Businesses today have a wide and diverse range of options when it comes to deciding where to headquarter and how to structure their international operations. These decisions are often complicated and require careful consideration of factors such as domestic market size, stability of the Government and legal systems, competitive tax rates, as well as the availability of talent, financing, grants and subsidies.
Additional factors include the lifestyle afforded to management and employees, educational opportunities and personal tax rates.
The UK has traditionally been a very popular destination for overseas business, scoring highly in many of the aforementioned factors. As such, the UK has long been on the shortlist for international businesses when considering their base and structure.
The changes brought about by Brexit, and to an extent, COVID has led international businesses to review their structure, ensuring they remain agile and fit for purpose. As expected, the uncertainty brought about by these changes has led to increased activity and company registrations in the UK. Many international businesses, with UK headquarters or previously using the UK as a hub for EU business, have been setting up subsidiaries in the EU in an attempt to mitigate the impact of Brexit. On the flip side, EU businesses have been setting up subsidiaries in the UK for the same reason.
Examples of sectors experiencing such change are Aviation and Finance, being sectors not covered comprehensively within the EU-UK Trade and Cooperation Agreement.
Historically, many businesses were incorporated in the UK to allow overseas companies to sell their goods into the UK market. However, increasingly new businesses are technology and R&D centric, as opposed to traditional goods and services. The UK is an attractive destination for many of the reasons stated above, and the availability of tax breaks, grants, UK law and the UK labour market means that continues to be the case.
Practicalities of international group audits
While many fundamentals of a company audit remain the same, whether dealing with a UK- only business or an international business, there are additional practicalities and priorities in dealing with international businesses. Indeed, International businesses can almost be treated as a sub-sector of audit in their own right.
Whilst many of the core issues involved are the same, such as revenue recognition, accounting estimates, laws and regulations, there are other factors that make auditing UK subsidiaries more complex. Differences such as language and time zone, regulatory environment and variations in accounting standards. In addition, there may be additional layers of management, with increased opportunity for management override. Ownership structures are often more complex, commonly having private equity involvement.
The quality of communication in a group engagement is therefore paramount and is naturally a higher-order priority because the auditor is likely to be working with multiple layers of management and a more diverse shareholder group. Shareholder engagement and ensuring shareholders have the opportunity to address audit and assurance matters are key points of focus in the ongoing Government consultation regarding ‘Restoring Trust in Audit and Corporate Governance.
Therefore, company directors and their auditors have a responsibility to ensure they understand their differing expectations and requirements, so that audit and assurance procedures can be tailored appropriately.
As a group auditor, the first priority must be making early contact with the management and their auditors in other jurisdictions, with the aim of building a rapport, understanding what the group as a whole is working to achieve, assessing the risks involved and ensuring all parties understand the brief. While this can take time, it is vital to avoid duplication of effort, control costs and reduce the risk of future complications.
Would you expect the group and sub-auditor to be from the same firm in an international audit?
The short answer – there is absolutely no requirement for the same firm to be both group and subsidiary auditor.
Ultimately, the right approach will depend on the Group and what they want to achieve. Often, particularly in larger companies, it is assumed that the same firm will act, particularly if they have an international presence. However, there can be some significant benefits to having a different auditor.
These benefits include:
- A fresh pair of eyes and approach that can result in the subsidiary auditor looking at information from a different perspective and, in doing so, improving the breadth of scepticism and challenge required for a quality audit;
- Access to sector specialisms for the business in that jurisdiction;
- The potential for cost benefits – e.g., the subsidiary may not want to pay the same fees for audit as the group, and therefore may find a more cost-effective, regional solution;
- This also brings into consideration the right fit of auditor for the company size; depending on the nature and scale of the subsidiary’s trade, it may not be suitable to have an auditor geared towards a much larger group scenario, i.e. FTSE 100.
- Having an auditor that is closer to the business of the subsidiary rather than the group as a whole may also increase the likelihood of identifying issues.
The right approach will be a decision based on a careful balancing of all of those aspects.
Useful to note: ISA (UK) 600 requires the group auditor to evaluate and review the work of any subsidiary auditors. If, for whatever reason, this is not possible, then the group auditor has to undertake other measures and notify the Financial Reporting Council (FRC). This requirement is a UK addition, but depending on the regulatory requirements in other jurisdictions – similar rules may apply in other countries too.
Audit regulations & reporting standards
The development of country-specific audit and accounting standards and practices will be determined by a complex combination of the specific legal environment, capital markets, financing, tax, and business dynamics of that jurisdiction.
How all these aspects come into play will impact how information is used and presented, the influence and power of stakeholder groups, and the expectations and standards of regulatory bodies. For groups operating in a number of jurisdictions, this can make things incredibly complicated, particularly when it comes to presenting a consolidated view of performance and making judgements on reporting.
Additionally, it can create differences in the expectations of the level of detail or formality of audits for certain entities, e.g. often US subsidiaries do not require a formal audit, so group auditors in other jurisdictions may have to do further work themselves in order to ensure the group accounts remain free from material misstatement resulting from errors in the unaudited subsidiaries accounts.
As alluded to earlier, one of the common differences in international group audit situations is the potential that subsidiaries operate under different accounting standards (e.g. IFRS vs UK GAAP). In terms of reporting, it’s important to understand and work through differences in accounting standards in order to identify any areas where differences may exist and ensure they are sufficiently communicated to management and evidenced during the audit.
A good example is the differing treatment of goodwill and intangibles between UK GAAP and IFRS.
Often a parent company preparing accounts under IFRS will require its subsidiaries to prepare financial statements using the same accounting standards. In such situations, UK GAAP allows companies to make use of FRS 101, which enables qualifying entities to prepare IFRS based accounts without the significant disclosure requirements of full IFRS. This reduced disclosure option is often used by UK subsidiaries whose parent company prepares a full IFRS consolidation.
This approach has the advantage of avoiding the need to consider the differences in accounting treatment between IFRS and FRS 102. A qualifying entity for FRS 101 is a member of a group where the group prepares publicly available consolidated finance statements, and the entity’s results are included within the consolidation.
Before 31 December 2020, most of the focus from a business perspective was on planning – understanding if and how Brexit was going to affect the business, testing different scenarios, scrutinising the business model and building in contingencies. Early 2021 became all about the practicalities, e.g., at the beginning of 2021, many clients experienced significant customs and delivery issues for both receiving goods from EU suppliers and shipping their products to EU customers. Since then, the focus has changed to assessing the real operational and financial impact of Brexit and considering whether the current structures and processes remain optimised.
At Price Bailey, we have seen many groups making changes in how they operate, such as revising organisational and operational structures or establishing subsidiaries in Europe. For example, many international groups that used to service Europe from the UK have now opened new offices or made acquisitions in Europe to remove the risk of any barriers to future business.
Brexit is also driving changes in regulations; we have seen many UK subsidiaries of international companies that used to be exempt from audit through statutory guarantees now no longer qualify for the exemption. Prior to the UK leaving the European Union, UK subsidiaries could be exempt from a statutory audit by utilising parent company guarantees under European Economic Area (EEA) law, which can provide a useful cost-saving on audit fees. Now, this exemption is only an option for UK subsidiaries of UK domiciled parents. Therefore, for those no longer exempt, it is important that they take the time to ensure they have in place the appropriate systems, processes and controls in order to meet the scrutiny of an audit if they haven’t already.
The result of this is that many UK subsidiaries of EU groups are now required to have an audit in the UK. This change will add administrative time and cost.
The economic shift to significantly higher proportions of UK tech or tech-enabled companies brings new challenges to the audit profession. As the ICAEW stated in a recent report, these changes have created an environmental shift from not just ‘knowing your client’ but also ‘knowing your data’, as our abilities to collect, access and analyse data have developed ten-fold. While this brings with it incredible possibilities for how to view an organisation’s data, it also increases the degree of scrutiny and attention-to-detail that is indispensable in modern audits.
In some ways, the practicalities for auditing the impact of Brexit have become significantly easier. Businesses now have a far clearer picture of how Brexit will impact them and will have a clearer view of the changes (if any) required as a result. This is arguably easier to audit than it was prior to Brexit, while there was still much speculation.
While there is a significant amount of change and uncertainty ongoing internationally, the common challenges and practicalities involved in group and international group audits are not something that we believe group directors should be overly fearful of. The areas for consideration can be complex, and both the time and resource requirements for getting it right can seem extensive at times. However, if the group has the right advisors for each of the entities, quality communication channels between all parties (including shareholders), and appropriate systems for data collection, reporting and analysis, then many of the complications and risks can be mitigated.
This article was written by Darren Amott, Corporate Partner at Price Bailey LLP. Price Bailey LLP work with a significant number of international groups and their subsidiaries across audit, tax, systems, corporate finance and legal advisory. Our audit team have a wealth of experience in auditing both UK groups with overseas subsidiaries and UK subsidiaries of larger international groups – so we understand the nuances and challenges from both sides of the coin.
For more information, or if you would like to speak to one of the team about your audit requirements, please contact one of the team using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.
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