ACCA P7 Chapter 9 Group Audits

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Chapter 9

Introduction to Group Audits

In a group situation, the parent entity will have to prepare its own audited financial statements together with audited group financial statements incorporating the results of all subsidiary entities. The group financial statements will be audited by the parent entity auditors, who are known as the Group Auditors.

Using the work of another auditor

The group auditors have sole responsibility for the opinion on the group financial statements. The auditors of the subsidiary entities (component auditors) are a source of evidence only.

The group auditors must decide how much reliance they will place on the work performed by these component auditors. In order to do this they will consider the qualifications, experience and resources of the component auditors.

Generally the group auditors should have the right to ask the component auditors for all reasonable information and explanations. In addition, the component auditors should inform the group auditors of any matter they discover during their audits that might be relevant to the audit of the group financial statements.

Matters to discuss with the component auditors

The component auditors must be informed of the use that is to be made of their work. They should also be advised of the standard and scope of work required, together with reporting deadlines.

It is common practice to ask the component auditors to complete a checklist to confirm that they have applied the required audit procedures.

Issues arising when a subsidiary is located overseas

When a subsidiary is located overseas a number of potential difficulties could arise:

Different accounting policies might be used in the overseas country. Under IAS 27, the subsidiary financial statements must be brought into line with the accounting policies used by the parent entity in order to consolidate properly. The group auditors will use the checklist mentioned above to determine the accounting policies used.

There may be cultural problems unique to the country in which the subsidiary operates. The group auditor will need to be sensitive to these during dealings with the other auditors.

Language problems may arise. This problem can be easily overcome by using staff who can speak the relevant language or by using a translator.

There may be issues in existence which are specific to the country in which the subsidiary operates. For example, in some countries in the continent of Africa, inflation runs at in excess of 100% per annum. Financial statements produced in these circumstances will need to be adjusted prior to consolidation with the parent entity. Factors such as these will need to be identified for each subsidiary and resolved as appropriate during the audit.

Matters to consider before accepting appointment as group auditor to a group

The group auditor must participate sufficiently in the audit of the group to enable them to give an opinion on the group financial statements.

Before accepting appointment as group auditor they should consider:

• the materiality of the portion of the financial statements which they do not audit
• the degree of their knowledge regarding the business of the subsidiaries
• the nature of their relationship with the component auditors
• their ability where necessary to perform additional procedures to enable them to act as group auditors; and
• the risk of material misstatements in the financial statements of the subsidiaries audited by component auditors

The correct classification of investments

An investment is treated as a subsidiary when the parent entity has dominant influence over that invested entity. Where significant influence is held the investment is treated as an associate in accordance with IAS 28. It is important that the degree of control exercised by the parent entity is tested by the auditors.

The auditors need to consider how an investment fits into the activities of the group. They should review board minutes for evidence of the degree of influence exercised by the parent entity. They should also discuss the matter with the parent entity directors.

The existence of other significant shareholders may indicate that the parent entity has little influence. The auditors should check the register of members to determine the level of shareholding and potential influence held by other shareholders.

The auditors should also consider how easy it is to obtain information about the invested entity. This could also be an indicator of significant influence.

Group consolidation – audit procedures

After receiving and reviewing the financial statements from all subsidiaries and associates, the group auditor must audit the group financial statements. The main procedures would be as follows:

• check the transcription of the audited financial statements of each invested entity to the consolidation schedule.
• check that the adjustments made on consolidation are appropriate and consistent with prior years. The adjustments could be permanent or current year adjustments.
• the consolidation schedules should be checked for arithmetical accuracy.
• the group financial statements should be checked for compliance with international financial reporting standards.
• an opinion should be formed on the truth and fairness of the group financial statements.

Letters of support

A ‘letter of support’ is an agreement made between a parent entity and its subsidiary or fellow subsidiary under which one entity agrees to provide support, in the form of funding, to the other entity in order that it may meet its debts and liabilities.

A letter of support may be required from the parent entity where it appears that a subsidiary is not a going concern and will be unable to pay non-group creditors as they fall due.

Audit work

The auditor needs to determine whether the parent entity has the power to provide a letter of support. The following should be obtained:

written confirmation from the parent entity’s solicitors to the effect that the giving of the support is permitted under the constitution, is not beyond the entity’s powers, and that it is within the powers of the board of directors to give the support; or

if the transaction is not permitted by the constitution, a certified copy of the special resolution amending the constitution to authorise the parent entity to give the letter of support.

Implications for the auditors’ report where a subsidiary has been qualified

In a group situation, materiality and risk must be assessed in the context of the group as a whole. It is possible therefore for a qualification in a subsidiary to be wholly immaterial in the group financial statements. If this is the case, an unqualified opinion could be given on these financial statements.

Where the group auditors conclude that adequate evidence about the work of the component auditors cannot be obtained and they have been unable to perform sufficient additional procedures with respect to that subsidiary, they should consider the implications for the audit report.

Example

You are auditing the group financial statements of the Royle Group plc for the year ended 30 September 2010.

The group has three group subsidiaries, James plc, Barbara plc and Anthony plc.

You are not the auditor of Anthony plc, a manufacturer.

Describe the audit work that you would carry out before placing reliance upon the work carried out by the auditors of Anthony plc.

Joint audits

A joint audit can be defined as one “where two or more auditors are responsible for an audit engagement and jointly produce an audit report to the client”.

Reasons for joint audits

Two or more firms could act as joint auditors for the following reasons:

in a new acquisition the parent entity may insist that their auditors act jointly with those of the new subsidiary.

an entity operating from many distant locations may find it useful to have joint auditors.

overseas subsidiaries may need to employ local audit firms to satisfy the laws of the country in which they operate. These local auditors may act jointly with the group auditors.

some entities may prefer to use local auditors while at the same time enjoying the greater range of services offered by a large international firm.

Before accepting appointment as a joint auditor it will be necessary to consider the experience and standards of the other firm.

The allocation of work between the firms needs to be agreed and the auditors should agree whether joint or separate engagement letters will be sent.

Both firms must sign the audit report and both are responsible for the whole audit. They are jointly liable in the event of litigation.

Fair values

Goodwill must be calculated based on fair values according to IFRS 13. The auditors will need to audit these calculations.

Example

One of your firm’s largest clients, Sydney plc, is in the process of negotiating a substantial takeover of Lake Eyre plc. The following calculation of goodwill has been prepared:

State the audit work that you would perform on the goodwill relating to Lake Eyre arising on consolidation