Group Audit Reliance on a Component Auditor
Meridian Holdings plc (MHL) prepares consolidated financial statements. Its subsidiary, Sylhet Components Ltd (SCL), represents 38% of group revenue and 45% of group total assets. SCL is audited by a small local firm, Chowdhury & Co, which is not part of MHL's audit network. The group auditor, Apex LLP, plans to use the work of Chowdhury & Co. Chowdhury & Co has provided its audit report and a brief summary of work performed but declines to share its working papers, citing client confidentiality. SCL's management is resistant to Apex contacting Chowdhury & Co directly. SCL has a bank loan of Tk 120 million with a covenant on debt-to-equity, and SCL's draft ratio is 1.98 against a limit of 2.00. Group materiality is Tk 15 million; component materiality for SCL is Tk 6 million.
1. Evaluate whether Apex can place reliance on Chowdhury & Co's work and what must happen before the group audit report is signed.
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Under ISA 600, the group auditor must obtain sufficient appropriate evidence over the component's financial information and the consolidation process. SCL is significant (45% of assets, 38% of revenue), so Apex cannot rely on a brief summary alone. Reliance requires evidence of the component auditor's competence, independence and quality control, and access to the component auditor's work or the ability to perform sufficient work itself.
Chowdhury & Co's refusal to share working papers and SCL's resistance to direct contact are red flags. Apex should first seek written consent from SCL to allow communication; if refused, that refusal is itself a matter to report to those charged with governance. If access remains unavailable, Apex must perform its own procedures at SCL, including substantive testing of the loan covenant calculation, or engage another firm under its direction. If neither is possible, Apex cannot obtain sufficient evidence and should consider a scope limitation. The debt-to-equity ratio of 1.98 against 2.00 is within Tk 6 million of breaching, so the covenant is a significant risk requiring direct testing of the loan agreement, covenant calculation and any waivers.
2. Explain the documentation and communication requirements Apex must satisfy regarding the component auditor and the covenant risk.
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Documentation under ISA 230 and ISA 600 must record the component auditor's identity and the basis for assessing competence and independence; the nature, timing and extent of work performed on the component; the component materiality of Tk 6 million and how it was derived from group materiality of Tk 15 million; the significant findings communicated; and the resolution of any disagreements. Any refusal of access should be documented with the dates and persons involved.
Communication: Apex must communicate significant matters to those charged with governance, including the access restriction, the covenant proximity and any uncorrected misstatements at SCL. Apex should also communicate directly with Chowdhury & Co on significant risks, including the covenant, and instruct it on the work required. The group engagement partner retains sole responsibility for the group opinion; reliance on a component auditor does not dilute that responsibility. If the access limitation is unresolved, the partner should consider whether a qualified opinion or disclaimer is required and document the rationale.