2351 Consideration in auditing the consolidation process

Apr-2018

OAG Guidance

When consolidation adjustments such as those discussed in CAS 600.A56 relate to a component, the group engagement team needs to consider communicating adjustments to component auditors as appropriate. Such adjustments may include, for example, adjustments made at group level to align accounting policies between components, journal entries that should have been pushed-down to the component, or adjustments suggested by the component auditor but booked only at the group level.

Testing of consolidation adjustments may sometimes be performed before the entity completed the preparation of its financial statements. In such circumstances, the group engagement team needs to review the final consolidation schedules for any significant differences from the consolidation schedules initially tested, as any such changes are journal entries made in the preparation of the financial statements, and therefore, according to CAS 330.20(b) (OAG Audit 9031) and CAS 240.33 (OAG Audit 5509) need to be audited. In doing so, we may use technological solutions to identify any differences between the two sets of consolidated schedules, we may obtain from management a complete list of all journal entries booked between the schedules we tested initially and the final schedules and agree them to the differences between the schedules, or any combination of the two.

OAG Guidance

The consolidation section of the audit file normally includes (unless included elsewhere in the audit file):

• Copies of the financial statements and audit reports of components where work was performed in connection with the group audit.
• Evidence of tie out of component audit reporting package with the financial statements.
• Documentation of our review of the component auditors’ communications.
• Notes of accounting policies and any major variations in policy between consolidated entities. This is best documented as carry-forward information.
• A copy of the consolidated financial statements and significant supporting working papers showing the aggregation of the financial statements of the parent and the components’ financial statements.
• Details of consolidation journal entries, including intercompany eliminations. Recurring consolidating journal entries may be documented as carry-forward information.

OAG Guidance

CASs require us to perform substantive procedures for each material class of transactions, account balances and disclosure. Therefore, if there are material intercompany balances that are not eliminated on consolidation (either at the group or component level), we need to test them substantively in addition to any controls testing performed.

OAG Guidance

The guidance above outlines the procedures we would perform in relation to the consolidation process, including elimination of intercompany balances and transactions. However, in addition to work performed on the consolidation process, we also need to consider intercompany balances that are not eliminated on consolidation and therefore may not be covered by the procedures listed above.

For example, group entity financial statements may include significant receivables or payables from/to a component accounted for by the equity method, which would not eliminate upon consolidation. These balances and transactions need to be tested substantively by either the group engagement team or the component auditor on the group engagement team's behalf. Similarly, if a component auditor is engaged to perform an audit of the component's standalone financial statements, the component financial statements would ordinarily include intercompany balances and transactions, which need to be tested substantively (if material) by the component auditor for the purposes of the standalone component audit. This block provides guidance on procedures we would perform in relation to such non-eliminated intercompany balances and transactions in situations like those described above. Such procedures would be considered in addition to the work on consolidation performed as part of the group audit.

Group and component auditors need to consider if sufficient appropriate evidence has been obtained with regards to material intercompany balances and transactions not eliminated on consolidation. CASs require us to perform substantive procedures for each material class of transactions, account balance and disclosure (see CAS 330.18). Therefore, if there are material intercompany balances that are not eliminated on consolidation (recorded at either the group or component level), either the group engagement team or component auditors need to test them substantively in addition to any controls testing performed.

Procedures to be performed to obtain sufficient appropriate audit evidence regarding intercompany balances and transactions not eliminated on consolidation depend on materiality, results of the risk assessment, group and component controls over intercompany processes and other specific circumstances of the engagement. For example, more extensive substantive procedures would ordinarily be performed if there is a significant risk related to intercompany balances or transactions and the amounts of such balances and transactions significantly exceed the relevant materiality level. Group and component auditors use their professional judgment when developing the testing plan over intercompany balances and transactions and consider the relevant factors that may impact this judgment.

The engagement team needs to have an understanding of the purpose of significant intercompany transactions and consider if significant transactions outside the entity's normal course of business have occurred in order to plan to address the related risks, as appropriate (see OAG Audit 7533 for guidance on testing significant related party transactions outside the entity's normal course of business).

Controls Over Intercompany Processes

As part of developing evidence gathering activities regarding intercompany balances and transactions not eliminated on consolidation, engagement teams would consider results of evaluation of the controls over intercompany processes (both group-wide and component level controls, where appropriate), as results of controls evaluation would affect the nature, timing and extent of further procedures. When we plan to rely on controls over intercompany processes, our test plan would also need to include testing the operating effectiveness of such controls. For example, when intercompany balances and transactions are reconciled at the group entity level, the group engagement team may evaluate and test related group-wide controls to determine if they operate effectively and share the results of such testing with component auditors. When each component is responsible for recording and reconciling its own intercompany balances and transactions, evaluation and testing of corresponding controls (where we plan to rely on controls) would be performed by component auditors.

Recoverability of Intercompany Receivables Not Eliminated on Consolidation

Consider if non-eliminated intercompany receivables are recoverable, e.g., by inquiring of the component and group management and performing other procedures as appropriate. Sometimes the decision regarding settlement of intercompany balances is made by group management and therefore even if the counterparty component represents a financially viable entity, it may be necessary to obtain evidence regarding group management plans to determine if the receivables will be recovered.

Procedures Summary

The following table summarizes procedures that a component auditor may consider when developing a plan for obtaining evidence about material intercompany balances and transactions included in component financial statements (i.e., not eliminated on consolidation). The first column outlines various testing procedures and the second column indicates if such procedures are expected to be effective and efficient in specific circumstances of the engagement. For example, it illustrates that obtaining a schedule of intercompany balances directly from the group engagement team would normally only be appropriate when the group and component entities have the same period end. The component auditor applies professional judgment when deciding which substantive audit procedures included in the table below may need to be performed. The list of audit procedures is not exhaustive and therefore component auditors need to consider if other procedures may be more effective and efficient in the specific engagement circumstances.

(Note 1) As explained in OAG Audit 2342, OAG Audit teams acting as group engagement teams need to consider communicating to OAG Audit teams acting as component auditors a schedule of intercompany balances (or otherwise facilitate access to such information) and procedures performed by the group engagement team over such balances and transactions. This communication will provide OAG Audit teams acting as component auditors with evidence over intercompany balances and transactions recorded in the group entity's financial statements and make the component auditor procedures performed for the group and component audit purposes (providing the group entity and components have the same period end) more effective and efficient. The schedule of intercompany balances would be agreed to the group entity's financial records by the group engagement team.

(Note 2) Where a schedule referred to above is not provided by the group engagement team, appropriate audit evidence for the component auditor may come in the form of testing an intercompany confirmation, obtained by the management of the component under audit from the management of the counterparty component with whom the balance is held or transaction(s) undertaken. As the inherent risk and significance of the balance under consideration increase, the extent of necessary evidence increases as well and the more likely it is that other procedures may need to be performed in addition to testing the intercompany confirmation.

This procedure would normally be effective only when management of both components is sufficiently independent from each other. In particular, management of the component providing the confirmation cannot be accountable for the balances recorded at the component requesting the confirmation (which may be the case when the accounting function is centralized in a shared service center). Otherwise there may be an increased risk of fraud and such procedures may be not effective. Consider if there is a potential risk of inadequate segregation of management duties before performing this procedure. Note that similar considerations would generally apply when the confirmation is obtained from the group management.

(Note 3) The component auditor may also seek confirmation of significant intercompany transactions or balances from the counterparty component auditors. This would normally be most effective in situations when the component from which the confirmation is sought has the same period end. Such confirmations are facilitated in a shared service center environment, where the component engagement team may well have access to the records of both of the entities that are parties to the intercompany balances. Consider the understanding of the counterparty component auditors, previous experience of working with them and other relevant factors when determining whether requesting a confirmation from the counterparty component auditor would be effective and efficient.

(Note 4) Note that if an intercompany balance not eliminated on consolidation represents a receivable, there is a rebuttable presumption that requesting external confirmations will be performed (unless specific criteria apply), in line with the accounts receivable confirmations policy in OAG Audit 7055. We may rebut the presumption to confirm when accounts receivable are irrelevant or immaterial, when the use of confirmations would be ineffective, or when based on our assessment of risk and assurance obtained from controls testing, the combined assessed level of inherent and control risk over applicable assertions is low. Refer to OAG Audit 7055 for further guidance. When a confirmation regarding the intercompany balances and transactions has been obtained using other procedures listed above (e.g., a confirmation was obtained from the group engagement team), requesting external confirmations from the component management may not be necessary. Also note that requesting a confirmation from the counterparty component management would normally be effective only when management of both components is sufficiently independent from each other (as explained in Note 2 above).