Group audit of a PIE: component materiality and a component auditor who refuses access

Who sets it. Under ISA 600 (Revised) the group engagement team determines component materiality for each component where component auditors will perform work. The component auditor may propose a figure; it cannot decide the basis alone. The plan as submitted is a proposal that must be reviewed and, if necessary, replaced.

Critique of 1% of total assets. The benchmark is misaligned with where the risk sits. The Polish plant contributes 35% of group profit before tax (about CZK 315m) but only 22% of revenue; assets are the least relevant measure for a manufacturing component whose main risk is margin, related-party pricing and inventory valuation. A purely asset-based benchmark also ignores the aggregation risk: the group auditor must be able to conclude that misstatements not detected across all components, taken together, do not exceed group materiality of 45m.

A defensible calculation.

• 5% of component profit before tax: 5% × 315m = 15.75m → round to CZK 16m component materiality (about 36% of group materiality, comfortably inside the usual 50–75% ceiling).
• Component performance materiality at 70%: CZK 11.2m, to leave headroom for undetected misstatements in the component.
• A separate, much lower threshold for the transfer-pricing and consolidation schedules, say CZK 3m, because a small change in the cost-plus percentage on CZK 1.2bn of intra-group purchases moves group profit materially and is invisible at component level.

Also required. Document the rationale, communicate the figures and the threshold to the component auditor in the instructions, and confirm they will be applied to the specific accounts that matter to the group (revenue, inventory, intercompany balances), not only to the component's own statements. Where the component auditor's benchmark is left unchanged, the group auditor must perform additional work to reach the same level of assurance.

First, recognise what is at stake. The group engagement partner signs the group opinion and remains solely responsible for it. Delegation to a component auditor does not delegate that responsibility. ISA 600 (Revised) treats access to the component auditor's documentation, and to the component's records, as a precondition for the direction, supervision and review the group auditor must perform. A file that arrives after the component report is signed, and possibly after the group report is signed, is not usable.

Sequence of responses.

1. Contractual fix first. The parent, as shareholder, has rights to the subsidiary's accounting records; ask the client to authorise disclosure in writing, and add the authorisation to next year's component engagement letter. Local confidentiality rules generally permit disclosure with the entity's consent, so the refusal is often about the engagement letter rather than the law.
2. Negotiate timing. Access before the component report is signed is enough; a review of the significant working papers, not the entire file, is a reasonable compromise.
3. Substitute work. If access is genuinely unavailable, the group team can perform the work on the significant accounts itself – the Polish plant's revenue, inventory, intercompany balances and the transfer-pricing schedules – or engage a different firm on those balances. This is usually cheaper than the alternative.
4. Escalate the risk assessment. Absence of access is itself an indicator of risk; the component ceases to be a component where work can be relied on and becomes a scope problem.

Reporting consequence. If, having exhausted these steps, the group auditor cannot obtain sufficient appropriate evidence on a component contributing 35% of group profit, this is a limitation on the scope of the audit. Under ISA 705 the opinion is qualified where the effect is material but not pervasive, and a disclaimer where it is pervasive. Do not issue an unmodified opinion supported by a component report you have neither reviewed nor been able to look behind.

Governance. Report the matter to those charged with governance promptly, in writing, and record in the file why the alternative procedures were or were not sufficient.

Related-party pricing (ISA 550).

• Obtain the full population of intra-group transactions and reconcile the sum of the component's intercompany balances to the parent's corresponding accounts before any consolidation entry is posted; a one-sided entry is the classic failure mode.
• Understand the business rationale for cost plus 6% inbound and cost plus 12% outbound: the asymmetry systematically shifts profit into Poland. Test whether the rates in the invoices match the transfer-pricing documentation and whether the documentation covers the actual transactions, not a generic benchmark study.
• Because the group eliminates intra-group profit, test the inventory still on hand at the group level that carries the Polish margin. A mark-up left in closing inventory overstates group profit even after the revenue elimination.
• Obtain the CZK 60m prior-year consolidation adjustment and check it was reversed or rolled forward correctly; test the current-year computation with the same rigour as any other estimate.
• Consider whether the pricing is arm's length for the component's own statutory statements, where it affects local tax and distributable reserves – a different question from consolidation.

Consignment stock.

• Obtain the consignment agreements and establish when control passes under the Incoterms and the contract: goods at a customer's premises are frequently not sold at all until the customer draws them down.
• Instruct the component auditor to attend the physical counts at the Polish customers' sites, or obtain direct confirmation from those customers of quantities held and the terms on which they are held.
• Test the movement between consignment listings at the year-end and the revenue recorded: goods still on consignment must stay in inventory, with the associated margin eliminated.
• Extend the cut-off test around the year-end and inspect the January draw-downs to see whether December revenue related to goods actually consumed in January.

Link to materiality. Run the transfer-pricing and consignment procedures against the CZK 3m specific threshold, not the CZK 11.2m component performance materiality – both are small-balance, high-leverage areas.