You are the manager responsible for the audit of the Nassau Group, which comprises a parent company and six subsidiaries. The audit of all individual companies’ financial statements is almost complete, and you are currently carrying out the audit of the consolidated financial statements.

One of the subsidiaries, Exuma Co, is audited by another firm, Jalousie & Co. Your firm has fulfilled the necessary requirements of ISA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) and is satisfied as to the competence and independence of Jalousie & Co.

You have received from Jalousie & Co the draft audit report on Exuma Co’s financial statements, an extract from which is shown below:

‘Basis for Qualified Opinion (extract)

The company is facing financial damages of $2 million in respect of an on-going court case, more fully explained in note 12 to the financial statements. Management has not recognised a provision but has disclosed the situation as a contingent liability. Under International Financial Reporting Standards, a provision should be made if there is an obligation as a result of a past event, a probable outflow of economic benefit, and a reliable estimate can be made.

Audit evidence concludes that these criteria have been met, and it is our opinion that a provision of $2 million should be recognised. Accordingly, net profit and shareholders’ equity would have been reduced by $2 million if the provision had been recognised.

Qualified Opinion (extract)

In our opinion, except for effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view of the financial position of Exuma Co as at 31 March 2011...’

An extract of Note 12 to Exuma Co’s financial statements is shown below:

Note 12 (extract)

The company is the subject of a court case concerning an alleged breach of planning regulations. The plaintiff is claiming compensation of $2 million. The management of Exuma Co, after seeking legal advice, believe that there is only a 20% chance of a successful claim being made against the company.

Figures extracted from the draft financial statements for the year ending 31 March 2011 are as follows:

Required:

Identify and explain the matters that should be considered, and actions that should be taken by the group audit engagement team, in forming an opinion on the consolidated financial statements of the Nassau Group. (10 marks)