The Impact of Auditing Standards on Investors

This assignment explores the crucial role of auditing standards in safeguarding investors' interests. It highlights the consequences of inadequate auditing practices, illustrated by a case study involving ABC Company where investors suffered significant losses due to misleading financial reports. The document further examines the implications of newly implemented auditing standards and their potential to enhance transparency and accountability within the financial reporting system, ultimately promoting investor confidence.

Auditing Theory
and Practice

1
By student name
Professor
Date: 02 September, 2017.
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Executive Summary
Auditing is a process in which the trained professionals review the books of account prepared by
the company and comment on the effectiveness of the same. Audit is done by independent entities
without any biasness and all proper professional judgement must be involved in the same. With the help
of the audited statements, the users who depend on these statements to take important decisions can
be sure about the validity of the same. There have been many standards that have been developed to
the help the auditors in taking important decisions regarding the statements that they are reviewing.
The auditors must follow the standards with all effectiveness and the auditor must comment on all the
matters that have been there in the financial statements. In this given report, we will discuss one such
standard of auditing ASA701 Communicating Key Audit Matters in the Independent Auditor’s Report.
This standard was developed when there was a global crisis that led to the downfall of one of the
biggest organisations ABC Learning Centre, and what effect it might have, if this standard was developed
prior to the crisis faced by the investors of the company.
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Contents
Introduction……………………………………………………………………………………………..........…..4
Analysis……………………........................................................................................... 5
Downfall of the ABC Learning Centre................................................................................5
Features of the ASA 701.....................................................................................................8
Effect of the ASA 701 on the ABC crisis................................................................................9
Conclusions.............................................................................................................10
References.............................................................................................................. 11
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Introduction
The ASA701 Communicating Key Audit Matters in the Independent Auditor’s Report, is a new
standard that has been developed by the IAASB, it deals with the duties of the auditor to comment on
key important matters of the financial statements that focuss on the assumption of going concern. It
applies to all audits of the general purpose financial statements of all the listed companies. Whnever the
auditor is required to communicate the key audit matters to the important entities that ask for the
same, or when the auditor does it on voluntary basis, the auditor needs to follow this standard. It
applies to the audit of the financial statements for the period ending on or after December 15,2016. It
ahs been one of the biggest changes in the overall standards of auditing, since it was first developed in
2004. The main reason behind this change was to help the investors and provide the shareholders of the
companya snapshot of the overall audit so that they can comment on important matters in the lieu of
the same. This is main reason that this standard was developed. But the first initiation that was taken to
develop this standard occurred when the global crisis occurred with the downfall of the ABC learning
center. This led to the need of developing a standard that can help the investors in getting an insight
into the financial of the company and also with the auditors stating their take on the key audit matters ,
it helps in development of the effectiveness of the overall report. Thus these standards are very
important and it is important that the auditor follows the same to the best of his ability. In cases if he
fails to amke his report on the basis of these standards than the auditor will be held liable by the
government and can be penalised for the same. The downfall of the ABC learning centre was the major
reason that led to the development of this stanadard and we will analyse the overall effect it had on the
functioning of the company. And what if the auditors had followed the standard before the crisis, would
the global crisis would have been prevented or not (Abbott et al., 2016).
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Analysis
Downfall of the ABC Learning Centre
The ABC learning centre was founded in 1988. By 1996, the company had around 18 childcare
centres and was one of the biggest players of the private childcare centre in Australia. By 2201, the
company was listed on the Australian Stock exchange and by 2007; the overall market capitalisation of
the company grew to about a$2.5 billion. The company reported an after tax profit of A$143.1 million
and revenues of A$1.7 billion. However, post that the business was not functioning well and the
company had to incur a lot of debt, which led to the delisting of the company from the stock exchange
and the went into liquidation. Because of all these, the investors who had invested in the company had
to suffer a lot, there was a decline in the share price of the company from the highest bid of A$8.62, to
as low as A$0.54. This showed how badly the investor had suffered because of the delisting of the
company and its failure to continue as a going concern (Burke & Clark, 2016). Many factors led to the
downfall of the company that included the bad business model, regressive accounting policies, large
capital expenditures, and poor acquisition policies, low advantage levels all that in combination led to
the downfall of the company and had affected the investors of the company. After the collapse of the
company, the investors found that the business model of the company was very hard to decipher and
the overall operations that the company undertook was very opaque that was where the company
failed. If the accounts of the company were properly audited and the key matters were included, then
such loopholes would have been identified and that would have helped the investors of the company in
taking important decisions and could have saved them from such major losses (Brannen, 2016).
The major accounting issues that were involved in the downfall of the company involved the
need of recognition of certain items in the auditor’s report as key audit matters. The first was the huge
flaws in the intangible assets of the company and the same was not even recognising by the stock
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exchange on which the company had its account listed. The company had a large number of intangible
assets in its financial statements, like goodwill, derivatives, and other biological assets that were hard to
value and accounted for. Most of these assets were because of the company’s aggressive acquisition
policy rather than the basic operational business model. The problems was not there just in the
functioning of the company , but the auditors that were appointed also failed to do their task with
diligence. Since 2003, the company had appointed Pitcher Partners Brisbane firm, to audit its account,
and the auditor happily obliged with the view of the management and issued unqualified audit report.
They failed to identify that the overall payments from the loss making centres were shown as normal
revenues and hid the fact that these institutions were merely El Dorado for ABC Learning shareholders.
The Pitcher partner supported the same, and this led to the accumulation of millions worth intangible
assets on the financial report of the company that was not valued properly and was neither accounted
for. Many experts described the situation as the failure of the accounting and regulatory processes and
deviation from the standard laws and methods.
When the new auditor Ernst & Young's took over from the previous auditor, and started the
overall auditing process, it found that there were many loopholes in the overall accounting process of
the company. It took over the audit from the year ending 2007, and it took seven weeks for the
company to provide them with their interim reports. When the new auditor tried to reconcile their
findings with those of the previous year, they found that there were many issues involved. When they
asked the management of the company to make the requisite changes, the management found that if
they inculcate all that the new auditors are telling in their books of account, it would lead to a lot of
chaos on part of the management. The Ernst & Young's audit was able to provide a clearer and true
picture of the position of the company apart from what the previous auditor presented that was more
of an illusion than a reality. Because of the deadlock of opinion between the two auditors, a third party
was roped in to comment on the overall financials of the company. However, as per reports, KPMG was
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not successful in proving any of the auditors wrong. This raises a very important question to where is
this process of auditing heading and what is something that the investors can believe that can help them
in taking decisions.
The main points that were concluded were that there elitists an audit expectation gap, a spar
which people expect that the auditor goes through everything, every small details related to the
business and comments on the proximity of the business. The company appoints the auditors, to check
the accounts to have an assurance that the accounts of the company are OK. When they find matters
that are fishy, than they look deep into the matter and probe the same, just as the EY team did in case of
the ABC (Jones, 2017). It is very well stated that the work of the auditor of the company is to just
express an opinion and not certify or justify anything. There are guidelines that have been prescribed to
the auditors, but as the we see in the case of ABC that there is many divergent opinions that might
affect the overall audit statements and reports. So the main question is whom the investors should rely
on and what should be there taking if the audit is not done with the conviction that is required. It has
been said that such standards must be developed that helps the accountants and the auditors of the
company to give their opinion on unique matters that are related to accompany rather than strict
standards that allows them to try to cover everything and fail. Hence, the need for such strong auditing
standards have raised that has led to the development of the ASA 701 Communicating Key Audit
Matters in the Independent Auditor’s Report (Guragai et al., 2017).
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Features of the ASA 701
The main features of the standards includes that it asks the auditors to comment of the key matters of
governance and make an opinion on the same. It is applicable to all the listed companies so that it
provides some help to the investors that depends on these reports for their decisions.
 The auditor has the right to decide the key audit matters. The auditor can determine the same,
by mandating the matters with those charged with governance and making an opinion on the
matters that they feel require special attentions. They must take matters that are more prone to
risk, like the intangibles, acquisition, revenue and taxes. These areas will include significant
auditors judgment, management judgment, and specific event and transaction that will affect
the same
 The auditor describes each of the KAM with utmost precision and proper scrutiny must be done
before stating the same in the reports. Proper description with regard to each matter must be
given and how is it affecting the overall profit of the company.
 Specific circumstances, in which the matters related to the KAM, cannot be included in the
auditor’s report.
 The audit documentation must be related to the key audit matters. In addition, all the
documents must be properly stored by the auditor and used as audit evidences (Knechel &
Salterio, 2016).
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Effect of the ASA 701 on the ABC crisis
If these standards were developed before the crisis took place, it would have helped the auditors of the
company and the auditors those were at fault had to comment on the key matters that were important.
Because these standard was not there, the Pitcher Partner firm very easily stated that it still stands with
all the opinion that is framed on the financials of the company, and the application and interpretation of
the accounting standards is subject to the overall personal judgement and understanding. Hence making
it clear that it possible that two auditors can have different opinion on the same company, because
there is no specific standards that can ask the auditor to comment on certain specified matters. The
auditors will check the accounts or their own assurance that they are ok, and in cases when they find
discrepancies, they will probe further. Hence, it allowed the previous auditor to make use of major
loophole in the auditing standards (Sonu et al., 2017). If this standard was there beforehand, the
company had to include proper details regarding many matters that included the intangibles and the
overall revenues from the loss making units. Because of this downfall of the ABC learning centre the
need for the new standards has raised so that the investors who are dependent on the audit report,
who cannot have an insight in the financials of the company can easily take important decisions. In
addition, it also makes the auditor more responsible and they cannot foray into wrongdoing with ease.
They have to comment effectively and give their opinion and the management has to provide support to
the auditors of the company in whichever very possible (Raiborn et al., 2016).
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Conclusion
Hence through the above discussion and analysis we saw how important it is that the audit
report that the company is providing to the investors and the auditors who are authenticating and
forming the same, must do their work with utmost effectiveness and precision. It is very important that
the investors who are relying on these reports gets the facts that can help them in taking important
decisions with regard to the company they are investing their money in. In case of the ABC Company,
the investor has to face a huge loss because as per the auditor, the company was doing well, had large
revenues, and was a going concern entity. However, in reality most of the revenue that was shown was
dud, and the company was incurring huge losses (DeZoort & Harrison, 2016). So when suddenly the
company went into liquidation, these investors were very terribly affected. This again emphasises the
importance of audit and preparation of the financial statements of the company to best of one’s ability,
so that all the stakeholders including the investors, government, public, who depends on these reports
to take important decisions are able to benefit with the same. The issued new standard will help in
solving a large number of issues, it is one of the biggest changes in the accounting standards since 2004,
and will give power to the auditor with the abolition of many loopholes that was previously there in the
system (Lefkowitz, 2017).
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References
Abbott, L.J., Daugherty, B., Parker, S. & Peters, G.F., 2016. INTERNAL AUDIT QUALITY AND FINANCIAL
REPORTING QUALITY: THE JOINT IMPORTANCE OF INDEPENDENCE AND COMPETENCE. Journal of
Accounting Research, 54(1), pp.3-40.
Brannen, J., 2016. Mixing Methods: Qualitative and Quantitative Research. NY: Ashgate Publishing.
Burke, J.J. & Clark, C.E., 2016. The business case for integrated reporting: Insights from leading
practitioners, regulators, and academics. Business Horizons, 59(3), pp.273-83.
DeZoort, F.T. & Harrison, P.D., 2016. Understanding Auditors sense of Responsibility for detecting fraud
within organization. Journal of Business Ethics, pp.1-18.
Guragai, B., Hunt, N.C., Neri, M.P. & Taylor, E.Z., 2017. Accounting Information Systems and Ethics
Research: Review, Synthesis, and the Future. Journal of Information Systems: Summer 2017, 31(2),
pp.65-81.
Jones, P., 2017. Statistical Sampling and Risk Analysis in Auditing. NY: Routledge.
Knechel, W.B. & Salterio, S.E., 2016. Auditing:Assurance and Risk. 4th ed. New York: Routledge.
Lefkowitz, J., 2017. Ethics and Values in Industrial-Organizational Psychology, Second Edition. 2nd ed.
NY: Routledge.
Raiborn, C., Butler, J.B. & Martin, K., 2016. The internal audit function: A prerequisite for Good
Governance. Journal of Corporate Accounting and Finance, 28(2), pp.10-21.
Sonu, C.H., Ahn, H. & Choi, A., 2017. Audit fee pressure and audit risk: evidence from the financial crisis
of 2008. Asia-Pacific Journal of Accounting & Economics , 24(1-2), pp.127-44.
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