Group audit: significant component, access restrictions and going concern
Your firm is auditor of Meridian Hospitals PLC, a listed group with a wholly owned subsidiary, Care Maldives Pvt Ltd. For the year ended 31 March 2025, group revenue is LKR 4.0 billion and group profit before tax is LKR 500 million. Care Maldives has revenue of LKR 1.2 billion, total assets of LKR 1.8 billion and profit before tax of LKR 150 million. Group total assets are LKR 6.0 billion. Care Maldives is audited by a local firm, which is not part of your network. The local firm's report is unmodified, but local law prevents it from giving you access to its working papers. It can confirm that it complied with ISAs and provide a memorandum of key audit matters. Meridian has a bank loan of LKR 500 million. At 31 March 2025, it breached a current ratio covenant (actual 1.2, required 1.5), making the loan repayable on demand. On 20 May 2025, before the audit report date of 30 June 2025, the bank granted a waiver until 31 March 2026. Group materiality is LKR 60 million.
1. Assess whether Care Maldives is a significant component and outline the group audit response.
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Care Maldives is a significant component. It contributes 30% of group revenue (1.2/4.0), 30% of group assets (1.8/6.0) and 30% of group profit before tax (150/500). These exceed a typical 15% benchmark, so it is significant by size and likely by risk.
The group auditor should set component materiality below group materiality, for example LKR 45 million or lower, and instruct the component auditor to perform an audit of the component's financial information using group materiality and reporting requirements. Because the component auditor is not in the network, the group auditor must evaluate its competence, independence and quality control, communicate significant risks, and review its report and memorandum. Additional procedures should target consolidation adjustments, related parties, revenue recognition and going concern.
2. The component auditor cannot provide access to its working papers. Evaluate whether the group auditor can rely on the component auditor's evidence.
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Access to working papers is not an absolute requirement, but the group auditor must obtain sufficient appropriate audit evidence. An unmodified report and a memorandum of key audit matters may be adequate for a lower-risk component, but Care Maldives is significant. For a significant component, the group auditor is likely to need more direct evidence: a detailed questionnaire, direct communication with the component auditor, review of the component's financial information and, if necessary, additional procedures by the group team.
If local law genuinely prevents access, the group auditor should document the restriction, assess the credibility of the component auditor and consider whether the evidence obtained is sufficient. If not, this is a scope limitation. A qualified opinion may be appropriate if the effect is material but not pervasive; a disclaimer may be needed if pervasive. The group auditor cannot simply rely on the component auditor's report without evaluating the evidence.
3. Evaluate the going concern and loan classification implications of the covenant breach and the post-year-end waiver.
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At 31 March 2025, the breach made the LKR 500 million loan repayable on demand. Under LKAS 1, it is classified as current unless the lender agreed before the end of the reporting period to a grace period ending at least 12 months after the reporting date. The waiver was granted on 20 May 2025, after the reporting date, so it does not change the classification at 31 March: the loan remains current.
The waiver does, however, affect going concern. It gives the group until 31 March 2026 before the bank can demand repayment, which may remove the immediate going concern threat. The auditor should still challenge cash flow forecasts, covenant compliance and the risk of further breaches, and consider whether a material uncertainty remains. Disclose the breach, the waiver and the current classification. If disclosure is inadequate, qualify the report; if a material uncertainty remains, include a going concern paragraph.