Audit of group financial statements (part I)

 Objectives of the group financial statements audit

Group audit is the audit of group financial statements. Group financial statements are financial statements that include the financial information of more than one component. The term “group financial statements” also refers to combined financial statements aggregating the financial information prepared by components that have no parent but are under common control.

Component is an entity or business activity for which group or component management prepares financial information that should be included in the group financial statements.

The objectives of the group auditor of the group financial statements are:

(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.

 

Assessing and identifying the risks of material misstatements of the group financial statements

 Auditors identify and assess the risks of material misstatement through obtaining an understanding of the group and its environment by performing the following steps:

(a)   Enhance its understanding of the group, its components, and their environments, including group-wide controls, obtained during the acceptance or continuance stage; and

Group-wide controls may include a combination of the following:

·       Monitoring of components’ operations and their financial results.

·       Group management’s risk assessment process.

·       Monitoring, controlling, reconciling, and eliminating intra-group transactions and unrealized profits.

·       A process for monitoring the timeliness and assessing the accuracy and completeness of financial information received from components.

·       A central IT system controlled by the same general IT controls all or part of the group.

·       Monitoring of controls, including activities of the internal audit function.

·       Consistent policies and procedures, including a group financial reporting procedures manual.

(b) Obtain an understanding of the consolidation process, including the instructions issued by group management to components.

The group engagement team’s understanding of the consolidation process may include matters such as the following:

·       Matters relating to the applicable financial reporting framework (the process for identifying and accounting for components in accordance with the applicable financial reporting framework, the process for identifying related party relationships and related party transactions, the procedures for dealing with components with financial year-ends different from the group’s year-end).

·       Matters relating to the consolidation process (ensuring that uniform accounting policies are used to prepare the group financial statements, ensuring that translating the financial information of foreign components into the currency of the group financial statements is correct, ensuring that group management’s process for obtaining information on subsequent events takes place).

·       Matters relating to consolidation adjustments.  Matters relating to consolidation adjustments are listed below:

·   The process for recording consolidation adjustments, including the preparation, authorization, and processing of related journal entries.

·  The consolidation adjustments required by the applicable financial reporting framework.

·       Business rationale for the events and transactions that gave rise to the consolidation adjustments.

·       Frequency, nature, and size of transactions between components.

·  Procedures for monitoring, controlling, reconciling, and eliminating intra-group transactions and unrealized profits, and intra-group account balances.

·       Steps taken to arrive at the fair value of acquired assets and liabilities, procedures for goodwill calculation and impairment testing of goodwill.

Conditions and events that may Indicate risks of material misstatement of the group financial statements.

The following examples of events and conditions may Indicate risks of material misstatement of the group financial statements:

·       A complex group structure with frequent acquisitions and disposals or reorganizations

· Poor non-transparent corporate governance structures including decision-making processes.

·       Non-existent or ineffective group-wide controls

·       Components operating in foreign jurisdictions may be exposed to factors such as unusual government intervention in areas such as trade and fiscal policy, restrictions on currency and dividend movements, and fluctuations in exchange rates.

·       Business activities of components that involve high risk, such as long-term contracts or trading in innovative or complex financial instruments.

·       Unusual, related party relationships and transactions.

·     Prior occurrences of intra-group account balances that did not balance or reconcile on consolidation.

·    The existence of complex transactions that are accounted for in more than one component.

·     Components’ application of accounting policies that differ from those applied to the group financial statements.

·       Components with different financial year-ends, which may be utilized to manipulate the timing of transactions.

·       Prior occurrences of unauthorized or incomplete consolidation adjustments.

·     Aggressive tax planning within the group, or large cash transactions with entities in tax havens. Frequent changes of auditors engaged to audit the financial statements of components.

The list of examples is not complete, and auditors may meet other events and conditions in their practice that may indicate risks of material misstatement of the group's financial statements.

Information used to identify the risks of material misstatement of the group financial statements due to fraud.

The auditor is required to identify and assess the risks of material misstatement of the financial statements due to fraud, and to design and implement appropriate responses (procedures) to the assessed risks. Information used to identify the risks of material misstatement of the group financial statements due to fraud may include the following matters:

·     Group management’s assessment of the risks that the group financial statements may be materially misstated as a result of fraud.

·     Group management’s process for identifying and responding to the risks of fraud in the group.

·       Whether there are particular components for which a risk of fraud is likely.

·      How those charged with governance of the group monitor group management’s processes for identifying and responding to the risks of fraud in the group.

·       Responses of those charged with governance of the group, group management, appropriate individuals within the internal audit function to the group engagement team’s inquiry whether they have knowledge of any actual, suspected, or alleged fraud affecting a component or the group.

Materiality for the purposes of the group financial statements audit

Misstatements, including omissions, are considered to be material if they, individually or in aggregate, could reasonably influence the economic decisions of users taken on the basis of the financial statements.

Financial statements are reliable if there are no material misstatements in them. Accordingly, when conducting an audit, it becomes necessary to determine the level of materiality.

During planning, the group auditor must establish the following:

·       Materiality for the group financial statements as a whole.

·    The materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures (in the specific circumstances of the group).

·      Component materiality for those components where component auditors will perform an audit or a review for purposes of the group audit. Different component materiality may be established for different components. Additionally, the group engagement team shall evaluate the appropriateness of performance materiality determined at the component level.

·       The threshold above which misstatements cannot be regarded as clearly trivial to the group financial statements. Misstatements identified in the financial information of the component that are above the threshold for misstatements are communicated to the group engagement team.

Overall Audit strategy and audit plan for audit of group financial statements

An overall audit strategy and an audit plan are the main documents of the planning of an audit of financial statements. An overall audit strategy sets the scope, timing, and direction of the audit and may include following matters:

Characteristics of the engagement

The financial reporting framework on which the financial information to be audited has been prepared, including any need for reconciliations to another financial reporting framework.

The expected audit coverage, including the number and locations of components to be included.

● The nature of the control relationships between a parent and its components that determine how the group is to be consolidated.

● The extent to which components are audited by other auditors.

The reporting currency to be used, including any need for currency translation for the financial information audited.

● The need for a statutory audit of standalone financial statements in addition to an audit for consolidation purposes.

Reporting objectives, timing of the audit, and nature of communications

·       The entity’s timetable for reporting.

·     The discussion with management and those charged with governance regarding the expected type and timing of reports to be issued and other communications, both written and oral, including the auditor’s report, management letters and communications to those charged with governance.

·      Communication with auditors of components regarding the expected types and timing of reports to be issued and other communications in connection with the audit of components.

Significant factors, preliminary engagement activities, and knowledge gained on other engagements.

·       The determination of materiality.

·    The preliminary identification of significant components and material classes of transactions, account balances and disclosures.

·       Preliminary identification of areas where there may be a higher risk of material misstatement.

·       The impact of the assessed risk of material misstatement on the overall financial statement level on direction, supervision, and review.

·       Evidence of management’s commitment to the design, implementation, and maintenance of sound internal control, including evidence of appropriate documentation of such internal control.

·    Changes within the applicable financial reporting framework, such as changes in accounting standards, which may involve significant new or revised disclosures.

·    Significant business developments including changes in information technology and business processes, changes in key management, and acquisitions, mergers, and divestments.

·     Significant industry developments such as changes in industry regulations and new reporting requirements.

·       Other significant relevant developments, such as changes in the legal environment affecting the entity.

Nature, Timing and Extent of Resource

·       The selection of the engagement team (including, where necessary, the engagement quality control reviewer) and the assignment of audit work to the team members.

·      Engagement budgeting, including considering the appropriate amount of time to set aside for areas where there may be higher risks of material misstatement.

An overall audit strategy guides the audit plan. An audit plan is more detailed than the overall audit strategy and it includes the nature, timing, and extent of audit procedures to be performed by engagement team members. 

An audit plan may consist of following sections:

• Preparation and performance of audit planning procedures.
• Audit procedures to be performed at the assertion level.
• Review, and completion of the audit assignment