are all places where the group numbers can go wrong, so

Linden Ridge tests them itself.

Using a component auditor

Before using a component auditor, the group auditor considers whether it understands and will comply with the

relevant ethical requirements, including independence, and whether it has the competence and capabilities the

work needs, including enough time. The regulatory environment matters too, such as whether audit firms in that

country are actively inspected.

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Working with a component auditor

First, evaluate the

component auditor Ethics, including independence Competence and capabilities,

including enough time

Regulatory environment: are audit

firms there actively inspected?

Group auditor

Linden Ridge Partners,

Brisbane

Component auditor

The New Zealand firm

auditing the installation

subsidiary

Instructions

The work to be performed

Component performance

materiality

The deadlines

Identified risks, including fraud

risks

Known related parties

Reporting back

Findings, misstatements, control deficiencies, suspected fraud

The group auditor reviews the component auditor's documentation as needed. Its involvement depends on the risks, and it never accepts a

conclusion without understanding the work behind it.

Materiality and the consolidation

Aggregation risk. If every component were audited to the group's full performance materiality, undetected

misstatements just below that level in several components could add up to a material misstatement of the

consolidated statements. Setting component performance materiality below group performance materiality

reduces that risk; it need not be the same for every component.

The consolidation process gets its own procedures: consolidation adjustments, the elimination of balances

and transactions between group entities, the translation of figures in foreign currencies, and events after year

end at each component.

The report. Unless the law requires it, the auditor's report on the group financial statements doesn't refer to a

component auditor. The group auditor takes full responsibility for the opinion.

Case note: Sino-Forest

Sino-Forest was listed on the Toronto Stock Exchange and reported that it owned large forestry plantations in

China, with reported total assets of about US$5.7 billion. In June 2011 a short seller published a report alleging

that the company had greatly exaggerated its assets. The share price collapsed, the company sought creditor

protection the following year, and Ontario's securities regulator later found that former senior executives had

committed fraud. The company had bought much of its timber through intermediaries, and ownership was hard

to establish from documents alone. Its auditor later agreed to pay C$117 million to settle a class action, without

admitting liability, and reached a separate settlement with the regulator.

The lesson for group audits: when key assets sit far away, under unfamiliar legal systems, the auditor needs

evidence about existence and ownership that it can trust, from sources independent of management, and

enough local knowledge to judge it.

Source: Capital Markets Tribunal (Ontario) reasons and decision (July 2018); Ontario Securities Commission order (September 2014);

Ontario Superior Court approval of the class action settlement (2013).

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Practice questions

MODULE 3 | 3.6.1 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Scope the Varrigan group

Varrigan Cycles Ltd (imagined) is an ASX-listed designer of bicycles and e-bikes. The parent holds the brand

and sells online; it has five subsidiaries. Decide what kind of work each subsidiary needs for the group audit, and

who should do it.

Subsidiary and facts Kind of work, and who

does it

Why

(a) Varrigan Assembly Pty Ltd (Adelaide).

Assembles the bikes; 62% of group revenue; holds

most of the group's inventory and its warranty

provision.

(b) Varrigan NZ Ltd. Sells to bike shops in New

Zealand; 7% of group revenue; steady trading, no

unusual risks; audited by a local firm for its own

statutory accounts.

(c) Varrigan Frames (Vietnam). Makes frames and

sells all of them to (a) at prices set by head office;

no outside revenue, but 15% of group inventory; a

new stock system went live this year; audited by a

local firm.

(d) Varrigan UK Ltd. A European distributor bought

on 1 March; 14% of group revenue since then; $38

million of goodwill arose on the purchase; its auditor

was appointed by the previous owners.

(e) Varrigan Finance Pty Ltd. Holds the group's

$120 million bank loan, with covenants tested

quarterly, and its foreign exchange contracts; no

revenue.

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Question 2 - Instructions to a component auditor

Varrigan's group auditor will use the UK firm that audits Varrigan UK Ltd as a component auditor. Draft the main

contents of the group auditor's instructions to that firm.

Question 3 - No access to the working papers

The Vietnamese firm that audits Varrigan Frames tells the group auditor that it will not let anyone outside the firm

see its working papers. How should the group auditor respond?

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Worked answers

MODULE 3 | 3.6.1 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Scoping Varrigan (suggested)

Work, and who Why

(a) Assembly An audit of its financial information, by the group

team

The largest component; risks in inventory,

warranty and revenue

(b) NZ No further work may be needed beyond the group

auditor's own risk assessment at group level

Small, stable and low risk

(c) Frames Procedures on inventory, the prices charged to (a)

and the balances to eliminate

Risk, not size: big inventory share, new stock

system, prices set by head office

(d) UK Audit by the UK firm as component auditor; the

group team audits the acquisition accounting

Material and new, with an auditor to evaluate;

goodwill and fair values are group judgements

(e) Finance Specific procedures by the group team, possibly

with a valuation expert

The loan, covenants, foreign exchange contracts

and hedging all affect the group statements

Question 2 - Main contents of the instructions

Area What to include

The work An audit of Varrigan UK's financial information for the group audit, using the group's accounting

policies and reporting package, at the group reporting date

Materiality Component performance materiality, and the amount above which misstatements must be

reported to the group team

Risks and related

parties

Group risks that affect the component, including fraud risks and those from the acquisition;

related parties known to the group, and a request to report any others

Ethics The ethical requirements, including independence, and a confirmation of compliance

Timetable Deadlines for planning, interim and final reports; key dates such as the stocktake

Reporting back Findings; corrected and uncorrected misstatements; control deficiencies; fraud or suspected

fraud; breaches of laws; going concern doubts; later events; significant judgements

Access Which working papers the group team will review, and arrangements for discussions or visits

Question 3 - Refused access to working papers

Find out why. A law that stops audit papers leaving the country, a firm policy or plain reluctance each needs

a different answer. A restriction imposed by group or component management is more serious.

Look for other routes. Review the papers at the firm's office or by supervised screen share, hold detailed

discussions, and ask Varrigan's management and audit committee to help remove the restriction.

Do the work another way. If the work still can't be understood and evaluated, the group team performs the

procedures on inventory and group balances itself, or engages another firm.

Consider the opinion. Without sufficient appropriate evidence, the opinion is modified: qualified, or a

disclaimer if the possible effects are pervasive. Tell those charged with governance, document it, and weigh it

when deciding whether to continue as auditor.

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.1 | WORKED ANSWERS

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