AUDITOR’S REPORTING – GROUP AUDIT AND USING THE WORK OF OTHER AUDITORS

Under the International Standard on Auditing 600 issued by International Auditing and Assurance Standards Board, the group auditor is responsible for the direction, supervision, and performance of the group audit and the appropriateness of the group audit report. Where SA 600 applies and when the group auditor has to base his/her opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, the group auditor shall clearly state in his/her report the division of responsibility for the financial information included in a group financial statement of components audited by other auditors and that they have been included as such after performing appropriate procedures. However, it is important to note that it is not blind reliance on the work done by other auditors.

When the group auditor or principal auditor concludes that the financial information of a component is immaterial, the procedures outlined in SA 600 do not apply. Principal auditor should consider materiality portion of financial information which the principal auditor audits, degree of knowledge regarding business of the components, risk of material misstatement in financial information of the components audited by other auditor, whether principal auditor can perform additional procedures before accepting his/her position as principal auditor.

The objective of this article is to highlight some important aspects relating to group audits in India and role and responsibilities of the principal auditor or the group auditor when using the work of other auditors.

ISSUE 1 – ACCESS TO WORKING PAPERS OF COMPONENT AUDITORS
ICAI issued a clarification in May 2000 which provides that an auditor is not required to provide the client or the other auditors of the same enterprise or its related enterprise such as a parent or a subsidiary, access to his audit working papers. The main auditors of an enterprise do not have the right of access to the audit working papers of branch auditors. In the case of a company, the statutory auditor must consider the report of the branch auditor and has a right to seek clarifications and/or to visit the branch if he deems it necessary to do so for the performance of the duties as auditor. An auditor can rely on the work of another auditor without having any right of access to the audit working papers of the other auditor. For this purpose, the term ‘auditor’ includes ‘internal auditor’. The only exception is that the auditor may, at his discretion, in cases considered appropriate by him, make portions of or extracts from his working papers available to the client.

The above clarification is based on the principles of SA 230, Audit Documentation, in accordance with which audit documentation is the property of auditor and SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, which provides that the auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose. In addition to this, Part I of the Second Schedule to the Chartered Accountants Act, 1949 provides that “A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he discloses information acquired in the course of his professional engagement to any person other than his client, without the consent of his client or otherwise than as required by any law for the time being in force.”

In line with the above, under SA 600, where another auditor has been appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it essential for him to visit the component and/or to examine the books of account and other records of the said component. However, this poses a practical limitation on the principal auditor while conducting a group audit.

ISSUE 2 – RESPONSIBILITY OF PRINCIPAL AUDITOR/GROUP AUDITOR WHILE USING WORK OF ANOTHER AUDITOR
(i) SA 600 requires that the Principal Auditor should perform the following procedures while planning to use the work of another auditor:

• Consider the professional competence of Other Auditor, if other auditor is not a member of ICAI;

•    Obtain sufficient appropriate audit evidence, that the work of other auditor is adequate for principal auditor’s purpose. For this purpose, the principal auditor should advise the other auditor of the use that is to be made of the other auditor’s work and report and make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit. The principal auditor would inform the other auditor of matters such as areas requiring special consideration, procedures for the identification of inter-component transactions that may require disclosure and the timetable for completion of audit; and advise the other auditor of the significant accounting, auditing, and reporting requirements and obtain representation as to compliance with them;

• There should be sufficient liaison between the principal auditor and the other auditor. For this purpose, the principal auditor may find it necessary to issue written communication(s), i.e., group instructions to the other auditor;

• The principal auditor should share detailed group audit instructions to other auditor, which may include the following:

• Significant Risk-Group Financial Statement Level (e.g., management override of control, revenue recognition, impairment).

• Group Structure-Details of subsidiary/joint venture and % stake for current year and previous year.

• Significant accounting and auditing issues.

• Timetable of communication, contacts, communication protocols.

In addition to being asked to complete group audit questionnaires and/or provide memoranda of work performed, component auditors may be asked to report directly to group auditors in the form of an audit or review opinion on financial information i.e., the group reporting/consolidation package prepared by component management.

• Principal auditor may require another auditor to submit a detailed questionnaire with reference to the work performed by him, checklist etc.

• Consider significant findings of other auditor and perform supplement tests if necessary.

(ii) Regulation 33(8) of SEBI (Listing Obligations and Disclosure Requirements) (Regulations) 2015

SEBI Circular dated 29th March, 2019 states that the principal auditor is required to send Group Audit / Review Instructions to component auditors for audit/review of the consolidated financial statements / results. Since the audit/review report requires specific assertion on performance of procedures in accordance with the SEBI Circular, it is mandatory that component auditor should respond to the instructions and provide the requisite information.

It is important to note that the parent company management is responsible for ensuring co-ordination between the principal and other auditor to comply with the requirements of SA 600.The requirements specified in the SEBI circular seems to be mandatory for the entities whose accounts are to be consolidated with the listed entity and to the statutory auditors of entities whose accounts are to be consolidated with the listed entity.

The circular requires the principal auditor to communicate its requirements to the component auditors on a timely basis. This communication shall set out the work to be performed, the use to be made of that work, and the form and content of the component auditor communication with the principal auditor. Therefore, the principal auditor is required to send the group audit/review instructions to the component auditor, and if the component auditor does not respond to such instructions on a timely basis, then it may be considered as a non-compliance with the requirements of the circular since the audit/review report (format issued by SEBI) requires specific assertion that “we also performed procedures in accordance with the Circular issued by SEBI under Regulation 33(8) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended, to the extent applicable”.

Accordingly, if the component auditor does not respond to the questionnaire, checklist or information request sent by the principal auditor, it may be considered as a scope limitation, and the principal auditor may issue a qualified opinion/conclusion in such a situation in accordance with SA 705, Modifications to the Opinion in the Independent Auditor’s Report.

ISSUE 3 – CONSIDERATION OF MATERIALITY BY PRINCIPAL AUDITOR
The principal auditor is required to compute the materiality for the group as a whole (which is different from materiality to issue an opinion on the standalone financial statements), which should be used to assess the appropriateness of the consolidation adjustments (i.e., permanent consolidation adjustments and current period consolidation adjustments) that are made by the management in the preparation of CFS. The parent auditor can also use the materiality computed on the group level to determine whether the component’s financial statements are material to the group to determine whether they should scope in additional components and consider using the work of other auditors as applicable.

ISSUE 4 – REPORTING BY PRINCIPAL AUDITOR
SA 600 requires that the report on consolidated
financial statements and standalone financial statements (in a situation where the branch auditors are other than principal auditor), should state clearly the division of responsibility between principal auditor and other auditor. The principal auditor should express a qualified/disclaimer of opinion if:

• Principal auditor cannot use the work of other auditor and is unable to perform sufficient additional procedures as required by SA 600.

• If there is modification in another auditor’s report, then the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the entity’s financial information and whether it requires a modification of the principal auditor’s report.
    
It is important to note the requirements in Guidance Note on Audit of Consolidated Financial Statements, which requires that while considering the observations (for instance, modification and /or emphasis of matter/other matter in accordance with SA 705/706) of the component auditor in his report on the standalone financial statements, the parent auditor should comply with the requirements of SA 600. Reference should be made to paragraph 23 of SA 600 which states, “In all circumstances, if the other auditor issues, or intends to issue, modified auditor’s report, the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the financial information of the entity on which the principal auditor is reporting, that it requires a modification of the principal auditor’s report.”

Hence, the principal auditor needs to evaluate the observations (modification and /or emphasis of matter) in the component auditor’s report, in his auditor’s report on the CFS. For example, the considerations may include materiality and scope of the component; the assessment of risk of material misstatement for the group; the impact of the modification in light of the materiality thresholds for the group audit, etc.

The principal auditor should document how they have dealt with the qualifications or adverse remarks contained in the other auditor’s report in framing their report on the CFS of the group, considering materiality and risk assessment of the component.

The principal auditor of Consolidated Financial Statements in accordance with an ICAI announcement is required to state if certain components have been audited by other auditor and if such component/s is/ are material to the consolidated financial statements of the Group.

Where the financial statements of one or more components are unaudited, the principal auditor should consider unaudited components in evaluating a possible modification to his/her report on the consolidated financial statements. The evaluation is necessary because the auditor (or other auditors, as the case may be) has not been able to obtain sufficient appropriate audit evidence in relation to such consolidated amounts/balances. In such cases, the auditor should evaluate both qualitative and quantitative factors on the possible effect of such amounts remaining unaudited when reporting on the consolidated financial statements using the guidance provided in SA 705, Modifications to the Opinion in the Independent Auditor’s Report. If such unaudited component/s is/are not material to the consolidated financial statements of the group, the principal auditor is required to state this fact in an ‘Other Matter’ paragraph.

REPORTING ON KAM
Reporting on KAM applies to audit reports issued on consolidated financial statements of listed entities, in addition, to the report issued on standalone financial statements. The Implementation guide to SA 701 refers to SA 600 in case where the parent’s auditor is not the auditor of all the components to be included in the consolidated financial statements. It further states that the group auditor would be required to assess matters that in his professional judgement, are key audit matters from the perspective of consolidated financial statements. This needs to be done at the planning stage and updated during the performance of the audit.

Though there is no mandatory requirement in SA 701 read with SA 600 to mandatorily send group reporting instructions to the auditors (if they are different from group auditors) of unlisted subsidiaries to specifically seek a response to KAM pertaining to these subsidiaries, however, since the group auditor would be required to assess matters that in his professional judgement, are key audit matters from the perspective of
consolidated financial statements, the group auditor may seek a response from component auditor if any KAM is required to be included for that component. This can be done as part of the group audit instructions.

ISSUE 5 – RESPONSIBILITY OF THE COMPONENT AUDITOR/OTHER AUDITOR
During planning, performance or completion of the audit, component auditor/other auditors are expected to communicate with the principal auditor immediately if:

• Timing of the work creates an irresolvable problem,

• Instructions are not fully understood,

• It is necessary to vary procedures from those specified,

• Circumstances arise that may result in a qualified opinion,

• Services have been performed without the appropriate pre-approvals or consideration of the independence matters discussed in the group audit instructions,

• Local conditions are such that work cannot be done within the estimated time or fee,

• Issues are identified that may affect work performed outside their territory, or

• Other auditor become aware of events, transactions, or recent or proposed legislative changes that may have a significant impact on the component or other members of the affiliated group (e.g., instances of fraud, significant changes to the level of control reliance, illegal acts, etc.).

The principal auditor will request acknowledgement of receipt of Group Audit Instructions and confirmation of cooperation from other auditor. Other auditor will be required to comply with the Guidance Note on Independence of Auditors (Revised), Code of Ethics issued by Institute of Chartered Accountants of India and the Companies Act, 2013 in relation to the work carried out on the component.

ISSUE 6 – AUDITORS’ REPORTING ON INTERNAL FINANCIAL CONTROLS OVER FINANCIAL REPORTING IN CASE OF CONSOLIDATED FINANCIAL STATEMENTS

The auditors of the parent company should apply the concept of materiality and professional judgment while reporting under section 143(3)(i) on the matters relating to Internal Financial Controls over Financial Reporting that are reported by the component auditors. The auditor should also assess the impact, if any, of the subject matter of any qualification, adverse opinion or disclaimer stated by any of the component auditors in their respective components, and any remedial measures effected by the parent company to mitigate the effect of such observations in the component audit reports on the financial reporting process for the consolidated financial statements.

ISSUE 7 – AUDITOR’S REPORTING UNDER CARO 2020
There are certain new/revised clauses in CARO 2020, which are related to consideration of reports of other auditors, e.g.:

• Consideration of reports of the internal auditors
(Clause 3(xiv)),

• Consideration of the issues, objections or concerns raised by the outgoing auditors in case of resignation of auditors during the year (Clause 3 (xviii)),

• Reporting on funds taken by the company from any entity or person on account of, or to meet the obligations of its subsidiaries, associates or joint ventures
(Clause 3(ix)(e)), and

• Reporting on loans where the company has raised loans during the year on the pledge of securities held in its subsidiaries, joint ventures or associate companies and report if the company has defaulted in repayment of such loans raised (Clause 3(ix)(f)).

Additionally CARO 2020 is also applicable to audit report for consolidated financial statements for only one clause i.e. clause (xxi) of CARO requires an auditor to comment on whether there have been any qualifications or adverse remarks by the respective auditors in the Companies (Auditor’s Report) Order (CARO) reports of the companies included in the consolidated financial statements, if yes, details of the companies and the paragraph numbers of the CARO report containing the qualifications or adverse remarks need to be indicated. The following points should be noted in this regard:

• Reporting under this clause is only required for those entities included in the consolidated financial statement to whom CARO 2020 is applicable.

• CARO report is to be included as separate annexure in the audit report to the consolidated financial statements.

• Assessments of responses by component auditors as qualification/adverse remark requires application of professional judgment.

• The concept of materiality is relevant when reporting under CARO. However, if a qualification/adverse remark is given by any individual component, there is a presumption that the item is material to the component. Hence when reporting under clause 3(xxi), the auditor is not required to re-evaluate the materiality from a consolidation perspective. Hence every qualification/adverse remark made by every individual component including the parent should be included while reporting under this clause.

• Qualification/adverse remarks given in parent company’s standalone CARO report are also required to be included.

• In case the audit report of the components has not yet been issued by its auditor, then the principal auditor would include the fact in his/her report.

BOTTOM LINE
Effective two-way communication between the principal auditor and the component auditor is of essence for the group audits, the starting point for which is the clear and timely communication of the requirements by way of group audit instructions. Also, it is equally important for the group management to play an active role for high-quality group audits. Similarly, when the auditor decides to use the work of another auditor e.g., branch auditor in an audit of standalone financial statements, internal auditor or auditor’s expert, the principal auditor should adhere to the procedures prescribed in SA 600 and ensure timely planning and communication along with documentation to demonstrate performance of such procedures. Besides this, the principal auditor is required to communicate important and group-related matters to those charged with governance and group management in a timely manner.