 Hello and welcome to this session in which we will discuss the audit of a group financial statements. What is the big idea of a group financial statement? Let's assume I own an audit firm in New York City, United States. Now I ordered a company called Adam Shipping Inc. It's a U.S. company but this U.S. company will have a foreign subsidiary. Now the subsidiary does not have to be foreign. I'm creating this example to make it more realistic or easier to kind of relate to. Now ASI, which is Adam Shipping Services, they own a subsidiary which is what we're going to be calling a component in Beirut, Lebanon, which is in the Middle East called Lebanese Shipping Inc. LSI. Now since I am the auditor of Adam Shipping Company, I am the auditor of the parent company and LSI is part of ASI. Therefore, when I have to audit, I have to audit the whole group. I have to audit ASI. They might even have another subsidiaries in Dubai, another subsidiaries in Egypt. It doesn't matter. I have to audit all of them but I happen not to have an office in Beirut, Lebanon where that location is being audited. So what do I do under those circumstances? Well, I am the principal. I am the main. I am the group engagement partner. I'm the principal partner. So I'm responsible for all these companies, not only ASI, ASI and its component. So the group engagement partner, which is Farhat Accounting and Other Services, is responsible for the group engagement, its performance and the report on the group financial statements. Now what is the group financial statements? I'm going to show you the definition in a moment but think of it as the consolidated financial statement. So when you audit a company, a parent at the subsidiaries, you are auditing everything, the group financial statement. This is what we mean by the group financial statement. I'm responsible for establishing the audit strategy, evaluating the evidence in order to draw a proper conclusion because I have to assure an opinion on the group financial statement. I have the final say. So there is a lot of responsibilities on this group engagement partner. For public companies, they call it the principal partner. The main idea in this situation, Farhat Accounting and Other Services is the group engagement partner. Now what is a group financial statement? Again, as I told you, think of them as the consolidated. Refer to the financial statement that present the financial information of multiple component. Now ASI could have again multiple component. It doesn't have to be one component. I'm going to keep it with one component to make the illustration simple. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. Now we need to learn a few definitions. One, we already kind of covered it briefly. A component, what is a component in this recording? What is the component in this explanation? Lebanese shipping ink, which is this subsidiary. It could be a subsidiary, a joint venture, an equity method of investee for which the group or component management prepare financial statement to be included, consolidated in the group financial statement as required by the framework. So any company, a subsidiary, a joint venture that we need to include is called a component. Now we're going to learn about what's a significant component. Now it's not only a component, it's a significant component. A significant component should be audited by the group engagement or the component auditor. Don't worry, we're going to define component auditor in a moment. The significant component is identified by the group engagement team as an entity or a business that is either. So how can you be a significant component, an important component, either financially, you have plenty of assets, plenty of revenue, financially significant to the group, or it doesn't have to be financially significant, have the potential to contain significant risk of material in the statement. So either, either to dollar amount, it represents a large dollar amount relative to the total company, either an assets or revenue, or the risk that it involved, it's significant to the group of financial statement. Either of these will qualify the component as a significant component. Once it's a significant component, it has to be audited by either the group engagement or which is ASI, the company in New York, or some other auditor, a component auditor. Now, if the component is not significant, simply put the component is very small, then under those circumstances, analytical procedures, conducting analytical procedures will suffice as far as the auditing procedure. Now, what is a component auditor? I just mentioned that a significant component must be audited by the main auditor or a component auditor. What is a component auditor? It's that audit firm that I'm going to be contacting in Lebanon and asking them to audit this company. Well, in this situation, we're going to call it Lebanese auditing services. So I call this office, I say, okay, I don't call them randomly, you're going to say, I'm going to have to do some work before I call them, is an auditor who perform work on the financial information of the component, which will be used as an evidence in the group audit. So I'm going to be relying on these, on this group, Lebanese auditing services. So guess what? I'm going to be, I'm going to have to do a lot of work in terms of this audit firm, LAS, LAS. A lot of acronyms, just to make the point because there's a lot of definitions, that's why I'm trying to make it a realistic scenario. A component auditor may be part of the group engagement partner firm. For example, PWC would have an office in Lebanon, it could be a network affiliated firm, they could have a network, or it could be unrelated firm. So on this example, I'm going to assume this LAS, it's an unrelated firm to me, just totally unrelated. I just, you know what? I went to the website, I looked up a few companies, I said, I like these guys, let me call them, and let me do some search about them. They're unrelated to me. Okay? Obviously, if I know someone, it's even better, but I'm just going to make up the example. Now, what is my responsibility since I selected this group? What is my responsibility as a group engagement partner and the team? And the team means the team of the group engagement partner. Well, I should understand the LAS independence and professional competence. Are they independent of this shipping company? Are they professionally competent? That's my responsibility because you're going to see later, I'm going to have to assume their work in one way or another. If they're not independent, I have to determine whether I should use them or not. Better not use them, but I have to make that determination. I also have to understand the extent in which they will be involved in the work of the component auditor, like how much work they are going to be doing. What's the extent of the work? Whether they will be able to obtain information necessary for the consolidated process. I'm going to have to understand, look, tell me, are you going to obtain enough information for me where I can draw a proper conclusion? And I have to understand what type of regulatory environment the component auditor is operating under. Are they using IFRS? Is the auditing standard in Lebanon highly regulated? So on and so forth. I have to understand this. Also, what am I responsible for? I am responsible for overseeing and performing the group audit engagement at accordance with the professional standard and regulatory requirement. So although they're doing the work, I'm responsible for their work and for determining whether the auditor's report is appropriate and the given circumstances. So I'm basically, at the end of the day, I'm responsible for everything as the engagement partner. The group engagement team should have a thorough understanding of the group, the component and their environment in order to identify significant component. It's my job to determine whether that component is a significant component. I need to gather sufficient appropriate audit evidence, including the work of the component auditor to support the audit group of the financial statement. All we're saying here is as an engagement partner, my responsibility of a group engagement partner is basically the box stops with me. So I have to do all this work. Now, if sufficient appropriate evidence cannot be obtained, cannot be obtained, the auditor should either decline to take on the new engagement or withdraw from a current engagement. Unless withdrawal is not possible, you would issue a disclaimer if that's the case, if you cannot gather enough. What type of documentation do you have to have? Well, the group engagement team should document at least the following. An analysis of component, whatever team could be more than one component, identifying which one are significant and the type of work performed on them. What type of work did we perform on them? Two, any written communication between the group engagement team and the component auditor. Remember, my office in New York and I am working with a Lebanese auditing firm. All the communication regarding the engagement team requirement has to be documented. A list of component for which the component auditor's report were referenced in the auditor's report. I need to take a look at the report. Also, the financial statement of the component and the report of the component auditor for the component reference and the auditor's report on the group financial statement. Simply put, I want a list of the financial statements, a list of the financial reports, of course, a list of all the paperwork. Simply put, this is what I would keep. Now, would I reference the component auditor or would I not reference them? I have two options. Option one, no reference. Simply put, this is called I am assuming responsibility, no reference. In other words, I am accepting their work and I'm not mentioning their name and their report whatsoever. So if you look at the report, you're not aware that there's a company in Lebanon called Lebanese auditing services that any work. So you don't mention anything about them in the report. That's one option. Now, if you have to do that, if the auditor assume responsibility, well, they must be involved in that work to the extent that it relates to expressing an opinion on the group financial statement. So if you don't say anything, you have to be involved. You have to know what's going on because you are taking basically full responsibility. The involvement may include performing risk assessment procedure. You might have to do that. You might have to perform additional procedures. They did the work. You might want to maybe send the team just to do a little bit of work, review their documentation, review the components auditor documentation, review their audit program. So you have to do a little bit more work because what you are doing here is you are assuming responsibility because you are not mentioning them. You are not referencing anything in the report that you had another auditor work help you or you can reference them. Here you are not assuming responsibility alone. You are dividing responsibility. Now, you mentioned them. When do you divide the responsibility? Two conditions has to exist. The component auditor that Lebanese auditing firm followed GAAS or the PCAOB. If they did not follow them, mentioned the additional procedures to compensate in order to meet the relevant requirement. If I'm following GAAS or PCAOB and they're not following GAAS or the PCAOB, they could be following international auditing standards. That's fine. That's acceptable to them. But since I am accepting the work, I have to make sure the amount of work needs the GAAS and the PCAOB. Two, the component audit auditory report is not restricted. Simply put, they have to give me that report. And if somebody asks for it, I have to be able to furnish it because you're going to see in the audit report, I will show you shortly, it says we rely on the report, which was furnished to us. If you want to see it, we can also show it to you. It's not restricted. So the report cannot be restricted and they have to do enough work that's comparable to the US standards, whether it's a private or a public company. Now, the report should include in the opinion section and the basis of opinion, depending what type of report we're looking at, we'll look at both. Because sometimes it's only in the opinion, then we have in other reports, it's the opinion and the basis. If it's a PCAOB, we'll look at a report, don't worry about this. The component was audited by the component auditor. We have to mention this clearly. You're going to see it in the report. The magnitude, how much were they responsible for the magnitude, the size of the financial statement audited by the component, percentage of revenue, percentage of assets, which framework they used, IFRS or whatever framework they use. And the group auditor is responsible for making any necessary adjustment for the framework. In other words, they used IFRS because that's the standard that they use in that country. We in the US, we use GAP. I am the auditor. I'm responsible to make the appropriate adjustment, if any, to convert them from IFRS standard framework to GAP standards. Now what happened if the component auditor opinion is not clean? So they gave an opinion, it could be a modified or they included an explanatory paragraph. What should I do as a group engagement partner, as the main auditor? Well, I have to determine whether I should modify the opinion for the group financial statement or simply put add an emphasis of a matter or other explanatory paragraph to explain the issue. So now it depends on the situation itself. So it's a judgment. That's all what you need to know for now. Let's take a look at a component auditor's report, AI CPA. And obviously we're going to be looking at report that reference the component auditor. Otherwise, if they don't reference the component auditor, it's just a regular report, which we cover in a separate session. So this is the AI CPA standard. And it's called an opinion. We have audited the financial statement of Adam company in its subsidiary, which compromise of the balance sheet, we named the financial statement in our opinion based on our audit notice and notice here and the report of other auditors. We don't mention their names, other auditors. The company consolidated financial statement present fairly in order to your respect and its subsidiaries and the result of their operation basically standard language. We did not audit the financial statement of the company. So this is the subsidiary of the parent company of Adam company, a wholly owned subsidiary, which statement reflect total asset and constituting 18% of the asset and 16% of the revenue of the whole company. These statements were audited by other auditors whose report has been furnished to us. And as in our opinion and so far it relates to the amount included in B is based solely on the report of the auditor and our opinion is based on their auditors. So now we reference them. We said we did our work. They did their work. We looked at the report. This is what we're telling you. Now if we're looking at a component auditor under a PCAOB. The PCAOB we're going to have an opinion and the basis for the opinion. Let's take a look at the language. Again, we have audited the financial statements of Adam company, blah, blah, blah. So we did not audit the financial statement of the company, the wholly owned subsidiaries. Same language. We just want to let you know that we did not audit that company. Those statements were audited by other auditors whose report has been furnished to us and in our opinion it looks good. Now in the basis of the financial statement we believe that our audit and the report of the other auditor provide a reasonable basis for our opinion. Notice we are relying on their. We are dividing the responsibility between us and them, the other auditor. What should you do now? Go to far hat lectures and look at additional MCQs. True, false, additional resources. That's going to help you if you're studying for the CPA exam. Those questions, they should be easy, easy questions if you understand the topic. Don't take any chances, invest in yourself, invest in your career. Good luck and stay safe.