(PDF) Auditing and assurance : Some emerging issues

AUDITING AND
ASSURANCE

EXECUTIVE SUMMARY
Auditing standard 701 regading communicating Key Audit Matters in the independent
auditor’s report is presented to correlate the global financial crisis. The case of Bankruptcy of
Lehman Brothers critically analysed and auditors role evaluated with in depth analysis. ASA
gives additional infomraton to the users that is the reason its is most recommended standard to
deal with circumstenses like globalisation and finance risk.

Table of Contents
EXECUTIVE SUMMARY.............................................................................................................2
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
Explanation and Rationale for the new auditing standard ASA 701..........................................1
Key Audit Matters in Australian Banking Industry....................................................................4
RECOMMENDATIONS.................................................................................................................8
CONCLUSION................................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
'Auditing' relates to the independent examination of financial accounts of a business
entity with an objective to review the performance of the enterprise on the basis of collectible
evidence and its evaluation thereof (Castelo Branco and et.al., 2014). This process of obtaining
evidence by the auditors for the purpose assessing the degree of authenticity present in the
financial statements of the organisation is known as 'Assurance'. Hence, Auditing and Assurance
are complementary concepts. For this purpose, many standards have been formulated by
different regulatory bodies operative worldwide.
This report aims to provide a detailed account on various ASA developed and the
rationale behind them. Essentially, the report entails ASA 701 and ASA 570 (ISA 570) which
outline instructions in regards to communication of key audit matters as well as material
uncertainty related to going concern concept. In addition to it, necessary recommendations are
made on the basis of research analysis that takes into account the Companies of Australian
Banking Industry which are listed on ASX 100 (Moroney and Trotman, 2016).
MAIN BODY
Explanation and Rationale for the new auditing standard ASA 701
The new auditing standard ASA 701: Communicating Key Audit matters in the
Independent Auditor’s Report was developed in the wake of the global financial crisis. On 1
December, 2015, the ASA 701 was incorporated by Auditing and Assurance Standards Board
(AUASB) pursuant to section 227B of the Australian Securities and Investments Commission
Act 2001 and section 336 of the Corporations Act 2001. It is an equivalent standard to ISA 701.
However, the two have slight differences as ASA 701 has been developed in accordance with the
business environment of Australia. Here, the term 'Key Audit Matters' relates to those state of
affairs which have significant impact upon the financial reporting of a business entity for a given
financial period (Nicolaou, Nicolaou and Nicolaou, 2012). This Standard is applicable to:
(a) Audit of a Financial Report for a given financial year on an annual or semi-annual basis
pursuant with the Corporations Act, 2001 (Aus 0.1); and
(b) Audit of a General Purpose Financial Report or a complete set of such statements, for any
other purpose (Aus 0.1);
(c) Audit of other historical financial information, if required (Aus 0.2).
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Paragraph Aus 5.1 signals out those key audit matters that are not required to be
communicated in auditor’s reports on condensed financial reports prepared in accordance with
AASB 134 Interim Financial Reporting. However, ASA 705 forbids the auditor from
communicating key audit matters when the auditor disclaims an opinion on the financial report
unless such reporting is required by law or regulation (Christensen, Glover and Wood, 2013).
One of the key factors responsible for the origination of this standard is the demise of
Lehman Brothers, shortly after it received an unqualified report from their auditors, Ernst &
Young. This report gave no prior warning whatsoever regarding such incident to occur in the
near future to the company's investors. Thus, resulting in commencement of Global Financial
Crisis. Thus, one can say that the aforementioned standard is mainly developed in response to
warning or creating awareness among the investing parties about such business entities.
To elaborate more on this incident, prior to the existence of ASA 701, Lehman Brothers'
independent auditors Ernst & Young were responsible to review the financial statements of the
company and comment on its financial position, materiality as well as fairness. One of the major
role of this independent auditor was to identify fraudulent activities, ascertain the matters that
required public disclosure as well as communicate issues to the business' members of Audit
Committee. As per the new standard it is of paramount importance to communicate the key audit
matters by the independent auditors in the Auditor's Report. Hence, in this case, it would be the
responsibility of Ernst and Young to pass on all the relevant and important information regarding
key audit matters to the investors as well as other key stakeholders of Lehman Brothers
Corporation. The main purpose of ASA 701 is to provide greater transparency to the auditing
activities performed, thus, provisioning additional information to parties interested in the
auditor's report of the business (Simnett, Zhou and Hoang, 2016).
Prior to the introduction of ASA 701, it was important for the businesses to disclose or
give prior warning or indication of dissolution or bankruptcy. The unqualified audit opinion
marked by the independent auditors of Lehman Brothers Corporation did not throw light on any
incident to occur in the near future (Gomes, Eugénio and Branco, 2015). On the contrary, it
disclosed a financial transaction named Repo 105, an unorthodox item, that is used to inflate the
numbers stated in the financial statements so as to depict a healthier financial position of the
audited firm. Such transactions were termed as 'Financings' by the company in its Balance Sheet
with a similar impact observed as an increase or decrease in Cash. It was the policy of Lehman
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Brothers Corporation to regularly use sale and repurchase agreements in order to fulfill its short-
term working capital requirements by way of borrowing funds for a short period of time. This
was done using some of its assets as collateral which were then repurchased once such
borrowings were repaid. Such a policy was made effectual in response to the Statement of
Financial Accounting Standards 140 (SFAS, 140) allowing certain 'Repos' to be treated as 'Sales'
rather than 'Financings'. Hence, the business started to record these transactions as a part of Sales
rather than Financings.
Changing the name of such transactions resulted in having a positive impact on
Company's Balance Sheet as it could now reduce the amount of assets shown under the head
'Collateral'. Also, the borrowings were no more impacted the Cash Account present in the
Balance Sheet of Lehman neither any increase in liabilities was effected in the Financial
Statements of Lehman Brothers Corporation (Gramling, Johnstone and Rittenberg, 2012). As a
result, the net leverage ratio of Lehman reduced drastically. Sudden bankruptcy of Lehman
Brothers right after its independent auditors claimed that the business was good to go in the
future years created a lot of chaos and upheaval among the investors as well as US Government.
Thus, causing an international emergency leading to a Global Financial Crisis in the coming
quarters. Discovery of Repo 105 by Anton R. Valukas, the investigator of Lehman's Bankruptcy,
led to believe that the independent auditors of the business enterprise did not fulfill its duties in
entirety claiming that they had resorted to malpractices. The Financing Transaction of Repo 105
was related to repurchase agreements that allowed Lehman to manipulate a substantial amount of
$50 billion from its Quarter-end Balance Sheet to project a healthier state for the business. It was
also claimed that EY Accountants who were directly and regularly associated with the personnel
employed at Lehman Brothers did not take necessary steps to evaluate the Repo 105 Policy of
the company to see whether or not it was in accordance with the guidelines laid down by the
SFAS 140 (Soh and Martinov-Bennie, 2015).
This incident resulted in going back to the basics and questioning the roles and
responsibility of independent auditors towards general public who have invested their money in
such businesses with good faith. Additionally, it also questioned the extent of study that such
auditing parties have in relation to Generally Accepted Accounting Principles (GAAP) or any
other relevant standard along with the regulatory schemes that are applicable on the independent
auditors associated with public companies. However, at the time of Bankruptcy declared by
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Lehman Brothers in 2008, the advent of Global Financial Crisis swept almost every financial
system it could find in a downward spiral. Thus, causing global recession. This incident also
affected the Australian Banking Industry in a grave manner (Lenz and Sarens, 2012). Thus,
giving rise to the ASA 701 which required now the independent auditors practicing in Australia
to convey the Key Audit Matters.
Apart from this, investors also requested that a solution be introduced that can help
protect the interests of general investing public through the aversion of potential issues that may
exist with respect to an entity's ability to continue as a going concern. As a result, ASA 570, key
equivalent of ISA 570, related to going concern concept was revised. Post its revision, the
aforementioned standard included a clause which emphasized on the going concern
uncertainty. Especially during the Global Financial Crisis, this clause became of paramount
importance thus being replaced by a “material uncertainty related to going concern” paragraph
altogether.
Key Audit Matters in Australian Banking Industry
The Australian Banking Industry is one of the most resilient and strongest internationally.
This industry has been able to fight off sudden global financial shocks in the past as well as in
present as compared to its international counterparts. The Banks' Capital Ratios are much higher
and are equally supported by the high profit levels even though most of the banking companies
divested its non-interest income-generating businesses. For the purpose of successfully
evaluating the Key Audit Matters in this industry, those banking institutions have been taken into
account which are listed on ASX 100, an index that comprises Top 100 Large as well as Mid-
Cap Companies of Australia. Hence, the specific companies included for this research are:
 ANZ Banking Group Limited (ANZ)
 Bank of Queensland (BOQ)
 Bendigo and Adelaide (BEN)
 Commonwealth Bank (CBA)
 CYBG Plc Cdi 1:1 Foreign Exempt Lse (CYB)
 National Australian Bank (NAB)
 Westpac Banking Corp. (WBC)
These Seven Banking Corporations are some of the biggest players of Australian Banking
Industry with major market leaders being Westpac (WBC) and Commonwealth Bank (CBA).
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Listed as Financials Business on ASX 100 Index, these players form 33.5% of the whole of
index. All these banking companies regularly publish annual reports with a dedicated section of
Independent Auditor's that provide the authenticity of the information published by such
enterprises (Martinov-Bennie, Frost and Soh, 2012). This research mainly extends to conducting
of quantitative as well as qualitative analysis of key audit matters in the independent auditor’s
reports of all companies in Banking industry that are listed on ASX Top-100 so as to evaluate the
efficiency of reporting key audit matters in the independent auditor’s report. This means that the
research attempts to prove whether or not the information disclosed is of substantive nature to
the users.
Comparing Auditor Reports of Different Companies:
It is an industry wide practice to employ a non-IFRS measure to assess the performance
of business activities. In this case, the relevant non-IFRS measure is Cash Profit. It is calculated
as under:
Statutory Profits xxx
Add/Less:Non-Core Items:
Revaluation of policy liabilities xxx
Economic and revenue and expense hedges xxx
Structured credit intermediation trades xxx
Cash Profit xxx
Bank Name
(ASX Code;
Independent
Auditors)
Auditing Disclosure in Annual Reports (In accordance with Section 307C
of Corporation Act, 2001)
ANZ Banking
Group Limited
(ANZ; KPMG)
 One of the major step taken by the business is to withdraw from
Structured Credit Intermediation Trades which it entered into prior
the Global Financial Crisis with six of eight US Guarantors. This
included Credit Default Swap sales and purchases (ANZ Annual
Report, 2018). For the remaining two portfolios, it has established
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adequate compliance measures with a motive to reduce the amount of
exposure as well as its impact.
 Also, the business tends to employ hedging techniques in order to
reduce its interest rates as well as foreign exchange risks. Any income
or loss is recognized at its fair value in the Income Statement.
 Credit Impairment Charges have also been decreased so as to record
the change in such assets that hold a potential risk of causing material
misstatements.
Bank of
Queensland
(BOQ; KPMG)
 Impairment for loans is taken as a key matter due to its complex
nature as well as its importance in taking various decisions by the top-
management. For this purpose, Expected Cash Flows that differs based
on individual preferences and Estimated Recoverable Amount of
Assets that are held as Securities that are externally valued have been
taken into consideration.
 Taking into account AASB 9 Financial Instruments, Expected Credit
Loss (ECL) has been determined in order to see the impact of such
losses on loans & advances and their provisions (BOQ Annual Report,
2018).
 Goodwill Valuation has also been carry out through the
implementation of Cash Generating Unit (CGU) Concept. For this
purpose, Operating Cash Flows and Discount Rate have been applied
to assess the significant risks attached to them. For this, a sensitivity
analysis has been employed.
 The Auditor Report also entails the information, financial and non-
financial that have been excluded while formulating the audit opinion.
Commonwealth
Bank (CBA;
PwC)
 The Independent Auditor's Report defines the scope or extent to which
the independent auditors, PwC, have carried out reasonable
investigation and collected corroborative evidence so as to enable
formation of a reliable audit opinion.
 The Audit Scope defined was based on the entities as well as business
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activities that were critical to the financial statements of
Commonwealth Bank (CBA Annual Report, 2018).
 This report also enumerates the procedure to define the Audit Scope
along with the criterion that formed the group materiality score.
Also, the rationale behind adopting such a measure also provides
additional information regarding the benchmarks set, Profit value
undertaken (PBT) among others.
 The report describes each Key Audit Matter along with the Summary
on the basis of which critical audit opinions were formed. These
included Loan Impairment Provisions, ECL as well as Legal
Proceedings.
CYBG Plc Cdi
1:1 Foreign
Exempt Lse
(CYB; Ernst &
Young LLP)
The Key Audit Measures undertaken here include Payment Protection
Insurance (PPI) Provisions, SME lending impairment provisions and Revenue
recognition (Effective interest method accounting). Based on this, the audit
scope has been defined which is inclusive of Bank's Subsidiaries. In addition
to this, PBT of £15m (4.5% of total PBT) has been chosen to indicate the
overall group materiality (CYB Annual Report, 2018). Through Valuation,
Clerical Implication to determine the accuracy using historical experience as
well as Integrity Testing are some of the tools described by the Auditors to
form the audit opinion for this bank.
National
Australian Bank
(NAB; Ernst &
Young LLP)
Following the APES 110 Code of Ethics for Professional and ASA 701, the
Key Audit Matters defined by the Bank included Loan Impairment Provisions,
Restructuring provisions as well as IT Systems and Control (NAB Annual
Report, 2018). These included analysis of restructuring plans as well as
valuation techniques employed to ascertain audit opinion.
Westpac
Banking Corp.
(WBC;
The Auditor Report includes both Auditing as well as Non-Auditing Services
Provided by the Independent Auditors. It also outlines the roles and
responsibilities of the auditors to the business along with the degree of
independence with which such procedures have been undertaken (WBC
Annual Report, 2018).
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RECOMMENDATIONS
Looking at the findings above, it is recommended that companies must undertake ASA
701 in accordance with ASA 570 while formulating internal as well as external audit activities as
they provide more information to the users and help in averting potential issues.
CONCLUSION
From the above report it can be concluded that Auditing and Assurance play a major role
in determining the authenticity of the financial statements published by public companies for a
given financial period. Also, the Key Audit Matters play an important role in forming the Audit
Opinion to aware the general investing public.
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REFERENCES
Books and Journal
Castelo Branco, M., and et.al., 2014. Factors influencing the assurance of sustainability reports
in the context of the economic crisis in Portugal. Managerial Auditing Journal. 29(3).
pp.237-252.
Christensen, B. E., Glover, S. M. and Wood, D. A., 2013. Extreme estimation uncertainty and
audit assurance. Current issues in auditing. 7(1). pp.P36-P42.
Gomes, S. F., Eugénio, T. C. P. and Branco, M. C., 2015. Sustainability reporting and assurance
in Portugal. Corporate Governance. 15(3). pp.281-292.
Gramling, A. A., Johnstone, K. M. and Rittenberg, L. E., 2012. Auditing. Cengage Learning.
Lenz, R. and Sarens, G., 2012. Reflections on the internal auditing profession: what might have
gone wrong?. Managerial Auditing Journal. 27(6). pp.532-549.
Martinov-Bennie, N., Frost, G. and Soh, D. S., 2012. Assurance on sustainability reporting: State
of play and future directions. Contemporary issues in sustainability accounting,
assurance and reporting, pp.267-283.
Moroney, R. and Trotman, K. T., 2016. Differences in auditors' materiality assessments when
auditing financial statements and sustainability reports. Contemporary Accounting
Research. 33(2). pp.551-575.
Nicolaou, C. A., Nicolaou, A. I. and Nicolaou, G. D., 2012. Auditing in the cloud: Challenges
and opportunities. The CPA Journal. 82(1). p.66.
Simnett, R., Zhou, S. and Hoang, H., 2016. Assurance and other credibility enhancing
mechanisms for integrated reporting. In Integrated Reporting (pp. 269-286). Palgrave
Macmillan, London.
Soh, D. S. and Martinov-Bennie, N., 2015. Internal auditors’ perceptions of their role in
environmental, social and governance assurance and consulting. Managerial Auditing
Journal. 30(1). pp.80-111.
Online
ANZ Annual Report. 2018. [Online]. Available Through:
<https://shareholder.anz.com/sites/default/files/anz_2018_annual_report_final.pdf>
BOQ Annual Report. 2018. [Online]. Available Through:
<https://www.boq.com.au/content/dam/boq/files/shareholder-centre/financial-results/
2018/FY2018_Annual_Report.pdf>
CBA Annual Report. 2018. [Online]. Available Through:
<https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/
results/fy18/cba-annual-report-2018.pdf>
CYB Annual Report. 2018. [Online]. Available Through:
<https://www.cybg.com/resources/0e94c28f-78b1-4a4e-826a-2eb90ee5c072/
CYBG+ARA2018-final.pdf>
NAB Annual Report. 2018. [Online]. Available Through:
<https://capital.nab.com.au/docs/2018_NAB_Annual_Financial_Report.pdf>
WBC Annual Report. 2018. [Online]. Available Through:
<https://www.cybg.com/resources/0e94c28f-78b1-4a4e-826a-2eb90ee5c072/
CYBG+ARA2018-final.pdf>
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