• 20 Marks

AAA – L3 – Q35 – Group Audits

Plan and manage the group audit of the Saffron Group, considering subsidiaries with separate auditors.

The Saffron Group is an international business, made up of ten subsidiaries and a head office. You are the manager in charge at the firm undertaking the group audit, but there are separate local auditors for the Cinnamon subsidiary in Japan, the Fennel subsidiary in Thailand, and the Cardamom subsidiary in Greece. You are aware of the following information:

(1) Cardamom is a loss-making subsidiary, with losses at the current year end totalling C2.7 million. There are significant control problems, high levels of irrecoverable receivables, and 25% staff turnover. The local auditors have already stated their intention to give a qualified opinion for the year just ended because of the material issues found.

(2) Cinnamon is operating to a different financial year to that of the group as a whole, being October 20X8 rather than December 20X8.

(3) Shortly after the year end, in January 20X5, the Saffron Group announced the sale of Fennel for $25 million, and this disposal is currently underway.

(4) The Saffron Group is guaranteeing loans of approximately $10 million for its subsidiaries.

Required:

(a) Set out how you would plan and manage the group audit of the Saffron Group.                                                                                        (b) Consider the impact of each of the above issues on the group audit.                                                                                                              (c) Explain the nature of the relationship between your firm and the auditors of the subsidiaries, making particular reference to the extent to which your firm may rely on the component auditors’ work and to the considerations involved where joint audits are conducted.

      (A) To plan and manage the group audit of the Saffron Group, the following steps should be taken:

  1. Understand the Group Structure: Obtain a detailed understanding of the Saffron Group’s structure, including all subsidiaries, their locations, and the nature of their operations. Identify significant components (e.g., Cinnamon, Fennel, Cardamom) based on their size, risk, or contribution to the group’s financial statements.
  2. Assess Component Auditors: Evaluate the competence, independence, and professional qualifications of the local auditors for Cinnamon (Japan), Fennel (Thailand), and Cardamom (Greece). Review their audit methodologies to ensure alignment with International Standards on Auditing (ISAs) and the group auditor’s requirements.
  3. Risk Assessment: Perform a group-wide risk assessment, focusing on:
    • Cardamom’s control deficiencies, high receivables, and staff turnover, which increase the risk of material misstatement.
    • Cinnamon’s different financial year-end, requiring adjustments for consolidation.
    • Fennel’s disposal, which may affect going concern or require disclosures.
    • Loan guarantees, which pose a contingent liability risk.
  4. Communication with Component Auditors: Establish clear communication protocols with component auditors. Issue group audit instructions specifying:
    • Scope of work, including significant risks and materiality thresholds.
    • Timelines for reporting findings and audit evidence.
    • Requirements for reporting on internal controls and significant matters (e.g., Cardamom’s qualified opinion).
  5. Consolidation Procedures: Plan procedures to ensure proper consolidation, including:
    • Aligning Cinnamon’s financial year-end with the group’s through additional audit procedures for the October to December period.
    • Reviewing the accounting for Fennel’s disposal and the group’s loan guarantees.
    • Ensuring intercompany transactions are eliminated.

These steps ensure a coordinated and effective group audit, addressing the specific risks and complexities of the Saffron Group.                                                                                                                                                                                                                                                    (B)

The issues identified have the following impacts on the group audit of the Saffron Group:

  1. Cardamom’s Issues (Losses, Control Problems, Qualified Opinion):
    • Impact: The C2.7 million loss, control deficiencies, high irrecoverable receivables, and 25% staff turnover increase the risk of material misstatement. The local auditors’ qualified opinion indicates material issues that may affect the group financial statements if Cardamom is a significant component.
    • Audit Response: Increase audit procedures on Cardamom’s financial statements, focusing on receivables valuation and completeness of liabilities. Review the component auditor’s working papers to understand the basis for the qualified opinion. Assess whether the qualification affects the group audit opinion (e.g., if material to the group).
  2. Cinnamon’s Different Financial Year-End:
    • Impact: The October 20X8 year-end differs from the group’s December 20X8 year-end, creating a risk of misalignment in consolidation. Transactions or events between October and December may not be captured.
    • Audit Response: Request Cinnamon’s component auditors to perform procedures to cover the period from October to December 20X8. Obtain management’s consolidation adjustments and verify their accuracy. Ensure consistency in accounting policies.
  3. Fennel’s Disposal:
    • Impact: The sale of Fennel in January 20X5 is a subsequent event requiring disclosure in the group financial statements. If the disposal was planned or probable at year-end, it may affect the classification of Fennel’s assets and liabilities as held for sale under IFRS 5.
    • Audit Response: Review board minutes and sale agreements to confirm the timing and terms of the disposal. Verify the accounting treatment (e.g., held for sale classification, gain/loss on disposal). Assess whether the disposal affects the group’s going concern assumption.
  4. Loan Guarantees:
    • Impact: The $10 million loan guarantees represent a contingent liability. If a subsidiary defaults, the group may incur a liability, requiring recognition or disclosure under IAS 37.
    • Audit Response: Obtain details of the guarantees, including terms and the financial position of subsidiaries. Assess the likelihood of default and the need for provisions or disclosures. Review legal confirmations to confirm the existence and extent of guarantees.

These issues require tailored audit procedures to ensure the group financial statements are free from material misstatement, potentially affecting the group audit opinion if unresolved.                                                                                                                                                                                                                                                                                                                                                                                      (C)

The relationship between the group auditor (your firm) and the component auditors (for Cinnamon, Fennel, and Cardamom) is governed by ISA 600, Special Considerations—Audits of Group Financial Statements. Key aspects include:

  1. Nature of the Relationship:
    • The group auditor is responsible for the group audit opinion and must direct, supervise, and review the work of component auditors.
    • Component auditors perform audit work on subsidiaries’ financial information, reporting to the group auditor.
    • The group auditor communicates clear instructions, including the scope, materiality, and significant risks, and maintains regular contact to monitor progress.
  2. Reliance on Component Auditors’ Work:
    • The group auditor evaluates the component auditors’ competence, independence, and adherence to ISAs.
    • Reliance is possible if the component auditors are competent and their work is sufficient and appropriate. However, for Cardamom, the qualified opinion indicates issues, reducing reliance and requiring additional procedures by the group auditor (e.g., reviewing working papers or performing further tests).
    • The group auditor may visit component auditors’ offices to assess their work, especially for significant components like Cardamom.
  3. Considerations for Joint Audits:
    • In joint audits, two or more audit firms share responsibility for the audit opinion. This may occur if a component (e.g., Cinnamon) is significant, and the group auditor collaborates with the component auditor.
    • Considerations include agreeing on roles, responsibilities, and resource allocation to avoid duplication. A joint audit agreement outlines liability, reporting, and communication protocols.
    • Challenges include aligning methodologies, ensuring consistent quality, and resolving disagreements. The group auditor remains ultimately responsible for the group opinion.

The group auditor must balance reliance on component auditors with sufficient involvement to ensure the group financial statements are free from material misstatement.

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