Key Audit Matters and Auditing Issues: A Case Study on Lehman Brothers and ASA 701

The paper provides a study on the Key audit matters and auditing issues that led to the downfall of Lehman Brothers. It sheds light on the new auditing standard ASA 701 that makes it mandatory for the auditors to make adequate disclosures of KAMs in their audit reports. The mining industry is studied in the light of ASA 701 through the selection of eight different companies listed on the ASX.

AUDIT & ASSURANCE

ASA 701 - KAM
Executive summary
The paper strives to provide a strong study on the Key audit matters and auditing issues that
led to the downfall of Lehman Brothers. The following report sheds light on the major
reasons that attributed to the untimely demise of Lehman Brothers as well as the new auditing
standard ASA 701 that makes it mandatory for the auditors to make adequate disclosures of
KAMs in their audit reports. The report will also further discuss the conventional auditing
standards and what paved ways to the new auditing standard ASA 701. The mining industry
will be studied in the light of ASA 701 and will be done though the selection of eight
different companies listed on the ASX so as to get the overall structure of the industry.
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Contents
Introduction...........................................................................................................................................3
Audit failure in the case of Lehman Brothers........................................................................................3
Communication of Key Audit matter – ASA 701..................................................................................4
 Mining industry Analysis through analysis of different companies...............................................5
 BHP Billiton..................................................................................................................................6
 Hawkstone mining.........................................................................................................................6
 Metals Bank Limited.....................................................................................................................6
 CSR Limited..................................................................................................................................7
 Fortescue metal group....................................................................................................................7
 Evolution mining...........................................................................................................................8
 CSR Limited..................................................................................................................................8
 Alumina Limited...........................................................................................................................8
Industry.................................................................................................................................................9
Conclusion...........................................................................................................................................10
References...........................................................................................................................................11
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Introduction
Lehman Brothers Limited was one of the leading banks in the US and therefore, the
disintegration of the same shook the entire nation. The company collapsed in the year 2008
after it became insolvent. The disintegration of the company was highly due to the negligence
of the management and auditors towards the assessment of underlying risks and providing
disclosures on KAMs in the audit reports. The failure of Lehman Brothers was also on
account of the auditing issues. The auditing practices in the company were inappropriate.
Auditing is performed so as to assess the accuracy of books, statutory records, accounts,
vouchers and other documents maintained by an organization. Auditing helps an organization
encountering and getting rid of errors or frauds underlying in its documents.
Audit failure in the case of Lehman Brothers
An investor is more pleased with an organization that shows a sign of profound audit work.
Auditing also forecasts the financial performance of an organization for the upcoming years
which is very useful information for such investors who are willing to invest in a company’s
equity. However, the audit conducted in the aforesaid company seems weak and ineffective
as its auditors did not forecast the financial future of the same. The company suffered huge
losses from making huge investments in the housing industry. The management of the
company without any evaluation and research invested a huge sum of money in the housing
industry and for this very purpose, a heavier amount was also borrowed. The housing
industry collapsed in no time and therefore, the company suffered from severe losses. Such
vital information was not provided by the auditors in their audit reports which misguided the
investors to a huge extent.
The leverage ratio of the company was 31:1 in the year 2007 which was way higher than US
standards. This means that the company was into heavy borrowings while its revenues
remained almost the same. The auditors did not project this information in their audit reports
even after being aware of the criticality of the same. The company went for Repurchase 105
and 108 transactions (Viney, 2010). This means that the organization opted for over-
collateralization of 5% and 8%. The company opted for Repo 105 and 108 transactions so as
to conceal its high leverage. These transactions boomed the company’s balance sheet by $ 50
million. The auditors of the company neither alert the management of the consequences of
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such practices nor provided such significant information in their reports pertaining to the
company’s repurchase agreement transactions (Rezaee & Kedia, 2010).
The auditors of the company were unprofessional enough for not being able to detect the
impact of such repurchase transactions. The auditors of the company must have delegated
their responsibilities appropriately by means of providing adequate disclosures related to key
audit matters of the company. Failure to present such crucial information in their audit reports
not only suffocated the existence of an organization but also impacted the investors of the
same (Parker, Guthrie & Linacre, 2011). The investors suffered huge losses since the
company got insolvent. If the investors would have been aware of the company’s actual well
being then they might have not invested in its securities and the existing ones would have
opted to withdraw their association from the same (Roach, 2010).
Communication of Key Audit matter – ASA 701
There were many issues in the financial system that led to the introduction of new standard
ASA 701. The global financial repercussions in the year 2008 and the bankruptcy of Lehman
Brothers were one of the main reasons that initiated the development of ASA 701. The new
standard aims at the effective communication of key audit matters. ASA 701 has taken away
the choice from the auditors of portraying disclosures related to key audit matters in their
audit reports (Rezaee & Kedia, 2012). It is now more of compulsion on the auditors to
provide all the adequate disclosures in their audit reports with respect to key audit matters.
ASA 701 puts forth the provisions concerning the projection of KAMs in the audit reports.
Key audit matters are crucial in the opinion of an auditor. The impact of such matters decides
the significance of the same. There are numerous matters detected by an auditor in his audit
function but he cannot label all these matters as crucial. Therefore, matters that have the
ability to damage the financial status and performance of an organization and poses a threat
to the existence of the same must only be labeled as key audit matters (Matthew, 2015). Not
all matters pose a threat to the well being of an enterprise but it is still important to trace and
rectify them.
ASA 701 makes it compulsory for an auditor to mention the KAMs in his audit report. KAMs
are matters that are necessary to be traced and rectified on time otherwise, it can shake the
balance an organization in no time. These matters are critical in the viewpoint of an auditor.
Such matters must be dealt crucially and with due care (Lakis & Masiulevicius, 2017). The
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auditors must always look for the areas that indicate the presence of material
misinterpretation so as to detect underlying key audit matters. The reporting of KAMs is as
important as the detection of the same is. Once the key audit matters are located and
identified by the audit team, the same must be discussed with the management of the
company (Suphatsorn & Phapruke, 2011). The auditors in this discussion must not only bring
the underlying KAMs into the notice of the management but must also provide them with
professional judgment to the best of their knowledge regarding how these matters can be
dealt (KMPG, 2010). The sooner the management will know about the underlying key audit
matters, the sooner it will be able to incorporate necessary measures so as to minimize or
eradicate the presence and impact of the same. Rectification of KAM is significant too
otherwise the detection and reporting of the same is just a total waste (Murphy, 2015). The
ultimate aim behind the formulation of ASA 701 is to encourage transparency and
genuineness in the audit reports of the company so as to safeguard the interests of the
investors from getting deceived. ASA 701 aims at enhancing the audit reports by making it
mandatory for an auditor to represent a true and fair view of an organization’s state of affairs
(Geoffrey, Joleen, Kelli & David, 2016). The mandatory disclosures pertaining to key audit
matters has now made the audit reports of an organization seem more desirable in the
viewpoint of an investor.
ASA 701 has various features. For listed companies, ASA 701 puts a compulsion on the
auditors to project disclosures with respect to KAM in the audit report. For other companies,
it enhances the decisiveness of an auditor to construe if it is necessary to portray key audit
matters in their auditors’ report. The necessary documents required by an auditor with respect
to key audit matters are also defined by ASA 701. It also puts forth the liberty on an auditor
to decide if a particular matter is crucial enough to be labeled as KAM to the best of his
knowledge (Venanci, 2012). The standard also seeks appropriate justifications from an
auditor if any case he has not discussed the presence of key audit matters with the
management of an organization.
 Mining industry Analysis through analysis of different companies
To comment on the key audit matter of a particular industry, we need to have a complete
knowledge regarding the companies that is contained in it. However, owing to the
innumerable companies contained in the industry it is difficult to shed light on all the
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companies. For the purpose of evaluation and study we are considering the major right
mining companies listed in ASX. In order to determine the usefulness of such standards,
analysis of annual reports of two companies of the mining industry have been done in order
to ascertain the key audit matters that we need to be taken into account. All these evaluations
have been made by analyzing the annual reports of the company for the year 2018.
 BHP Billiton
There are many key audit matters that are affecting the audit process performed by the
auditor:
Asset valuation
It is very important for the organization to value assets in the most proper way and list all the
key audit matters because of the material misstatement that can be present in impairment
charges related to the assets. Therefore, for proper evaluation of the accounts and control of
impairment of assets the organization tried to conduct a little analysis for determining the key
controls that need to be monitored while evaluation of assets (BHP Billiton, 2018). The price
of the commodity was also forecasted and many other significant factors were determined for
finding the key controls that may have affected the values of assets.
 Hawkstone mining
This mining industry was observed to be in its initial stage for developing new market
opportunities and other exploration projects. Also, it has been observed that the company
depends highly on the debt instruments for raising the capital for the fulfillment of
exploration and other evaluation activities. It is very important for the directors of the
organization to always have sufficient cash resources for repaying all the debts they are liable
to pay (Hawkstone, 2018). Proper evaluation of all the accounts was made by keeping in
mind the growing concern concept of organization which helps them to forecast expenditure
and other cash flows in accordance with the company’s infinite life.
 Metals Bank Limited
Carrying value of capitalized exploration and evaluation
It is very important for an organization to determine the carrying value of the capitalized
exploration and evaluation process so as to get significant figures. This will help the
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organization to explore all of its assets properly and then determine the ability of the capital
structure. If property valuation is not conducted, then the value of assets will not be carried
because of which the accounts of the organization will be affected (Metals Bank Ltd, 2018).
The organization conducted the audit processes that were needed to evaluate all the
exploration and evaluation of assets in the desired area so that forecasts can be made in
relation to the future cash flows that will be operated or generated by the organization.
 CSR Limited
Asset valuation
It was observed that all the prices of assets were recorded higher than the expected price
because of which various assumptions and alternation are being taken in terms of inflation,
growth, etc. Therefore it was termed as a key audit matter by the auditors because of the
assumptions and alternations that were being taken. Various other judgments made by the
auditor in order to complete the evaluation process with full efficiency (CSR Ltd, 2018). The
effectiveness of the audit report provides a backbone to the organizational framework by
analyzing the impairment charges of assets efficiently.
Provision for liability of a product
The total of product liability amounted to 312.4 million dollars. Professional advisors were
also being taken in order to determine the complications and the size of the transactions. The
auditor of the company should also keep in mind that no isolation is present while
undertaking the decisions of evaluations of liabilities.
 Fortescue metal group
Revenue generated from the sale of iron ore
It was observed that the company generated total revenue of 8335 million by selling iron ore.
The huge amount of the figure of this transaction made it necessary for the auditor to
determine it as a key audit matter. In order to analyze the figure that has been stated by the
organization, the various non-cash adjustment was being evaluated for determining the actual
revenue (Fortescue, 2018). Proper analysis of the effort in the measurement was also made in
order to determine the professional sales. Various adjustments were made in order to get the
provisional prices and then confirm the total sales that were made by the organization.
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 Evolution mining
The organization clearly depicted the total of the deferred tax assets to value at $57.4 million.
Attitude also be noted that the organization was using the Australian accounting standards for
recognizing the values because of which border is needed to analyze the appropriateness of
the figures (Evolution mining, 2018). Therefore various kind of revaluation like deferred tax
assets, analyzing the correctness of the company’s taxable amount, etc were evaluated by the
auditor of the organization.
 CSR Limited
Asset valuation
It was observed that the company was recording all of its assets in the annual report at greater
prices because of the changes in the rates of growth, inflation, etc. Therefore they should be
considered as a key audit matter in the audit report because there have been a number of
changes made in the statement in relation to the values and figures of assets. Proper
examination of the impairment process and scrutiny of data should be conducted by the
management (CSR Ltd, 2018). The auditor's also asked to determine various base rates that
can help them to analyze the effectiveness of the framework that is being used by the
organization to evaluate the impairment charges of the assets.
 Alumina Limited
Investment in AWAC evaluation of the indicator
After observing annual reports of the organization it can be stated that investments worth
$2.3 billion were to be verified for the impairment charges. Various other procedures were
also to be conducted for determining the tenure price of Alumina Limited. The auditor of the
organization also determined the value of the internal or external sources that could have
helped it to check the impairment values identified by the organization. However, it was
noticed that the auditors failed to find any kind of evidence in relation to impairment from the
investment affairs of the organization (Alumina Limited, 2018). This indicates that the same
is not dealt effectively. Impairment holds a vital significance and the value relating to
impairment should be audited properly and the same was lacking.
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Industry
From the overall analysis, it can be commented that all the companies in the mining industry
has projected their KAM in the auditor report. This provides an interpretation that the
companies are ready to share the vital information and this aids in the process of decision
making. The investors can take relevant decision through the key audit matter projected in the
report. The KAM along with the steps taken by the auditor has been provided in mmost of the
companies however in some companies some of the matters has been left unattended because
it is mentioned that the auditor failed to provide an evidence. Hence, it is the need of the hour
that the auditor must provide relevant decision in regard to the KAM. Overall, the mining
industry is proving all the KAM and this will help the investors in their process of decision
making.
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Conclusion
It can be concluded that if Lehman Brothers had a profound auditing system then the same
would have not disintegrated so untimely. The company would have survived if there would
have been the implementation of ASA 701 prior to its failure. Communication of KAM in the
audit reports is as important as detection and reporting of the same is. This is because of the
fact that the investors have the full right to access the actual financial status of an
organization. The investors are entitled to learn about the actual financial performance of an
entity and therefore, the audit reports prepared by an auditor must portray necessary
disclosures pertaining to key audit matters. Further, the KAM of the mining industry sheds
light on the fact that the auditor are proficient in their duty of projecting the key audit matter s
and the steps undertaken by them. Hence, there are no chances of any misstatement or fraud
as all the vital matters are projected effectively.
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