Annual Audit Manual
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2323 Identifying components
Jul-2017
Overview
This section discusses:
- Considerations in identifying components
- Characteristics of significant components
CAS Guidance
The structure of a group affects how components are identified. For example, the group financial reporting system may be based on an organizational structure that provides for financial information to be prepared by a parent and one or more subsidiaries, joint ventures, or investees accounted for by the equity or cost methods of accounting; by a head office and one or more divisions or branches; or by a combination of both. Some groups, however, may organize their financial reporting system by function, process, product or service (or by groups of products or services), or geographical locations. In these cases, the entity or business activity for which group or component management prepares financial information that is included in the group financial statements may be a function, process, product or service (or group of products or services), or geographical location. (CAS 600.A2)
Various levels of components may exist within the group financial reporting system, in which case it may be more appropriate to identify components at certain levels of aggregation rather than individually. (CAS 600.A3)
Components aggregated at a certain level may constitute a component for purposes of the group audit; however, such a component may also prepare group financial statements that incorporate the financial information of the components it encompasses (i.e., a subgroup). This CAS may therefore be applied by different group engagement partners and teams for different subgroups within a larger group. (CAS 600.A4)
OAG Guidance
CAS 600 requires the group auditor’s work effort to be determined by the level of significance of an individual component. Thus, determining what constitutes a component (i.e., the identity of components that exist and their relative position (“level”) in the organization, that is relevant for purposes of designing the approach to the audit) is a critical aspect of the audit.
A “component” could be a head office, parent, division, location, business unit, branch, subsidiary, activity, shared service centre, joint venture, associated company, agency, department, Crown corporation, fund, non-governmental organizations, or other entity whose financial information is included in the group financial statements (see OAG Audit 2311).
Some entities may not report financial information based on a typical organizational structure. Some entities’ internal organization structures and financial reporting systems are based on products, services, or groups of products and services, rather than legal entities, and may even be based on geographical locations. The internal financial reporting systems of such entities may also present business activities and revenues in a variety of ways. In such circumstances, the entity’s financial reporting processes or internal control processes may not compile or accumulate financial reporting information based on each and every individual branch, division, subsidiary or other such component. In addition, the entity’s financial reporting and control structure will inevitably influence the design and approach of the group audit.
Determining what is a component will require professional judgment and is guided by the
- structure of the group,
- flow of the financial information, and
- audit approach.
The identification of components begins during the acceptance and continuance process and will be enhanced while obtaining an understanding of the group, its components, and their environments during the risk assessment procedures (OAG Audit 2331). The group auditor needs to gain an understanding of how the entity’s internal financial reporting processes are designed, and how management determines its business segments and geographical segments (see also OAG Audit 2322).
During the planning process, the group engagement team’s understanding of the group needs to be sufficient to identify those components that are “significant” (defined below). This is necessary because significant components require special audit consideration (see OAG Audit 2335) and the group engagement team’s evaluation of these considerations is important to the acceptance and continuance decision. It is anticipated that initial engagements would require additional effort during the acceptance process in order to determine that significant components are appropriately identified. Recurring engagements would focus on updating the understanding of the group structure and components, as well as identifying any changes in structure or circumstances that would impact the determination of components.
OAG Audit 2314 includes guidance on documentation of a group audit.
CAS Guidance
Components that Are of Individual Financial Significance
As the individual financial significance of a component increases, the risks of material misstatement of the group financial statements ordinarily increase. The group engagement team may apply a percentage to a chosen benchmark as an aid to identify components that are of individual financial significance. Identifying a benchmark and determining a percentage to be applied to it involve the exercise of professional judgment. Depending on the nature and circumstances of the group, appropriate benchmarks might include group assets, liabilities, cash flows, profit or turnover. For example, the group engagement team may consider that components exceeding 15% of the chosen benchmark are significant components. A higher or lower percentage may, however, be deemed appropriate in the circumstances. (CAS 600.A5)
Components with Significant Risks
The group engagement team may also identify a component as likely to include significant risks of material misstatement of the group financial statements due to its specific nature or circumstances. For example, a component could be responsible for foreign exchange trading and thus expose the group to a significant risk of material misstatement, even though the component is not otherwise of individual financial significance to the group. (CAS 600.A6)
OAG Guidance
See OAG Audit 2335 to determine the type of work to be performed on component of individual financial significance or component with significant risks.
See OAG Audit 5043.3 for definition of significant risks.
OAG Guidance
All other components in the group are considered “non-significant components.” These non-significant components, when aggregated, may be material to the group (i.e., they may be more than inconsequential to the group when aggregated). Components with a portion of one or more significant account balances where there is no significant risk may be considered non-significant components. Therefore, the group engagement team will need to use professional judgment in determining the type of procedures to be performed and whether the procedures will be performed by the component auditor or by the group auditor. Refer to OAG Audit 2335 for guidance on how to determine the appropriate type of work to be performed on these components.