We are auditing a client who uses a third-party warehouse overseas. We have not visited this warehouse, so we are looking at Technical Release 01/20 AAF on internal controls of service organisations made available to third parties. Because the auditors of that warehouse are also based overseas, we don’t think they will be familiar with that technical release, so we have sent it over for them to review. They have come back to us saying it is going to be very expensive to produce a Type 1 or Type 2 report on the internal controls. What should we do?

If you cannot get a Type 1 or Type 2 report then you cannot rely on the confirmation statement of quantities of inventory held, as you would not have assurances over the internal controls of the warehouse.

Looking at alternative options, is it possible to visit now, post year end, to undertake a count yourself and perform a roll-back procedure? Perhaps observing a count remotely might be an option you could consider? Or look to engage someone else to do that on your behalf?

Without being able to rely on a confirmation statement or a stock count, you are unlikely to have sufficient appropriate audit evidence around such assertions as existence, completeness and valuation (considering condition of stock and obsolescence). Therefore, where inventory is material, you would need to consider the impact on your audit report in relation to stock-related balances.

You may then want to think about next year’s audit and how you might plan to obtain sufficient appropriate audit evidence. For example, is it possible to engage an auditor’s expert to undertake the inventory count? Please note, you would need to assess their ability, controls, procedures and so on under ISA 620 to ascertain whether you could rely on this work. 

Key links

Further ICAEW guidance on the topics above is available. Although some of it was issued during the pandemic, the solutions may be useful, despite differences in the situation above. 

Assurance on internal controls of service organisations (TECH 01/20 AAF)

COVID-19: Considerations for inventory audit testing

Audit reports – modified opinions, emphasis of matter and other matter paragraphs

Limitation on the scope of the audit

Remote auditing frequently asked questions

We were appointed as auditors subsequent to the year end and therefore we did not attend the inventory count. Inventory is around 75% of the company’s assets, so we think the issue is pervasive and therefore we are anticipating a disclaimer of opinion. In that case, do we have to perform any audit work at all?

First, you should consider other procedures that may be performed to gain sufficient appropriate audit evidence over inventory, despite you not being able to attend the inventory count. You would not simply modify the audit report without looking at the possibility of alternative evidence. Perhaps you could attend an inventory count now, and roll back the figures? Or if the client has a continuous inventory system, could you test the controls around that system and place some reliance on that?

If, however, the level of evidence you can obtain is not sufficient to give you comfort over the inventory position, you will need to consider the impact on your audit report which may involve disclaiming your opinion.

Knowing you plan on issuing a disclaimer of opinion as a result of inventory being material and pervasive, even though this represents 75% of the company’s assets, does not mean that no further audit work needs to be performed on the rest of the financial statements.

When you disclaim your opinion, you are required to give details as to why you are doing so, as part of the basis for the disclaimer of opinion; we would expect this to include some mention of both inventory closing balance and also cost of sales. Here you would include any other modifications that would have been in your audit opinion.

Although you plan to issue a disclaimer of opinion, you should complete the remaining audit work as far as possible. This is because you need to obtain as much audit evidence as you can over the financial statements, and so that you can identify any other modifications or limitations that would have been in your opinion. That said, it will still need to be clear in the disclaimer of opinion that you are not providing any assurance over the financial statements.

Key link

Preparing an audit report with a disclaimer of opinion

We have an audit client that is a parent of a group and also has a 49% shareholding in an associate. The impact of the equity accounting of the associate will be material. What work as auditors do we need to carry out?

If you follow the link below, you will find some helpful guidance on auditing groups and your particular situation on page 9. The section on ‘Determining the coverage of components and the work to be performed’ includes associates in the assessment of significant and non-significant components. ISA 600 would be applied in determining whether the associate is a significant component to the group and therefore provides guidance as to the audit requirements over such associates.

As auditor, you must consider the need for the management of the parent entity to obtain the information you require, as the parent has no control but does need to account for the impact of that associate on the group financial statements. 

Auditors’ rights under the Companies Act 2006 only extend to subsidiaries per s499 and s500 and so group management may need to use their influence to obtain the necessary information.

Key link

Auditing groups: a practical guide (includes supplementary material)