Group Audit Reliance on a Component Auditor
You are the group auditor of Meridian Holdings plc, a listed group with a UK parent and a material subsidiary in Vietnam (35% of group revenue, 40% of group assets). The Vietnamese subsidiary is audited by a local firm, An Phat Audit, which is not part of your network and whose working papers are in Vietnamese. An Phat has given you a completed questionnaire confirming it applies ISAs and is subject to local inspection. The component's revenue includes £22m of intra-group sales to the UK parent, and the local auditor has not tested the transfer pricing on those sales. Group revenue is £210m; group materiality is £4.2m. The group audit report is due in three weeks and the parent's audit committee has asked why you are 'not just signing it off'.
1. Explain how you would decide the nature and extent of involvement in An Phat's work, and what you would do about the untested transfer pricing.
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This is an ISA 600 (revised) judgement about direction, supervision and review of component auditors, not a box-ticking exercise.
Assessing An Phat
- A completed questionnaire is not sufficient evidence of competence and independence. You need to understand the firm's regulatory environment, its inspection record, and whether it has the resources for a component of this size.
- Because the component is significant (35% revenue, 40% assets), you should plan more than a questionnaire: at minimum, review of key working papers, and likely a site visit or remote file review of the significant risk areas.
- Language is a practical barrier. You need translated key papers or a bilingual reviewer. Do not accept summaries you cannot test.
The transfer pricing issue
- £22m of intra-group sales is material to the group (well above £4.2m). Untested transfer pricing means the consolidation eliminations and the subsidiary's revenue are not corroborated.
- This is a significant risk. You cannot simply rely on An Phat's conclusion because it did not address the risk.
- Options: (a) ask An Phat to perform the work to your instructions and review it; (b) perform the work yourself or with your team; (c) engage another firm. Given the three-week deadline, (a) with your review is most realistic, but you must actually review it.
Deadline pressure
- The audit committee's question is reasonable, but the answer is not 'sign it off'. If the work cannot be completed, consider whether a modified report or a delay is needed. Do not let the timetable dictate the evidence.
2. What should you communicate to the parent audit committee, and what documentation should the group file contain?
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Communication to the audit committee
- The component is significant and audited by a non-network firm; explain the involvement you have planned and why a questionnaire alone is not enough.
- Explain the transfer pricing risk and what you are doing about it, including any additional work and its effect on the timetable.
- Be clear about responsibility: the group auditor signs the group opinion and cannot delegate that responsibility to An Phat.
- If there is any doubt about An Phat's access or cooperation, say so now rather than at the reporting stage.
Documentation on the group file
- The basis for your assessment of An Phat: competence, independence, regulatory environment, inspection history.
- The nature, timing and extent of your involvement - what you reviewed, who reviewed it, and what you concluded.
- The significant risks you directed to the component and how they were addressed, including the transfer pricing work.
- Communications with An Phat and with the audit committee.
- Any limitations and how they were resolved, or why they were not.
- The revised ISA 600 requires a clear record of the direction and supervision of component auditors; a thin file here is itself a quality management issue.