Group audit reliance on an overseas component auditor
You are the group audit manager for UK-based Meridian plc, which prepares consolidated IFRS financial statements. Its German subsidiary, Rheinwerk GmbH, contributes 45% of group revenue, 38% of group assets and is a significant component. Group materiality is £4.0m and component materiality has been set at £1.2m. The component auditor, a local firm, is independent and has relevant sector experience, but German law prevents it from giving you access to its working papers; it has provided a 12-page memorandum summarising its findings. The memorandum highlights a £8.4m intercompany payable/receivable mismatch, a £2.1m transfer pricing adjustment not reflected in the subsidiary's local accounts, and a local GAAP departure from IFRS 15 that the component auditor considers immaterial locally. The group reporting deadline is in three weeks and the component auditor is unwilling to perform additional work without a fee increase.
1. Explain how ISA (UK) 600 (Revised) applies to your reliance on the component auditor and what evidence you need beyond the memorandum.
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ISA (UK) 600 (Revised) principle. The group auditor is responsible for the group opinion and cannot simply accept a component auditor's memorandum. The standard requires involvement in the component's risk assessment, evaluation of the component auditor's competence, independence and objectivity, communication of group instructions, and review of the component auditor's work for significant components.
What the memorandum provides. It is a summary of the component auditor's findings, not audit evidence of the underlying transactions. It may help identify risks, but it does not give me access to the tests performed, the samples selected or the conclusions reached. Because Rheinwerk is a significant component (45% of revenue), I need to obtain sufficient appropriate evidence over its financial information.
Practical options. Request specific working papers under a confidentiality agreement, visit the component and review files on site, perform additional group-level procedures, or ask the component auditor to perform specified procedures. If local law blocks access, I must document the restriction and consider whether another firm can provide the evidence. The fee dispute does not change the standard required.
2. Evaluate the three matters in the memorandum and design the group audit procedures you would perform.
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Intercompany £8.4m mismatch. This is material against group materiality of £4.0m. Obtain the intercompany reconciliations, confirm balances with both entities, investigate timing differences and errors, and check that the consolidation elimination is complete. An unresolved mismatch may indicate unrecorded transactions or fraud.
Transfer pricing £2.1m. Obtain the transfer pricing study and the adjustment calculation. Check whether the adjustment is required under IFRS and whether the tax provision is adequate. Consider whether the adjustment is an error in the subsidiary's local accounts that must be corrected on consolidation.
IFRS 15 departure. Local materiality is irrelevant for the group. Assess the effect on group revenue and receivables. If the component auditor has not corrected it, calculate the group misstatement and request adjustment. If not adjusted, include it in the schedule of uncorrected misstatements and evaluate it against group materiality. I would also review the component auditor's independence and competence evidence.
3. If access remains restricted and no alternative evidence is obtained, what are the implications for the group audit report?
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Scope limitation. If I cannot obtain sufficient appropriate evidence over a significant component, ISA (UK) 705 applies. A 45% revenue component is likely material to the group financial statements. If the possible effect is material but not pervasive, I would issue a qualified opinion ('except for'). If it is pervasive - for example, if the component's records affect multiple areas and the group cannot be audited - a disclaimer of opinion may be necessary.
Judgement. The fact that the component auditor has done work does not remove the limitation if I cannot review it. I would ask the component auditor to confirm the scope of work and any exceptions, and consider a secondment or joint visit. I would communicate with those charged with governance and document why alternative procedures were insufficient. The group audit report should describe the limitation clearly.