As Vince Lombardi said, “Individual commitment to a group effort—that is what makes a team work, a company work, a society work, a civilization work.” I would add to this that an individual firm’s commitment to group audit considerations makes audit planning work.
Simply stated, group audits are audits of financial statements that include the financial information of more than one component. There seems to be diversity in practice when firms audit financial statements with multiple components. Group audits are addressed in AU-C Section 600, Special Considerations—Audits of Group Financial Statements (Including the Work of Component Auditors). The term “Special Considerations” can be confusing. AU-C sections with “Special Considerations” in their title address situations that, while common, don’t arise in every audit. However, consideration of whether these standards apply is required in every audit. This article covers consideration of when the group audit standard applies and how this can be determined.
When does this standard apply to my audit?
A good place to start is with some preliminary considerations and definitions of key terms.
- Group audit: The audit of group financial statements.
- Group financial statements: Group financial statements are financial statements that include the financial information of more than one component. “Group financial statements” also refers to combined financial statements aggregating the financial information of components that are under common control.
- Component: A component is an entity or business activity for which group or component management prepares financial information that is required to be included in the group financial statements. A component may include, but is not limited to, subsidiaries, geographical locations, divisions, investments, products or services, functions, processes, or component units of state or local governments.
I’m auditing everything from soup to nuts, so do the group audit requirements apply to me?
The key to answering this question is in the definition of group financial statements. When you audit a set of financial statements with multiple components, those are group financial statements. Your firm may be the only firm engaged, but you still have group audit considerations. It is fairly clear that the group audit standard (AU-C Section 600) applies when multiple accounting firms are involved in an audit of multiple entities. Many misinterpret the term “group audit” to mean: If the audit involves multiple accounting firms, group audit applies, but if it doesn’t then it isn’t a group audit. This is an easy mistake to make, since the applicable preclarity auditing standard, AU 543, Part of Audit Performed by Other Independent Auditors, focused on who was performing the audit, not what was being audited. Adding to the confusion, the subtitle of the AU-C 600 section (containing AU-C Sections 600, 610, and 620) is “Using the Work of Others.” Nevertheless, under the clarified auditing standards, AU-C Section 600 is applicable to any audit of group financial statements, even if only one auditor is involved.
When the component is being audited by the group engagement team, the group engagement team serves as both the group auditor and component auditor. In this article, the term “group auditor” refers both to the “group audit team” and the “group engagement partner,” even though the standard further differentiates responsibilities by referring to these parties separately. It is important to note that the same personnel may, and often do, function as both members of the group engagement team and a component audit team. The AICPA’s Technical Practice Aids, TIS Section 8800, Audits of Group Financial Statements and Work of Others, tackles group audits. Below are responses to questions about when a group auditor is also a component auditor.
Section 8800.24: Applicability of AU-C Section 600 When Only One Engagement Team Is Involved
Inquiry—Company X consolidates the operations of Entity A. The same group engagement team that audits Company X also audits Entity A. Because only one engagement team is involved, does AU-C Section 600 apply? If so, what does AU-C Section 600 require that is not already covered by other auditing standards?
Reply—AU-C Section 600 applies to all audits of group financial statements, which are financial statements that contain more than one component. In the circumstances when the same engagement team audits all components of the group, the considerations addressed in AU-C Section 600 that relate to component auditors are not relevant. However, considerations addressed in AU-C Section 600, such as understanding the components; identifying components that are significant due to individual financial significance and the significant risk of material misstatement; determining component materiality; understanding the consolidation process; and addressing the risks, including aggregation risk, of material misstatement in the group financial statements are relevant in all group audits.
[Issue Date: February 2013.]
Section 8800.39: Disaggregation of Account Balances or Classes of Transactions
Inquiry—Company X consolidates the operations of Entity A. The same group engagement team audits Company X and the operations of Entity A; no other auditors or engagement teams are involved. Are there any requirements in AU-C Section 600 to disaggregate account balances or classes of transactions for purposes of auditing the consolidated financial statements of Company X? For example, is the auditor required to disaggregate accounts receivable for purposes of confirmation procedures, or can the consolidated group of accounts be treated as one population?
Reply—AU-C Section 600 does not require the auditor to disaggregate account balances or classes of transactions. The group auditor should design an audit plan that is responsive to the risks of material misstatements to the consolidated financial statements. The less similar the risks of material misstatement at the group and component level, the less appropriate it may be to perform audit procedures for some or all accounts or classes of transactions at the group level. Additionally, the more complex the group (for example, decentralized systems, fewer groupwide controls, differing jurisdictions, or diverse product lines), the less likely that testing in the aggregate will sufficiently and appropriately address the risks of material misstatement.
[Issue Date: February 2013.]
How do I identify components?
A group audit is an audit of group financial statements, and financial statements are group financial statements when they contain the financial information of more than one component. So the first step in determining whether your audit is a group audit is consideration of components, including determining whether the financial statements include the financial information of more than one component. If so, the audit documentation should include an analysis of the components in accordance with the standard.
Professional judgment is required to determine if a specific business activity represents a component under AU-C Section 600. If an entity’s financial reporting system organizes financial information by function, product or service, or geographical location for purposes of external financial reporting, such functions, products or services, or locations may represent components for purposes of AU-C Section 600.
For example, group management may use financial information for several locations that is aggregated using a separate system or process from that used to prepare the group financial statements. The group engagement team may identify the locations as components. Alternatively, when financial information about a function, product or service, or geographical location is first part of the group’s financial reporting system and then disaggregated by group management for operating purposes, the group engagement team may consider such financial information in whole or in part as a class of transactions rather than components.
Financial information classified by business activity for the group financial statements may represent the operations of a single legal entity or a number of legal entities. In such cases, the group engagement team may determine the component to be the business activity rather than the separate legal entities generating the activity.
The financial statements are group financial statements, and thus the group audit standard applies if you answer yes to any of the questions below.
Do the financial statements include one or more of the following?
- Consolidated subsidiary.
- Entity combined because it is under common control.
- Consolidated affiliate (e.g., a variable-interest entity).
- Investment accounted for using the equity method of accounting.
- Investment in a joint venture.
- Investment accounted for using the cost method of accounting, where the work and reports of other auditors constitute a major element of evidence for the investment.
- Entity consisting of a head office and one or more divisions or branches, where the divisions or branches are separately managed and provide separate financial reporting to the head office.
- Entity where a separate function, process, product or service, or geographic location is separately managed and provides separate financial reporting to the head office.
- Any other grouping that would constitute a component for financial reporting purposes.
What are some items that are not components?
The AICPA’s Technical Practice Aids, TIS Section 8800, Audits of Group Financial Statements and Work of Others, also address items that are not components, including the following response:
Section 8800.36: Investments Held in a Financial Institution Presented at Cost or Fair Value
Inquiry—Paragraph .11 of AU-C Section 600 defines a component as “[a]n entity or business activity for which group or component management prepares financial information that is required by the applicable financial reporting framework to be included in the group financial statements.” Is an investment in a certificate of deposit or other types of cash investments held by a financial institution (for example, an overnight repurchase agreement) deemed a component for purposes of AU-C Section 600?
Reply—No. A certificate of deposit or other cash investments held by a financial institution or bank do not constitute components.
In addition to investments measured at fair value, inventory and company shares held by an employee stock ownership plan are examples of items that are not considered components.
OK, the group audit standard applies. Now what?
After identifying the components in the audit of group financial statements, the group engagement team is required to determine if any of these components represent significant components. The group engagement team makes this determination based on whether the component is (a) of individual financial significance to the group or (b) likely to include significant risks of material misstatement (due to its specific nature or circumstances) of the group financial statements.
During planning, the group engagement team should gain further understanding of the group, its components, and their environments to enable them to identify components that are likely to be significant. Think about the structure of the group financial reporting system. This knowledge and understanding can be obtained by the group engagement team as part of its risk assessment procedures when the team gains an understanding of the entity and its environment.
Significant components identified may result in the group engagement team’s spending more time performing risk assessment or further audit procedures than in the years prior to the group audit requirements. Paragraphs .A6–.A8 of AU-C Section 600 discuss ways the group engagement team may identify components that are significant. One way is to apply a percentage to a selected benchmark, such as group assets, liabilities, cash flows, revenues, expenditures, or net income, in order to determine components that are individually financially significant. However, the group engagement team may determine that other methods or benchmarks are more appropriate based on the type of group entity or additional facts and circumstances.
In addition, components with complex transactions from a business or accounting perspective may be identified as specific significant risks by the group engagement team. For example, a component could include significant risk from a business perspective if it is subject to regulation by a government agency, it produces products or conducts activities of a highly technical nature, or it transacts business with a governmental entity that is subject to public records laws. Significant risk from an accounting perspective can arise from complex related-party relationships, foreign currency or derivative transactions, or fair value measurements and disclosures, as well as other relationships or transactions.
If a component is clearly insignificant based on lack of financial significance to the group or a low risk of material misstatement of the group financial statements, then further consideration may not be deemed necessary at the component level. However, at a minimum, AU-C Section 600 requires the group engagement team to perform analytical procedures at the group level for any components that are not significant components.
Identification of a group audit is critical
As explained, the most critical first step in a group audit engagement is identifying that the engagement is a group audit. After that, applying the risk assessment standards in a group audit means that the auditor considers what could go wrong at the component level so that an audit can be properly planned and performed to obtain reasonable assurance that the group financial statements are free from material misstatement. These are critical first steps to properly planning a group audit. The resources listed below are available to assist in applying this guidance as well as the rest of the standard.
—Michael A. Westervelt is a partner in the National Assurance Technical Group of CliftonLarsonAllen LLP and a member of the AICPA PCPS Technical Issues Committee.
- AU-C Section 600, Special Considerations—Audits of Group Financial Statements (Including the Work of Component Auditors), AICPA Professional Standards, as of June 1, 2013 (Volume 1) (#APS13P, paperback; #WPS-XX, online subscription)
- Understanding the Responsibilities of Auditors for Audits of Group Financial Statements, AICPA Audit Risk Alert, 2013 (Appendix A of this publication also includes Technical Practice Aids 8800.01-.41 issued through March 2013) (#ARAGRP13P, paperback; #ARAGRPO, one-year online subscription; and #ARAGRP13E, ebook)
- AICPA TIS Section 8800.01-.43, Audits of Group Financial Statements and Work of Others, AICPA Technical Practice Aids, as of June 1, 2013 (#ATPA13P, paperback; #WTP-XX, one-year online subscription)
Group Audits: Clarifying the Complexities (#736510)
For more information or to make a purchase, go to cpa2biz.com or call the Institute at 888-777-7077.
AICPA Financial Reporting Center, SAS Clarity—Group Audits