Group audit scoping and a component auditor with restricted access
Your firm audits the consolidated financial statements of Kestrel Industrial Group Ltd, a listed manufacturer with revenue of $480 million and total assets of $610 million. Group materiality is $4.8 million. The group comprises the parent, Kestrel Australia, Component A (78% of group revenue, audited by your Sydney office), Component B (12% of revenue, audited by a local firm in Vietnam that applies Vietnamese standards and is not subject to regulatory inspection), Component C (6%, audited by your Melbourne office) and eleven small components (4% in aggregate). The Vietnam firm has issued an unmodified opinion on Component B and refuses access to its working papers, citing local law; it has completed a questionnaire confirming ISA application and independence. Component B carries a $9 million bank loan secured against group-guaranteed assets. The group audit report is due in four weeks.
1. Identify which components are significant components and explain what that means for the group auditor's involvement.
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Step 1 - financial significance benchmark. ISA 600 (Revised) uses a benchmark, commonly 15% of group revenue or assets. A (78%) is clearly significant. B is 12% of revenue, below 15%, but test assets and liabilities: the $9m loan is not large against $610m group assets, so B may not be financially significant on size alone.
Step 2 - significant risks. A component is also significant if it is likely to include a significant risk of material misstatement (SRM). B is audited under different standards by an uninspected firm, is in a foreign jurisdiction, and carries a group-guaranteed loan. The guarantee is a group-level risk, and B's loan classification could affect the group. That makes B significant on risk grounds.
Step 3 - non-significant components. C (6%) and the eleven small components (4% aggregate) are not financially significant and no SRM is identified, so they are non-significant.
Consequence for involvement. A: the group team performs the work. B: the group team must be involved in the component auditor's risk assessment and in work on the SRM (the loan and guarantee), not merely receive the questionnaire. Non-significant components: group-level analytical procedures at group materiality, plus a sample if aggregation risk is high.
2. How should component materiality be set and communicated across the group?
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Set component materiality below group materiality. ISA 600 requires component materiality to be lower than group materiality so that undetected misstatements across components do not exceed group materiality. With four scoped components and a risky significant component, 60-75% of $4.8m is defensible: use $3.2m for A and C, and $2.4m for B because of the covenant and guarantee.
Performance materiality. Set at 50-75% of component materiality, for example $1.6m for A. For B, use the lower end because of the loan classification risk.
Communication threshold. Require component auditors to report misstatements above $240k (5% of group materiality) so the group team can aggregate them. For the small components, group materiality can be used for analytics, but their 4% aggregate is not trivial.
Documentation. Document the basis and revisit it if the group structure or risk changes. Do not simply allocate group materiality to every component - that ignores aggregation risk.
3. Evaluate whether the evidence over Component B is sufficient and state the possible effect on the group audit opinion.
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Access refusal is a scope limitation at component level. ISA 600 requires the group auditor to have access to component information and, where relevant, to the component auditor. A questionnaire is a representation about the work, not evidence of it. Because B is significant due to an SRM, the group team needs direct involvement.
Procedures to attempt. Request a meeting with the component auditor; request specific working papers or a memorandum on the loan and guarantee; perform additional group-level procedures (audit the guarantee, review B's financial information, inspect the loan agreement); or engage another firm to perform procedures over B.
If access remains restricted and no alternative evidence is available, the group auditor cannot obtain sufficient appropriate evidence over a significant component. That is a scope limitation under ISA 705. B is 12% of revenue, so the possible effect is material but not pervasive: qualify the opinion 'except for'. If the limitation extended to a large portion of the group, a disclaimer would be considered. Communicate with those charged with governance and consider whether the limitation is imposed by management.