Future Directions for Group Audits
Written By: Douglas Chang
Today's corporations find themselves in an age characterized by globalization, but also by the active pursuit of synergies from consolidation. As enterprises expand, they find it expedient to organize into corporate groups. Given the large scale of many corporate groups, it is difficult for their audits to be performed by a single auditor and his/her direct supervisor. Meanwhile, under the trend towards internationalization, audits for members of corporate groups often have to be carried out separately by accountants in different countries and regions. That is why the International Auditing and Assurance Standards Board (IAASB), under pressure from all directions, decided to revise ISA 600 – “The Audit of Group Financial Statements” – and strengthen its group enterprise audit requirements.
ISA 600 has not been formally issued yet, but now that opinions have been solicited on the exposure draft, its main direction is more or less clear. It remains to be seen how much the Standard will affect audit reports in Taiwan, but international audit and accounting standards necessarily have a certain degree of influence on Taiwan's standards. Also, some accounting firms in Taiwan belong to large global alliances of member firms, and meeting international audit and accounting standards is for them a most basic requirement. For this reason, the direction of future revisions to ISA 600 is worth a preliminary examination.
1. Audit responsibility will no longer be divided between accountants.
In past audits of corporate groups, if a member of the group was not audited by the group auditor, the group auditor would typically include a note in the audit report to the effect that the member company's financial statements were not audited by the group auditor, but had been audited by another auditor, and the amounts recorded in the member firm's financial statements were based on that other auditor's audit report.
Under the draft ISA 600, the group auditor must take full responsibility for the group's financial statements. The group auditor is responsible for obtaining sufficient pertinent evidence to express an opinion with reasonable assurance as to the appropriateness of the group's financial statements. When a member firm is audited by another auditor, if the group auditor believes it is not possible to obtain the pertinent evidence required for the member firm's financial statements, the group auditor must regard the audit as limited in scope.
This change no doubt increases the responsibility of the group auditor. In the future, group auditors will have to make additional assessments for each of the firms that go into making the corporate group's financial statements, and they will not be able to simply divide up responsibility directly in their audit opinions. Under the new requirement, group auditors must also assess other auditors' audit quality, when necessary, and even consider reviewing other auditors' working papers and performing additional audit procedures. Therefore, when group auditors audit corporate groups in the future, they will need to communicate thoroughly with other accountants, and they must contact them early and inform them of their assessment needs. Those other accountants will also need to complete their audit work earlier so that group auditors will have time to perform their assessment work.
Under the draft ISA 600, the group auditor must take full responsibility for the group's financial statements. The group auditor is responsible for obtaining sufficient pertinent evidence to express an opinion with reasonable assurance as to the appropriateness of the group's financial statements. When a member firm is audited by another auditor, if the group auditor believes it is not possible to obtain the pertinent evidence required for the member firm's financial statements, the group auditor must regard the audit as limited in scope.
This change no doubt increases the responsibility of the group auditor. In the future, group auditors will have to make additional assessments for each of the firms that go into making the corporate group's financial statements, and they will not be able to simply divide up responsibility directly in their audit opinions. Under the new requirement, group auditors must also assess other auditors' audit quality, when necessary, and even consider reviewing other auditors' working papers and performing additional audit procedures. Therefore, when group auditors audit corporate groups in the future, they will need to communicate thoroughly with other accountants, and they must contact them early and inform them of their assessment needs. Those other accountants will also need to complete their audit work earlier so that group auditors will have time to perform their assessment work.
2. International accounting firm alliances will no longer be considered single accountants.
The draft ISA 600 has a clear rule as to what constitutes a corporate group's group auditor: A so-called group auditor refers to the person of the group auditor or his/her direct supervising auditor. This rule differs from the practice followed up to now by the major international accounting firms. In the past, since audit methods and training were more or less the same from one international accounting firm to the next, usually no additional evaluations were performed on the audit reports provided by other firms. In IAASB's view, however, although a group auditor's understanding of the depth and quality of another accountant's work can be influenced by the fact that they both belong to accounting firm alliances, the degree of influence is not consistent, so IAASB decided not to differentiate between the big accounting firm alliances and others: Whoever does not fall within the aforementioned definition of group auditor is to be considered another accountant.
Under this rule, when a corporate group is audited by a member of an accounting firm alliance, the group auditor must perform an evaluation of that member firm's audit work. The group auditor must consider whether or not there are differences as to depth or methods used in the audit work of different accounting firms, and must even take into account whether or not a given firm has a quality control mechanism in place. Of course, there may be a difference in the depth of evaluations performed depending on whether a firm is a member of an accounting firm alliance or not, but what is clear is that the workload of the group auditor will increase compared to what it was before.
Under this rule, when a corporate group is audited by a member of an accounting firm alliance, the group auditor must perform an evaluation of that member firm's audit work. The group auditor must consider whether or not there are differences as to depth or methods used in the audit work of different accounting firms, and must even take into account whether or not a given firm has a quality control mechanism in place. Of course, there may be a difference in the depth of evaluations performed depending on whether a firm is a member of an accounting firm alliance or not, but what is clear is that the workload of the group auditor will increase compared to what it was before.
3. Setting standards of materiality:
Under the rules of the draft ISA 600, the group auditor must set separate standards of materiality for each enterprise in a corporate group, and each individual standard may not be higher (i.e., looser) than the standard set for the group as a whole.
How are these individual enterprise materiality standards to be determined? The draft ISA 600 actually offers no clues, although the setting of materiality standards is a critically important aspect of any audit plan, being closely tied to both audit quality and cost. If materiality standards are set too high, then audit cost is low, but the probability of there being misstatements in the financial statements is higher. By the same token, one can lower the probability of financial statement misstatement by setting lower (i.e., stricter) standards of materiality, but audit cost will go up with the greater audit depth.
Generally speaking, individual materiality standards for each enterprise in a corporate group will lie between two extremes. One is to set materiality standards based on the scale of the individual enterprise. The other is to set standards based on the scale of the group enterprise as a whole. In the former instance, while it may be true that certain standards can avoid misstatement on the part of a subsidiary, they may appear to be set too low for the consolidated statements, resulting in unnecessary audit costs. In the latter case, if the materiality standards go by the scale of the entire group, then it is very likely that the combined, unadjusted misstatements of subsidiary companies will exceed the materiality standard set for the group, resulting in misstatement in the group's financial statements.
Some accounting firms are currently researching how to set reasonable materiality standards for individual members of corporate groups, hoping to arrive at an efficient method by which they can express an opinion on the appropriateness of financial statements with reasonable assurance.
How are these individual enterprise materiality standards to be determined? The draft ISA 600 actually offers no clues, although the setting of materiality standards is a critically important aspect of any audit plan, being closely tied to both audit quality and cost. If materiality standards are set too high, then audit cost is low, but the probability of there being misstatements in the financial statements is higher. By the same token, one can lower the probability of financial statement misstatement by setting lower (i.e., stricter) standards of materiality, but audit cost will go up with the greater audit depth.
Generally speaking, individual materiality standards for each enterprise in a corporate group will lie between two extremes. One is to set materiality standards based on the scale of the individual enterprise. The other is to set standards based on the scale of the group enterprise as a whole. In the former instance, while it may be true that certain standards can avoid misstatement on the part of a subsidiary, they may appear to be set too low for the consolidated statements, resulting in unnecessary audit costs. In the latter case, if the materiality standards go by the scale of the entire group, then it is very likely that the combined, unadjusted misstatements of subsidiary companies will exceed the materiality standard set for the group, resulting in misstatement in the group's financial statements.
Some accounting firms are currently researching how to set reasonable materiality standards for individual members of corporate groups, hoping to arrive at an efficient method by which they can express an opinion on the appropriateness of financial statements with reasonable assurance.
Looking at the content of the draft ISA 600, we can see that the IAASB has placed greater responsibility on group auditors, but there will also be a corresponding increase in conglomerates' audit costs. In the future, corporate managers and their group auditors should begin early to research and work out the most efficient means of performing corporate group audits.