Group Audits – Reference Component Auditors (or Not)

In group audits, you often need to make a decision about referencing other auditors

This article provides guidance concerning the decision to reference component auditors in group audits.

Does your firm audit consolidated financial statements that contain a subsidiary audited by another firm? How about a governmental audit that contains a component unit audited by another firm? Or maybe an audit of an entity that has an equity-method investment audited by another firm? 

Referencing component auditors

Decision – Assume Responsibility or Not

If you audit an entity (e.g., Father Company, Inc.) that contains a component (e.g., Son Company, Inc.) audited by another firm, you will make a decision to reference or not reference the component auditor.

If you reference the component auditors, you are not taking responsibility for the component.

If you don’t reference the component auditors, you are, in effect, taking responsibility for the audit of all entities comprising the entity. (There will be additional work for the group auditor as he directs audit activities related to the entity as a whole, including procedures of the component auditor.)

1. When to Reference Component Auditors

First Question – Are there any significant components of the consolidated financial statements that are audited by an external audit firm?

If yes, go to the next question.

Second Question – Do you (the group auditor) want to assume responsibility for the work of the component auditor?

Sometimes the answer will be “no,” and you will reference the other firm.

When referencing occurs, the group auditor’s report will normally state “we did not audit the financial statements of X Company” and that “those statements were audited by other auditors.”

The component auditor is usually not named, but you may, if you wish, provided that you:

  • Obtain permission from the component auditor
  • Include the component auditor’s report with the group auditor’s report

Communication with Component Auditor

Whether you name the component auditor or not, AU-C 600 requires the group auditor to check (orally or in writing) on the component auditor’s:

  • Compliance with independence and ethical requirements
  • Competence

Referencing should not occur unless the following is true:

  • The financial statements were prepared using the same accounting framework as the group financial statements.
  • The component auditor follows GAAS (or, when required by law, PCAOB audit standards).
  • The component auditor’s report is not restricted as to use.

2. How to Reference Component Auditors

Changes will be made to two auditor’s report paragraphs:

Auditor’s Responsibility Paragraph

You will add a paragraph like the following:

We did not audit the financial statements of ABC Company, Inc., a wholly owned subsidiary, which statements reflect total assets of $3,020,000 as of March 31, 2013, and total revenues of $7,050,200 for the year then ended. Those statements were audited by other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for ABC Company, Inc., is based solely on the report of the other auditors.

Notice you will disclose the magnitude of the financial statements not audited in:

  • Dollar amounts or
  • Percentages

Those magnitudes may be expressed using one or more of the following:

  • Total assets
  • Total revenues
  • Other appropriate criteria (whichever appropriately describes the portion not audited)

Opinion Paragraph

The opinion paragraph will state “In our opinion, based on our audits and the report of the other auditors…”

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5 thoughts on “Group Audits – Reference Component Auditors (or Not)

  1. As the group auditor I may assume the responsibility of the subsidiary which is audited by another CPA firm provided that, first, I know the reputation and the quality standard of the subsidiary auditor, second, that all of the audit workpapers are made available to me for its review and I am satisfied with the planning including the risks assessments and its response, the overall audit procedures and I agree with their conclusions.

    • Yes Armando, assuming responsibility is an option that many auditors take. As you say, you want to know the reputation and quality of their work.

      The new standards direct the group auditor (what used to be called the principal auditor) to consider all components in his or her planning – almost as though that person was planning to audit each entity making up the whole. The group auditor must plan the audit so that all relevant risks (regardless of which entity) are identified and addressed to the group auditor’s satisfaction. This new standard is more holistic, and the group auditor is more involved with component auditors than in the past.

      Of course the group auditor has the option to reference the other firm and not assume responsibility for that portion of the audit.

  2. I am wanting an example of what the internal control letters should contain if you do refer to component auditors in the audit report. From what I see in ARM you are supposed to reference the component auditors in the internal control letter as well. We issue our CAFR in December and then issue our SEFA, Yellow Book and Compliance findings separately in another report and include significant findings that the component auditors note in their audits. Any help appreciated.

    • Tammy, the audit guide Government Auditing Standards and Circular A-133 Audits (2013) provides information in Chapter 4—Auditor Reporting Requirements and Other Communication Considerations of Government Auditing Standards.

      The guidance speaks of two options: (1) reference option and (2) inclusion option.

      With the reference option, you communicate that the work of the component auditor is not included; with the inclusion option, you include the work of the component auditor. Both of these options are available when you reference the component auditor.

      Regardless of the option chosen, the audit guide states you are not responsible for the findings of the component auditor.

      Also if there are multiple component auditors, the guide states that we should use only one option – reference or inclusion – for all components. With the reference option, ordinarily the opening paragraph states that the report on internal control over financial reporting and compliance and other matters does not include the results of the audits performed by component auditors.