AAA - Understanding Group Audits

Group Audits is a frequently tested area in the AAA exam. Questions on Group Audit can be set at the audit planning stage in Question 1 and also at the completion, review and reporting stage in Question 2. A planned approach to these questions can guarantee you full marks in these question requirements. Reference to ISA 600 (Revised) can help you score more.

A typical question on group audit will test you on the following points.

• Incorrect classification of the group entity
• consolidation errors
• related party transactions
• goodwill
• work done by component auditors.

Let us dive deep into each of these issues

Incorrect Classification of Investments

The first issue is incorrect classification of the entity.

The entity that you have invested in might be subsidiary or it might be a JV or it might be an associate. The question will usually have an incorrect classification. For example an entity in which you have invested and classified as a joint venture might in fact be a subsidiary or vice versa and incorrect classification and presentation presents the risk of material statement. So this could be the first type of issue that you will be asked to comment upon.

What you have to understand is how exactly does the classification work ? You will have to refer to the relevant accounting standards. You should be well versed with IFRS 3, IFRS 11, IAS 28, IFRS 12. It might so happen in a question that your shareholding is more than 60% and yet the question will say that unanimous decision making is required, which means, even if you have 60% shares in the other company, you are not in a position to control, i.e direct the activities of the other company. All the 100% shareholders have to agree. So despite having a 60% shareholding, it will not be treated as a subsidiary. It is still a situation of joint control and hence its classification as a subsidiary is factually incorrect.

Work of Component Auditors

The second most commonly tested area is the work of component auditor. You have to understand why group audits are inherently risky.

You are the auditor of the holding entity or the parent entity and the subsidiary company has a separate auditor. Now naturally, if there is a separate auditor, you have not performed any of the audit procedures that are required to obtain sufficient appropriate audit evidence for expressing an opinion on the financials of subsidiary. But you are auditing the consolidated financial statements which includes holding company plus the results and performance and position of the subsidiary company. Also, you are commenting on the group as a whole, but you have not audited the subsidiaries so it will be very difficult for you to state that the financial statements of the group present a true and fair view. Now that they are getting consolidated, it is important that there are certain steps that have to be performed when it comes to the work of component auditors. The question tests you on this aspect.

When you are evaluating the work of component auditor, keep a constant reference to ISA 600 (revised,) which includes documentation requirements and other situations where there are restrictions on access to component auditor documentation. ISA 600 (revised) also emphasises the importance of group auditor's review of component auditor audit documentation.

When assessing the work of component auditor, points to be kept in mind ?

• Reputation / experience
• Competence / Qualifications ?
• Objectivity / Independence ?
• Regulatory Environment [ including ethics ] ?
• Ability to review the work of component auditor

Candidates may be asked to access the work performed by a component auditor and there could be a quality management impact. You should also include reference to ISQM1 in the response.

If it is being tested, in the completion review part, it might require you to evaluate whether sufficient appropriate audit evidence was obtained and how has that impacted the audit opinion you will also be asked to identify matters to communicate with management or to those charged with governance.

Consolidation Errors

The third type of issue could be consolidation related errors may be a certain value has been calculated incorrectly. Maybe the disclosure requirements have not been fulfilled. The subsidiary might have a different financial reporting framework. Its accounting policies could be different. There could be another error that reporting dates could be different. You will have to discuss consequences of these. You might be required to make reference to specific aspects of the accounting standards.

Related Party Transactions

Related party transactions, i.e. transactions between the holding and subsidiary company and transactions with the directors. If the companies have common directors , then transactions with them, all of these require adequate disclosure as per IAS 24. Also, in such cases a reference to the appropriate auditing standard is also important. The fourth issue could be that the disclosures relating to related party transactions are inadequate.

Goodwill

Goodwill calculation is another major challenge that can be given in a group audit question. There are multiple approaches to calculating goodwill. There is a full goodwill method. There is a proportionate Goodwill method. The Goodwill could be impaired in some cases.

You will need a good grip on these.

The issues could be

• Incorrect calculation of goodwill
• impairment impact not dealt with
• impairment has been reversed

Reference to accounting standard will help you score marks in this topic.

Consolidation Process

In the exam, it is expected that you are proficient in understanding the consolidation process. If you know how the consolidation process works, how is goodwill calculated, how is noncontrolling interest calculated you will be able to judge whether the figures are materiall misstated or not.

Candidates might be even expected to identify specific weaknesses or risks in the consolidation process. For example, a client producing group accounts for the first time may have increased inherent and control risk because of a lack of experience And how the group audit procedures are performed is dependent on that aspect also.

Now in terms of how much do you need to revise from the accounting standards? I am listing out areas for you which are important.

• Classification of investment in different entities
• calculation of goodwill and impairment
• intra-group transactions
• the equity method of accounting
• situations of changes in group structure. It could be a step acquisition, step disposal, control to control transfer
• foreign subsidiary

You need to be thorough with IFRS 3, IFRS 10, IFRS 11, IFRS 12, IAS 28.

Audit Procedures

What are some of the common audit procedures that these questions test you on

• evaluating the classification of components
• checking whether the figures taken into the consolidation process have been accurately extracted from the financial statements of the component
• reviewing the disclosure requirement
• treatment of component and gathering sufficient appropriate audit evidence for consolidation adjustments, specifically with respect to fair value of items
• translation of financial statements of the foreign subsidiary
• and you might be asked to comment on trading difficulties and subsidiary, which may indicate an impairment adjustment is required

How to secure Professional Marks in this question type ?

Professional Scepticism

ISA 600 specifically focuses on professional scepticism throughout the standard. Because you are using the work of another Auditor, and you don’t have access to books of accounts or any data of the subsidiary (because you are not the auditor of the subsidiaries), you will need to have a questioning mind.

The skill of scepticism will be tested here and that will include challenging the result of audit work of the component, assessing the judgements made by the management in goodwill calculation, accounting treatment of invest investment in entities, questioning the competence of the auditor and trying to obtain SAAE for the same

Commercial Acumen

The relative merits of travelling to overseas subsidiary or utilising a component auditor. Having a commercial consideration for an audit firm - do you need to travel to the subsidiary location to perform the audit or can you sit back here and rely on the work done by the competent auditor. That is basically where your commercial acumen skill will be tested.

Hope this helps you in preparing for the Group Audits question in your AAA paper.

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