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©2012 CliftonLarsonAllen LLP1 111

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Audit of Group Financial Statements for State & Local Governments

– Maryland Association of Certified Public Accountants

– April 26, 2013

– Keith F. Novak, CliftonLarsonAllen LLP

©2012 CliftonLarsonAllen LLP2

Agenda

• Overview of Group Audits

• Defining Components in a Group Audit

• Group Auditor Responsibilities

• Wrap‐Up


Overview of Group Audits


• Statement on Auditing Standards, “Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors)”

• Based on the performance requirements and guidance in International Standards on Auditing (ISA) 600

• ISA 600 does not provide the group auditor with the ability to make reference to the audit of component auditor in the auditor’s report on the group’s financial statements (split responsibility); however, the SAS retained the ability to continue to make reference, as currently described in AU 543 of the AICPA professional standards

• Effective for audits of group financial statements for periods ending on or after December 15, 2012 – It is upon us

Ensure Compliance

• Follow top‐down risk based approach

Perform with Effectiveness and Efficiency

Group Audit Methodology


Revised Group Audit Terminologies

Old Terminologies

Originating Office

Participating Location

Other Auditors

Entity Level Controls Over Group Financial Reporting

Revised Terminologies

Group Engagement Team

Component Auditor

Component Auditor

Group‐wide Controls

Besides the group‐wide controls, other entity level controls may exist at other levels within the group structure


What is a Group Audit ‐ Definitions

• Group Audit – An audit of a group reporting unit financial statements (e.g. Consolidated entity, combined entity, oversight entity in a government)

• Group – A reporting entity consisting of two or more components (e.g. Parent & subsidiary; primary government and component units)

• Component ‐ An entity or business activity for which group or component management prepares financial information that should be included in the group financial statements (e.g. College and affiliated foundation; primary government and Bdof Education)


Common Misperceptions

• In order to come under the Group Audit Standards, there must be more than one audit firm involved.– The Group Audit standards are activated when a group is identified for

audit purposes– One team must be responsible for the group– Group Audit Team may be made up as follows:

Same team from audit firm audits all components Different teams within the same firm audits the various components Teams from varying firms audit the various components

• Only separate legal entities can be componentsCan be: – Legally separate entities– Geographic locations with separate reporting – Department with separate reporting


Defining Components in a Group Audit


Identifying Components and Groups

Group

Financial Reporting System

Operational

* Functional* Process

* Product/Services* Geographical

Locations

Organizational Structure

*Parent* Subsidiaries* Joint Ventures* Equity Method

* Investees

* Head Office* Division* Branch


Factors to Consider

• Operational and financial reporting structure• Organization structures

– Parent / subsidiary(ies)– Related entity– Governmental entities

• Products or services• Geographical locations• Components of components

– College foundation


Examples of Groups

• Higher Education– University and its foundation(s)

• Not‐for‐Profit– Entity and affiliated entities

• Governmental Entity– Primary government and its component units


Factors to Consider

• Indicators of components for a government:– Part of audit performed by other auditors or another office of same firm

– Separate reporting – Separate legal entity– Separate governance structure (e.g. different Board or management)

– Outsourced operations– Equity method investment

Documentation of factors considered and analysis of potential components is critical !


Other Considerations for Governments

• The existence of components should be evaluated within individual opinion units– Each opinion unit should usually be considered its own group. The only

exception is when there are other auditors involved (department) or legally separate entities which would automatically be considered a component.

• For governments with multiple opinion units, components will commonly exist within:– Aggregate discretely presented component units

Individual component units, whether audited by same audit firm or other auditors

– Aggregate remaining fund information: Pension or OPEB trust funds Investment trust funds

• Departments within a major fund that are separately managed may also be components– Often happens with States (e.g. Dept of Transportation)


Group Auditor Responsibilities


Basic Outline of Process ‐ Planning

• Planning– Identify the Group, and gain an understanding of it’s components and the environment in which they operate (geography, governance, etc.)

– Establish a group audit strategy– Determine materiality for both group and the components– Identify the component auditors, and if necessary, gain an understanding of them

– Make a preliminary determination of whether group audit report will or will not make reference to other component auditor’s work

– Identify and assess risks


Basic Outline of Process ‐ Performance

• Understand the group‐wide controls and the reporting process (i.e. consolidation, combination, blending, etc.)

• Respond to assessed risks • Perform procedures over subsequent events as related to group

• Communicate with component auditor (s)• Evaluate sufficiency and appropriateness of group audit work– Review reports, etc.


Basic Outline of Process ‐ Performance (cont.)

• Communicate with Group management and those charged with governance

• Make reference to other auditors and their responsibility as it relates to the group audit report


The Top‐Down Risk Based Approach

Group engagement team must obtain sufficient understanding of the group, its components, and their environment to:• Identify and assess risks of material misstatements at the group level• Identify significant accounts and disclosures and related assertions at

the group level• Confirm identification of significant components• Determine the timing and type of work to be performed at significant

and non‐significant components• Determine which work will be performed by the group and component

auditor• Determine the nature, timing, and extent of work to be performed at

the group level


Identifying Significant Components

• Significant components are determined based on individual financial significance– Generally, select a benchmark and percentage that will be applied to determine the financially significant components

• Significant components can also exist based on risk of material misstatement, even if the component is not individually financially significant


Materiality for Group Audits – Key Terms

• Group Materiality• Group Aggregation Risk

– Performance materiality– Component materiality

• Group Audit Misstatement Posting Threshold (AMPT)

• Audit Misstatement Reporting Threshold (AMRT)


Component Materiality and AMRT

• Number of components• Nature and extent of misstatements expected in the

current period• Nature and extent of accounting judgments made at the

components• Proportion of the group not subject to audit, a review or

specified audit procedures• Proportion of the group not subject to statutory audits


Understanding With Component Auditor

Determine the following:• Whether a component auditor understands and will comply with ethical

requirements• Component auditor’s professional competence• Extent to which group engagement team will be able to be involved in the

work of component auditor• Whether the group engagement team will be able to obtain information

affecting the consolidation process from component auditor• Whether the component auditor operates in a regulatory environment

that actively oversees auditors

When component auditor does not meet independence requirements or group has serious concerns about above considerations, should not make reference to other auditors. Additionally, should not use or rely on the other auditor’s work.


Determining Whether to Make Reference to Component Auditor

• Component’s financial statements are prepared using same financial framework– See recent Q&A’s on this subject as they relate to GASB framework (e.g. FASB

based entity reported as discretely presented component unit)

• Component auditor performed audit of the component in accordance with GAAS, and has issued report that is not restricted to use

• Reading component’s financial statements and component auditor's report to identify significant finding and issues, and when necessary, communicating with component auditor in this regard– Identification of missing disclosures, sensitive issues, etc.

• Other additional procedures required when not making reference


Group Audit Performance Requirements

Financially Significant Component

• Audit of financial information (adapted as necessary) using component materiality

Risk‐based Significant Component

• Audit of financial information (adapted as necessary) using component materiality

• Audit (adapted as necessary) of one or more class of transactions related to the risk

• Specific audit procedures designed to address the risk

Non‐significant Components

• Analytical procedures to identify significant risks of material misstatements

• If additional significant risks of material misstatements are identified, using auditor judgment, apply requirements of risk‐based significant components


Audit of Components

• Adapt audit of the financial information of a significant component to meet specific needs of the group engagement team– Certain accounts may not be included in the audit of a component because

they are performed at the group level– Shared service centers may be tested at the group or corporate office level

• If same audit team is performing audit of multiple components, there is flexibility in organizing workpapers:– Consider using one electronic file (set of workpapers) and keep audit work

together, but clearly delineating substantive test work based on component materiality

– Test groupwide controls


Considerations Related to Non‐significant Components

• Risk assessment analytical procedures are required to be performed on non‐significant components

• Consider the use of substantive audit procedures on aggregation of non‐significant components that present reasonable possibility of misstatement to the group financial statements

• Audit procedures performed at the group and significant component levels do not reduce or eliminate the need to perform substantive procedures at non‐significant components if there is a reasonable possibility of misstatement to the group financial statements


Consolidation/Combination Process

• Obtain an understanding of group‐wide controls and the consolidation/ combination process

• Test operating effectiveness of group‐wide controls– Performed by group and/or component auditors

• Additional audit procedures to respond to assessed risks of material misstatement of group financial statements arising from consolidation/ combination process (e.g. eliminations)

• Evaluate appropriateness, completeness, and accuracy of consolidation adjustments and reclassifications

• If component financial information is prepared under different accounting policies applied to the group, evaluate whether information has been appropriately adjusted

• Determine whether information communicated by component is properly reflected in group financial statements

• If reporting period of component is different than group, determine whether appropriate adjustments have been made


Subsequent Events

• Group engagement team or component auditors should perform subsequent events procedures through date of group auditor’s report

• Practical considerations:– Timing of component auditor’s report– Legal/governance structure– Group management’s process for identifying subsequent events

related to components• Other procedures are required when not making reference


Subsequent Events Procedures When Making ReferenceProcedures may include the following (AU‐C600.A70)• Obtaining an understanding of group management’s procedures for

identifying subsequent events• Requesting the component auditor to update subsequent events procedures

to the date of the auditor’s report on the group financial statements• Requesting written representation from component management regarding

subsequent events• Reading available interim financial information of the component and making

inquiries of group management• Reading minutes of meetings of the governing Board, or any other

administrative Board with management oversight, held since the financial statement date

• Reading subsequent year’s capital and operating budgets• Inquiring of group management


Communication with the Component Auditor (Paragraph .41)

Request component auditor confirm:• That they will cooperate with group engagement team• They will comply with ethical requirements, including

independence rules• A list of related parties prepared by group management

and other parties the group engagement team is aware of– Request component auditor to identify other related parties that are not on the list that they are aware of

• Identified risks of material misstatement that are relevant to the component auditor


Communication with the Component Auditor (Paragraph .41) (Cont.)

• Request component auditor to communicate matters relevant to the group engagement team’s conclusion with regard to the group, including:– Whether the component auditor has complied with ethical

requirements relevant to the audit, including independence– Identification of the financial information of the component on

which component auditor is reporting– The component auditors overall findings, conclusions, or

opinion• Other communication requirements when not making

reference:– Work to be performed, and content and form of reporting– Component materiality, audit misstatement thresholds


Evaluating Sufficiency and Appropriateness of Audit Evidence Obtained• Evaluate component auditor's communication including:

– Significant findings and issues– Component management– Group management

• Evaluate sufficiency of audit evidence obtained from audit procedures performed by both the group and component auditors on the financial information of the components

• Evaluate the effect of any uncorrected misstatements (either identified by group engagement team or communicated by component auditors) and instances where there has been an inability to obtain sufficient appropriate audit evidence

Other (additional) procedures required when not making reference


Documentation Requirements Specific to Group Audits

• Analysis of components (including identification of significant components) and the type of work performed

• Group engagement team’s involvement in audits of significant components, including the group team’s review of component auditor’s work

• Group engagement team’s communication of its requirements to component auditors


Communication with Those Charged with Governance

• Group engagement team communicates to those charged with governance (in addition to those required by AU 380):– Type of work to be performed on the financial information of the

components– Nature of group engagement team's planned involvement in work to be

performed by component auditors on financial information of significant components

– Instances where the group engagement team's evaluation of work of a component auditor gave rise to a concern about the quality of that auditor's work

– Any limitations on the group audit, for example, where the group engagement team's access to information may have been restricted

– Fraud or suspected fraud involving group management, component management, employees who have significant roles in group‐wide controls, or others where fraud resulted in a material misstatement of group financial statements


Wrap-up

35


Final Reminders

Determine and document the significance of

group components

Determine the type of work to be performed over

significant components

Determine the type of work to be

performed over the remaining financial

information

Professional judgment is

required when identifying components

Effective two‐way communication is key to performing a

group audit

Communicate additional items to those charged with

governance


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Audit of Group Financial Statements for State & Local ...macpamedia.org/media/downloads/2013GNFP/novak_ppt_1slide.pdf · Audit of Group Financial Statements for State & Local Governments