Audit Report on Wrongdoing in Financial Statements

The article discusses the importance of auditors in maintaining the integrity and transparency of financial statements. It highlights that auditors are the guardians of the financial system, responsible for ensuring that financial reports accurately reflect a company's financial position. The case study of ABC Learning is used to illustrate the consequences of misleading financial reporting, which can have a negative impact on investors and the overall economy. To prevent such instances, it is essential to implement strict accounting policies and practices, as well as a strong corporate governance framework that emphasizes transparency and accountability.

AUDITING &
ASSURANCE

Audit ASA 701
Executive Summary
There have been many instances of corporate collapses that shook the corporate world. The most
noteworthy among them are the ABC leaning, Lehman Brother, OneTel, etc. As per the investigation
it is noted that the failure happened due to the failure in the policies of the corporate governance. In
this report, the major emphasis is on the concept of ASA 701. The collapse of ABC learning centre is
discussed in an in-depth manner and the usefulness of the new auditing standard ASA701 is pin
pointed. Moreover, the flaws in the auditing system have been adequately highlighted.
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Audit ASA 701
Contents
Introduction.................................................................................................................................................4
 Auditing standard ASA701 communicating key audit matters in the independent auditor report......5
Factors related to auditing which was responsible for the ABC Learning collapse......................................6
 Hiding of the manipulated transactions in the financial statements...................................................6
 Hiding of non-expectance of true sales estimation in the case of ABC Learning.................................6
 Non-disclosure of proper financial information treatment in Audit report and audit report and.......7
 The wrong classification of funds rose:................................................................................................7
 Approval of financial statements that covered faulty transactions:....................................................7
Recommendation........................................................................................................................................7
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10
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Audit ASA 701
Introduction
ABC learning was incorporated in the year 1988 and had coverage of more than 30 centers by the end
of 2000. The listing happened in the year 2001 and spread to more than 660 centers in Australia and
more than 2238 centers covering Australia, United States, and the United Kingdom. As defined by
CPA (2012), the higher ambition and audit failure on the part of the management led to the downfall of
the giant. There were several issues pertaining to recording of assets, as well as goodwill. There were
two opinions by the auditor that led to the major contravention. The debt was a huge problem that
arises from 2007 where ABC was required to renegotiate with the bankers. Also, few long-term loans
were not payable and it affected the cash flow of the company. In lieu of this, the share value fell in a
drastic mode. Had auditors taken a strong stand then such a drastic scenario could have been changed.
The main concern that came in the way was that the ABC learning was reaping profits from the
ordinary course of activities1. There was a huge discrepancy because any child care was unable to
perform in such a rapid manner. The manner in which ABC rose to significant height was truly
commendable and was highly noticed how a child care division rose in such a mammoth way
Inadequate presence of relevant matters and negligence that needs to considered during
preparation of the financials
The external auditor of ABC provided an unqualified opinion to ABC since the appointment happened
in 2003. After the resignation in 2007, Ernst & Young took charge and took a different evaluation of
the profit that was stated previously. KMPG was introduced as a third party so that the differences can
be settled. Even after having two major giant audit firms in the organization, no faults were traced
(Kruger, 2015). Hence, the case indicates that different auditors provided a different opinion regarding
the financial statement and it needs to be noted that the unqualified audit opinion by the giants led to
the major scandal and failure of the ABC learning2. Even after having all the major giants, there was a
huge mismanagement or pitfalls that ultimately led to the downfall.
Instruments coming into action
Erroneous usage of the related party transaction was a crucial ruinous and risky decision on the part of
the firm. The major reason behind adoption of such decision can be attributed to the fact that a
garnished picture of the firm can be depicted in front of the financial institutions and other investors.
This can assist in obtaining more borrowings by keeping the securities of the firm as collateral. The
related party transaction was in charge for the cry off of the firm by gradually lessening the securities
1 Manoharan, T.N., 2011. Financial Statement Fraud and Corporate Governance. The George
Washington University.
2 CPA 2012. ABC learning collapse case study. [online] Available at:
<https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-
study> [Accessed 5 September 2016]
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Audit ASA 701
by presenting such transactions as register sale for securities3. The management was helped by the
auditing staff to conceal the duplication of securities prevalent in the financials and also hiding that the
firm had been depicting all its major securities as third party collaterals equivalent to nothing in its
financials (Carcello, 2012). Further, the firm endeavored to present its entire amount of borrowings or
loan as ‘sale proceeds of the investment securities’. Moreover, not a single transaction related to such
was portrayed on the firm’s balance sheet. This makes it clear that the firm’s major target was to attain
an environment of less risky liabilities and more resourceful or liquid assets. The company was paid a
huge amount of $74 for works pertaining to the ABC centers. The Brisbane Bullets Basketball team
that Grooves owned was sponsored by ABC. Most importantly there were transactions pertaining to
1,2,3 global group of companies. ABC provided that such transactions were unrelated and that there
was no interest in the transactions of the company4. This was one of the poor acts of the corporate
governance that led to the downfall of ABC learning. It was a collective failure of the auditor and the
management failed in a collective manner (Geoffrey et.al, 2016).
It is the responsibility of companies to avoid related party transactions as it leads to the hampering of
goodwill in the market. Further, the common public, as well as other investors, are of the view that the
management is functioning the company for the sake of their own personal motive in place of the
motives of investors (Gilbert, 2005). However, in the case of ABC, it can be commented that corporate
governance was a weak and good performance by the auditors was missing (Carcello, 2012). Further,
the financial statements of the firm failed to disclose even one relevant matter about the scenario
prevailing within the firm. The financial statement projected information in a different manner and
hence, was a major cause of the discrepancy. The auditors endeavored to hide every relevant matter
and if they had not taken such a step, it would have been possible to delay the downfall of the company
or safeguarding it as a whole. The auditor company here in this case is Ernst and Young LLP that has
its headquarters located in New York.
 Auditing standard ASA701 communicating key audit
concerns in the independent auditor report
ASA 707 was adopted for corporate reporting in order to make sure that the relevant matters of audit
are tracked effectively and only after proper evaluation, such relevant matters must be disclosed to the
managing authority of the audit firm. Besides, there must be no delay in doing the same (Hoffelder,
2012). Hence, this auditing standard plays a key role in providing various efficacies to the users by
assisting them in extracting significant details from financial statements and make appropriate
decisions from the same. In addition, this also assists them in avoiding future losses and increasing
transparency. Moreover, the financial statements of ABC could be considered effective if such relevant
matters were not hidden from the stakeholders, thereby presenting a significant importance of the
prevalence of ASA 701.
3 Christensen, J., 2011. Good analytical research. European Accounting Review, 20(1), pp. 41-51
4 Mak Yuen Teen 2012, The ABC of a corporate collapse. [online] Available at:
http://governanceforstakeholders.com/2012/12/28/the-abc-of-a-corporate-collapse/ [Accessed 14 September 2017]
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Audit ASA 701
It is the auditor’s responsibility to put prior caution in relation to major matters during the audit
process. In addition to this, the auditor must also be capable in finding out important issues that
possess a bigger risk of material misstatements in the financials, issues that are associated with big
scale uncertainties, and the influence of such issues that may generate during the audit process.
Factors related to auditing which was responsible for the ABC
Learning collapse
If ASA 701 prevailed at the time of functioning of ABC Learning then the significant facts and figures
would have been easily disclosed. This gives rise to the fact that the absence of such standard played a
key role in favoring the auditors to conceal important matters from the financial statements and to
adopt non-communication and non-disclosure of relevant facts about the firm. Therefore, the absence
of such standard together with other loopholes in the regulatory system resulted in the disintegration of
the firm.
 Hiding of the manipulated transactions in the financial
statements
Related party transactions have framed the reduction as provisional and as false. The financial
information of ABC provided to be grave because the asset portion on its balance sheet constituted
around 80% of intangibles. Furthermore, the intangible assets comprised of various operating licenses.
Such operating licenses became a nightmare for the Government. ABC claimed the high value of the
license that was not trading and hence, high values were raised. All such matters would have resulted
in a decline of the firm’s leverage ratios to a level that would force the auditors to depict it in the audit
report and financial statements (Fazal, 2013).e trading sense of the term
The points that had to be depicted to those responsible for governance properly portray the major
issues that resulted in the disintegration of ABC Learning. Furthermore, the auditors would also have
been liable to adhere to strict regulations and would have safeguarded many investors and the company
itself as a whole, if the ASA 701 standard prevailed at that point of time (Carcello, 2012).
 Hiding of non-expectance of true sales estimation in the
case of ABC Learning
The major reason that attributed to the fall of ABC contained in the discrepancies of the company. As
per the ACCC representative, the downfall of ABC was not due to the stiff competition in the market
rather due to various financial mismanagement such as high debts and acquisition that was not
normal5. Further, the fall can be justified due to the significant inaccuracies in the financial information
projected by the company.
5 CPA 2012. ABC learning collapse case study. [online] Available at:
<https://www.cpaaustralia.com.au/professional-resources/education/abc-
learning-collapse-case-study> [Accessed 5 September 2016]
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Audit ASA 701
 Non-disclosure of proper financial information treatment
in Audit report and audit report and notes to accounts:
The non-disclosure of influence caused by material information was the firm’s plan that was cleverly
implemented in accordance with the auditors because it would picture the unfortunate conditions of
gigantic liabilities and the unmoved leverage ratio to the company’s investors (Blay et. al, 2011). The
auditors played the main role in this regard by beating all the influence caused because of such
transactions by the ABC Learning, thus they resolute not to disclose the fact.
 The wrong classification of funds rose:
The firm’s securities that were depicted as securities were now disregarded from the financials and
found no place elsewhere. Further, the firm smartly endeavored to minimize its liabilities to portray an
image that its securities are being provided to the third parties as compensation, and there are no
chances for minimization of leverage (Cappelleto, 2010). In addition, the loans obtained by the firm
was supposed to be depicted in the balance sheet until they were repaid but the transactions were
shown as ‘sales’ so that the sold securities were subtracted from the assets and there would remain no
knowledge of liabilities to the company’s customers.
 Approval of financial statements that covered faulty
transactions:
Firstly, it was nowhere disclosed that the ABC Learning applies the standard of AASB 138 that led to
revaluation only under a specific situation. The firm and the auditors together were intelligent enough
to show these dealings as petty variations in the balance sheet in accordance with the report of the
management. At the inquiry time, it came to the forefront that the standard AASB 138 provides
revaluation only under the special scenario. The same was not material to the company (Kaplan, 2011).
The firm was intellectual enough to put such previously mentioned transactions at the ending notes of
their financial statements. The auditors also played a key role in approving all the manipulation made
by the company in the financial statements (Blay et. al, 2011). All issues that had taken place within
the company’s affairs were undertaken after attaining the prior permission of the auditors who played a
key role in concealing relevant matters, thereby causing material misstatements in the financials.
Recommendation
Regarding financial reporting by companies, auditors both internal auditors and statutory auditors
plays a vital role in regard to the information’s and data are accurate and are provided in a transparent
manner within the ambit of regulations laid down in the company law. Therefore, the auditors are
assigned with the duty to thoroughly audit the books of accounts maintained by the company in
preparation of the detail financial statement. The auditors are equally responsible for preparation of
financial statement and correctly taken the audit process of books of accounts and to report the
wrongdoing to the company in their auditor’s report in the interest of the stakeholders and investing
community of the society (Baldwin, 2010). The auditors are the guardian and not the agent, so they
should carry out their duty and to comply with the standards of auditing, and apply them in practice
during the audit. The auditors should also try to be cognizant of working of the entity and accordingly
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Audit ASA 701
do his audit of the books of accounts in the company. Auditors can be held answerable for the loss to
the persons or another entity those believed in the financial reports that are audited by the audit firm
(Lapsley, 2012). The ABC learning case is the best example in the recent past as regard to
misreporting in the financial statement of the company, there was a gigantic divergence of the
regulations in operations and the actual applications on the ground, pointing fingers over the failure of
administrative and regulatory mechanism in the system (Heeler, 2009). Policy masters in the policy-
making institutions such as Accounting Standard Board, IFRS, and Basel are, therefore, pleading them
to formulate the regulations for strict supervision and ethical audit system to be followed by the
organizations so that integrity and transparency can be maintained throughout the system. Therefore, it
is the need of the hour to have a strong practice of corporate governance and risk management strategy
so that any type of risk can be mitigated (Matthew, 2015).
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Audit ASA 701
Conclusion
The organizations and companies in the system should stringently comply the best accounting policies
and practices that have been laid out in the rules and regulations keeping in view the aspects of each
finding in the financial procedures that are to be integrated at the time of preparation of the financial
statements as any misleading information provided in the financial reporting by the companies will
have an adverse impact on the country’s economy and image. As the case of ABC learning is the best-
suited example and present many meaningful lessons to Lawmakers and all entities no matter how big
or small they are regarding good corporate governance, transparency and the honest practices to be
implemented by the management, experts, and auditor’s fraternity. It clearly indicates the deficiencies
on the part of the management and the role of the auditor is questioned. Even after having two biggest
giant in the field of audit, the frailties were observed in the financial statements that are truly
misleading. It is, therefore, advisable that no misleading information’s are provided in the financial
statements that can misguide the investors and stakeholders, only accurate and actual financial
transactions should be incorporated in the financial report of the business carried out in the company in
a transparent manner to uphold the integrity of the company. Organizations and companies should try
to restore to regulatory accounting and best auditing practices which reflect the true impression of the
accounts in the matter of company’s business operations.
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Audit ASA 701
References
Baldwin, S., 2010. Doing a content audit or inventory. Pearson Press.
Blay, A. D., Geiger, M. A. & North, D. S. 2011. The Auditor's Going-Concern Opinion as a
Communication of Risk. Auditing: A Journal of Practice & Theory, 30 (2), pp. 77- 102.
Cappelleto, G., 2010. Challenges Facing Accounting Education in Australia. AFAANZ,
Melbourne
Carcello, J 2012. What do investors want from the standard audit report? CPA Journal, 82 (1), 7.
Christensen, J., 2011. Good analytical research. European Accounting Review, 20(1), pp. 41-51
CPA 2012. ABC learning collapse case study. [online] Available at:
<https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-
study> [Accessed 5 September 2016]
Fazal, H., 2013. What is Intimidation threat in auditing? [Online] Available at
<http://pakaccountants.com/what-is-intimidation-threat-in-auditing/> [Accessed 14 September
2017]
Gilbert, W. Joseph J & Terry J. E., 2005. The Use of Control Self-Assessment by Independent
Auditors. The CPA Journal, 3, pp. 66-92
Geoffrey D. B, Joleen K, K. Kelli S & David A. W 2016. Attracting Applicants for In-House and
Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons,
30(1), pp. 143-156.
Heeler, D., 2009. Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
Hoffelder, K., 2012. New Audit Standard Encourages More Talking. Harvard Press.
IFAC 2015. Strengthening organizations, Advancing Economies. [online] Available at:
<https://www.ifac.org/auditing-assurance/clarity-center/clarified-standards> [Accessed 14
September 2017]
Kaplan, R.S., 2011. Accounting scholarship that advances professional knowledge and practice.
The Accounting Review, 86(2), pp. 367–383.
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Audit ASA 701
Kruger, P., 2015. Corporate goodness and shareholder wealth. Journal of Financial economics,
pp. 304-329
Lapsley, I., 2012. Commentary: Financial Accountability & Management. Qualitative Research
in Accounting & Management, 9(3), pp. 291-292.
Manoharan, T.N., 2011. Financial Statement Fraud and Corporate Governance. The George
Washington University.
Matthew S. E 2015. Does Internal Audit Function Quality Deter Management Misconduct?. The
Accounting Review 90(2), pp. 495-527
Teen, M.Y., 2012. The ABC of a corporate collapse. [online] Available at:
<http://governanceforstakeholders.com/2012/12/28/the-abc-of-a-corporate-collapse/> [Accessed
14 September 2017]
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