Chapter 05 - Audit of Group Financial Statements

(1) If a German corporation has controlling influence, it must prepare consolidated financial statements and a group management report for the previous year.

(2) Controlling influence exists if the parent:

• Owns majority voting rights.

• Can appoint/dismiss key members of the administrative, management or supervisory body

• Determines financial/business policy through control agreement.

• Has economic interest in major opportunities/risks for a specific goal (special purpose entity).

(1) A parent is exempt from preparing consolidated financial statements and a group management report if it meets at least two of the following three criteria:

• Total assets and liabilities of parent and subsidiaries are less than €19,272,000.

• Combined sales of parent and subsidiaries are less than €38,544,000 in the past year.

• Average number of employees in parent and subsidiaries is below 250.

(2) Exemptions don't apply if the parent or any subsidiary is involved in the capital market as per § 264d HGB.

Degree of influence determines which standards have to be applied

• Participation -> lowest amount of influence, results in a financial investment classified as a financial investment under IAS 39

• Significant influence -> At least a larger amount of influence, below control but above participation -> Associated company under IAS 28, Investments in Associates

• Joint Control -> Joint Venture under IFRS 11: Joint arrangements

• If the control criteria is fulfilled -> IFRS 10 Consolidation (Group financial statements), the applied accounting rule is IFRS 3 Business Combinations

Important: CONTROL IS NOT SHARED

The risk that the component auditor may not detect a misstatement in the financial information of the component that could cause a material misstatement of the group financial statements, and the further risk that the group engagement team may not detect this misstatement (ISA 600.6)

The group engagement partner is responsible for:

the direction, supervision and performance of the group audit engagement (ISA600.4) and applies the requirements of ISA 220 (Quality Control for an Audit of FS), regardless of whether the group engagement team or a component auditor performed the work on the financial information of the component (ISA 600.5).

ISA 600

• may be useful to the auditor, when other auditors are involved in the audit of financial statements that are not group financial statements (ISA 600.2)

• may be adapted as necessary according to the circumstances

• assists the group engagement partner to meet ISA 200 requirements (Quality Control for an Audit of Financial Statements) where component auditors perform work of components (ISA 600.5).

Objectives of the Group Engagement Partner:

1. Clear communication with component auditors about scope, timing, and findings of their work.

2. Obtain sufficient audit evidence for components' financial information and consolidation process.

3. Express an opinion on group financial statements' compliance with reporting framework (ISA 600.8).

The group engagement partner is responsible for the direction, supervision and performance of the group audit engagement in compliance with professional standards and applicable legal and regulatory requirements, and whether the auditor’s report that is issued is appropriate in the circumstances. As a result, the auditor’s report on the group financial statements shall not refer to a component auditor, unless required by law or regulation.

2. Acceptance and Continuance

In applying ISA 220, the group engagement partner shall determine whether sufficient appropriate audit evidence can reasonably be expected to be obtained in relation to the consolidation process and the financial information of the components on which to base the group audit opinion.

4. Understanding the Group, its Components, and their Environments

The group engagement team shall obtain an understanding of the group, as well as its components, and their environments, including group-wide controls so the consolidation process is sufficient to...

(a) Confirm or revise its initial identification of components that are likely to be significant; and

(b) Assess the risks of material misstatement of the group financial statements, whether due to fraud or error

The group engagement team shall determine:

1. Materiality for the group financial statements as a whole

2. Materiality to be applied to particular classes of transactions, account balances or disclosures, where misstatements higher than materiality for the group financial statements as a whole could reasonably be expected to influence the economic decisions of users based on the group financials

3. Component materiality for those components where component auditors will perform an audit or a review for purposes of the group audit.

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 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.

  
  

Components with significant risks

• The group engagement team may also identify a component likely to include significant risks of material misstatement of the group financial statements due to its specific nature or circumstances (risks that require special audit consideration)

• 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.

The group engagement team’s determination of the type of work to be performed on a component and its involvement in the work of the component auditor is affected by:

• Significance of the component

• Identified significant risks of material misstatement of group financial statements

• Evaluation of design of group-wide controls and implementation

• Understanding of the component auditor

Determining the type of work to be performed on the components

• Individual financial significance: Perform audit using component materiality

• Specific nature or circumstances: Perform audit of financial information using component materiality or audit procedures related to significant risks

Determining work on non-significant components

• Perform analytical procedures at group level

• If evidence is insufficient, select and perform procedures like audit of financial information, review of financial information using component materiality, specified procedures

Involvement in work performed by component auditors for significant components

• Nature, timing, and extent of involvement affected by understanding of component auditor

• Minimum involvement includes discussing significant business activities, susceptibility to material misstatement, and reviewing documentation

Evaluation and response to significant risks

• Evaluate appropriateness of further audit procedures

• Determine involvement of group engagement team to address identified risks

Further Audit Procedures for Consolidation Process

• Group engagement team is requiredto address assessed risks of material misstatement in group financials arising from consolidation

• Involves designing and performing additional audit procedures

• Includes evaluating whether all components have been included!