Key Audit ASA 701

This report discusses the implementation of Key Audit ASA 701 and its importance in the accounting and auditing industry. It highlights the case of Lehman Brothers and the consequences of not disclosing key audit matters. The report also analyzes key audit matters in the banking industry, focusing on four banks.

AUDITING & ASSURANCE

Key Audit ASA 701
Executive Summary
The report is primarily based on Key audit matters and the reason how it came into practice. The
main reason behind the introduction of KAM that is ASA 701 was the downfall of Lehman
Brothers. Communication of key audit matters will assist the auditor in the preparation of an
audit report. Not sharing key audit matters with the auditors will not necessarily do any good to
the organization rather it will have an adverse impact on the business activities of the same. A
failure to communicate key audit matters on the directors and top level management part can
harm the hard earned positive reputation of an organization and can also impact the financial
well being of the same. The same scenario was observed in the case of Lehman Brothers.
Therefore, it is very essential for the board and top level executives to disclose key audit matters
to the auditors so as to not only ease the process of auditing and preparation of audit reports but
also in order to enhance the financial well being and goodwill of the company. The report further
discusses ASA 701 in the light of listed banks of ASX.
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Key Audit ASA 701
Contents
Introduction.................................................................................................................................................3
Case of Lehman Brothers Limited...............................................................................................................4
Key audit matters involved in the banking industry....................................................................................5
Westpac banking corporation......................................................................................................................5
Commonwealth Bank of Australia..............................................................................................................6
ANZ Bank...................................................................................................................................................7
Macquarie Bank..........................................................................................................................................7
AMP Bank limited.......................................................................................................................................8
Conclusion.................................................................................................................................................10
References.................................................................................................................................................11
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Key Audit ASA 701
Introduction
The implementation of ASA 701 has bought about a new revolution in the accounting and
auditing industry. This new standard puts a compulsion on the auditors so as to make necessary
disclosures related to KAMs in their auditors’ report. The auditors must delegate their
responsibilities efficiently so as to trace key audit matters from the financial statements of the
audit firm (Matthew, 2015). The matters identified by an auditor must be assessed in an effective
manner so as to ascertain whether the same are KAMs or not. The matters are labeled as KAMs
if the same has the tendency to disrupt the functioning and financial performance of an
organization. It is the duty of an auditor to identify such areas that have the possibility of
material manipulation and highlights even the slightest chance of related party transactions
(AUASB, 2015).
The auditor labels such matters as key audit matters that possess a threat to the business
operations of the company. These matters are crucial in the auditors’ judgment. It is important
for an auditor to detect key audit matters from the financials and convey the same to the
management of the company so that necessary measures can be taken on time (Needles &
Powers, 2012). If management fails to address these matters then there are huge possibilities for
the financial performance of the company to suffer and even the same might collapse. The
auditors must also offer professional judgment to the management pertaining to rightly deal with
the key audit matters of the company (Nicolaescu, 2013). The auditors must also offer all the
necessary disclosures with respect to key audit matters in their auditors’ report. This will
facilitate the transparency of the audit reports and this will ultimately benefit the readers of the
financial statements as they can easily make significant decisions (CAANZ, 2016).
Matters that make it difficult for an auditor to arrive at a verdict are to be labeled as key audit
matters. It is necessary for an auditor to trace such areas that bear a greater level of risks and also
where there is an involvement of related party transactions (Niemi & Sundgren, 2012). Areas
that indicate the presence of auditors’ and management judgment must also be prioritized by an
auditor. Transactions that have largely impacted the audit processes and areas that have a high
level of internal control team must also be prioritized by an auditor for assessment (AUASB,
2015). It is highly important for the auditors to ensure that the audit processes are conducted in a
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Key Audit ASA 701
manner that makes it impossible for the board and senior managers to hide key audit matters of
an organization. It is the duty of the auditors to implement auditing standards in a manner that it
becomes easier to detect key audit matters of an organization and the same must be later used in
the preparation and representation of audit reports (English, Guthrie, Broadbent & Laughlin,
2010). The duty of the auditors with respect to detection of key audit matters and the description
of the same under suitable subheadings in the preparation of financial reports of an organization
are also clearly mentioned in the ASA 701 (Parker, Guthrie & Linacre, 2011)
Case of Lehman Brothers Limited
Lehman Brothers used to be the fourth largest international financial service provider firm in the
United States. Later, the company went insolvent and henceforth, filed for Chapter 11
Bankruptcy (Hoffelder, 2012). The major reasons accounting to company’s failure can be
attributed to non-assessment of risks on the part of the management of the same. Also, there were
no disclosures pertaining to KAMs in the audit reports of the company. This not only led the
investors of the company to face huge losses but also the same collapse.
The company collapsed on account of not providing necessary disclosures in the auditors’ report.
The facts concealed by the company in the financial statements are-
• There was a noticeable fall in the company’s leverage ratio as compared with the last years.
This drop in the company’s leverage ratio was highly due to the indulgence of the company in
heavy borrowings. The organization also dealt with significant losses as the securities of the
same was falling short. The auditors of the company chose not to disclose all these key audit
matters in their auditors’ report. This ultimately impacted the decision-making ability of the
users of financial statements (Wood, 2011).
• The statements of the company were full of errors as the company opted for Repurchase 105
transactions. The auditors were well aware of it but chose not to reflect the same in their audit
reports (Merchant, 2012).
• The company did not disclose the information pertaining to its decision to buy back of
securities in the necessary statements. The company portrayed minimum rates of derivatives as
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Key Audit ASA 701
the buyback amount. This ultimately impacted the users of the financial statements because of
which the investors were affected (Mock et. al, 2013).
These were few factors that altogether attributed in the disintegration of Lehman Brothers. The
company would have not disintegrated if the same made necessary disclosures pertaining to
KAM in its financial statements.
Key audit matters involved in the banking industry
The banking industry was used for analyzing the key audit matters that was needed to be
specified in the audit report for disclosure of the major transactions that were present in the
financial statements. It was very important for assessing these transactions because they will
affect the decision of the users in terms of investment. Four banks have been chosen for
conducting an analysis process which is:
Westpac banking corporation
Some of the major key audit matters mentioned in the audit report of Westpac is:
• It was observed that the auditor considered impairment provision of loans as a key audit
matter and also held the rationale of the management to determine the impairment provisions that
were used for making judgments, functions and their workings. One of the most important duties
of the manager and auditor was to identify all the impairment charges in relation to the loans that
are needed to be mentioned in the financial statements (Westpac Bank, 2018). The analysis also
clearly stated that the order to divide the loans among the impairment and other loans. There are
various kinds of criteria that are needed to be considered while analyzing the impairment value
of the management and also so choose loans in accordance with the different samples by
recalculation of the impairment of loans. This way can be used by the auditor to understand the
impairment losses and the provisions that have been made by the organization.
• It was observed that the organization started to make application of AASB 9 from that
particular financial year. The standard introduced a new model of expected credit loss which has
the organization to depict various kinds of future economic events. Maintaining the transactions
of expected credit loss and their provisions are very complex in nature because of which they are
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considered to be as key audit matters in the audit report (Westpac Bank, 2018). In accordance
with the management reports of the organization, it was observed that the retained earnings were
having a substantial amount because of which any kind of increment or decrement in the value
can lead the organization to suffer various kinds of losses. This will also make the organization
suffer from impairment provisions. Different kind of methods and judgments are being made by
auditors in order to assess the value of expected credit loss and other future events that have been
changed because of the application of the new standard in the organization. Hence, it is very
important for testing the accuracy and completeness of the data by mentioning them as key audit
matters in the reports.
• By conducting proper operation of the IT systems and control the organization can conduct
the audit processes much easier. The IT system of the department it is very important for proper
efficiency of all the tasks that are being carried around the company. Hence proper assessment of
the IT system of the organization should be made and also they should be clearly assessed for
their designs and controls.
Commonwealth Bank of Australia
There are various kinds of audit matters that are needed to be reported by the auditor:
• It was observed that the bank was not adopting the Australian accounting standards properly
because of which various provisions of impairment in loans was not mentioned in the financial
documents. It is very important for the organization to provide all the impairment of loans
because they are considered to be as a very important and subjective matter that can affect the
decisions of the users of the financial statement (Commonwealth Bank, 2018). Property
valuation of the loans should be made in both the cases so that adequate classifications can be
made in accordance with the amounts. This matter consists of various kinds of risks because of
which it is very important to be reported as a key audit matter in the audit report of the
organization.
• Another important key audit matter is the valuation of the financial instruments of the
organization that are used to measure the derivative value of the assets and liabilities. It is
observed that 17% of all the transactions of the organizations consisted of assets and about 5%
consisted of liabilities (Commonwealth Bank, 2018). Hence, it was made very important for the
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Key Audit ASA 701
organization to value all the assets and liabilities at their fair prices. The valuation of the assets is
done in accordance with the Australian standards. Additional judgments in relation to the
liquidity of the market and the complexity of the product are assessed by the help of fair amounts
of judgment.
• The contingent labor nature of the liabilities should also be considered as a key audit matter
because they can easily lead to degrading the value of the revenue earned by the organization
because of which it will be very harmful to the company.
ANZ Bank
Provision for credit impairment
The financial statements of the organization determined with the help of various accounting
standards that were implemented by it after October 1st, 2018. By making proper disclosure in
relation to the audit process conducted by the organization, all the budgeted credit losses and
loans and advances that have been acquired by the organization can be clearly emphasized in the
statements of the company (ANZ Bank, 2018). The same method can also be used to determine
the credit losses which are too complicated and hence they are also significant importance
because they can create a huge impact on the profitability of the organization. The organization
can try to depict the future by proper application of the accounting standards and utilizing the
prototypes that are being required by them.
Checking the vital control over the risk of the counterparty for loan of wholesale
For identification of certain risks and exposures in relation to the wholesale loans that having
transacted by the organization, various type of controls were to be implemented. It is important
for the organization to determine the performance of the organization and also put to test the
auditors and audit statements of the organization (ANZ Bank, 2018). External macroeconomic
factors also affect the organization in various ways because of which any kind of risk related to it
should also be properly assessed.
Macquarie Bank
Provisions for loan losses
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Key Audit ASA 701
The Bank had various types of provisions present for the impairment charges on the loans. All
these provisions are required for the company to formulate the environment charges that have
been charged on the assets and liabilities of the organization. Specific and collective provisions
for impairment charges on loans were also observed. The collective provision for impairment
losses consists of various individually recognize transactions that need to be charged
appropriately for making construction models that can be helpful for a selection of the
assumptions that are needed to be incorporated in the management of the organization
(Macquarie Bank, 2018). Property valuation of the financial statements will help the auditor to
evaluate the structure and efficiency of the mechanism that is being used for charging
impairment on loans and provisions.
AMP Bank limited
Information technology environment
It is observed that the banking institutions generally rely on the information technology
mechanism used by them. The information technology system helps the organization to enhance
the systems and also access various type of information that is needed to fulfill the technological
requirements. The proper audit procedure conducted by the auditors of the organization clearly
stated that the IT controls are not working adequately because of which various problems have
been faced by the management (AMP Bank, 2018). Hence, it is also making the financial reports
look disarray. Therefore proper customization of the functions should be done in order to make
information technology mechanisms more comfortable for the organization. Further, it should be
mentioned as the key audit matters in the audit reports.
Goodwill and intangible assets
One of the most important intangible assets of an organization is the goodwill. They have no
physical existence but can affect the profitability of the organization at large. Hence it is very
important for the organization to determine the value of goodwill in the most appropriate way
possible (AMP Bank, 2018). Proper impairment charges should be drawn on such assets so that
their value can be generated after deciding the recoverable amount for the cash generating units.
Therefore this matter is of great importance and should be presented as key audit matters in the
audit report of the organization.
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Key Audit ASA 701
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Key Audit ASA 701
Conclusion
It has been clearly stated in the report that all the corporate requirements are to be fulfilled in
accordance with the ASA 701. This particular standard deals with all the key audit matters that
needed to be mentioned in the audit report for maintaining transparency of the statements. The
audit report of the organization plays a very important role in order to discuss all the reasons that
were needed to be implemented for safeguarding the interest of investors by making them aware
of the major transactions that took place in the organization. Hence, in order to fulfill the
material requirements for preparing the financial statements, it is important for working in
accordance with such standards. It is very important for the auditors to conduct all the tasks
confidently so that they can improve the Goodwill of the organization that will further help them
to improve the profitability at whole.
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Key Audit ASA 701
References
AMP Bank. (2018) AMP Bank 2018 Annual report & accounts. [online] Available at:
https://corporate.amp.com.au/content/dam/corporate/aboutus/files/AMP_2018_AR.pdf
[Accessed 21 May 2019]
ANZ Bank. (2018) ANZ Bank 2018 Annual report & accounts. [online] Available at:
https://shareholder.anz.com/sites/default/files/anz_2018_annual_report_final.pdf [Accessed 21
May 2019]
AUASB. 2015. Auditing Standard ASA 701 Communicating Key Audit Matters in the
Independent Auditor’s Report, [online]. Available at:
http://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf
[Accessed 21 May 2019].
CAANZ. 2016. Auditing, and Assurance Handbook 2016 Australia. Australia: John Wiley &
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Commonwealth Bank., 2018. Commonwealth Bank Annual report & accounts. Available at
https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/results/
fy18/cba-annual-report-2018.pdf [Accessed 19 May 2019]
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Macquarie Bank. (2018) Macquarie Bank 2018 Annual report & accounts. [online] Available at:
https://static.macquarie.com/dafiles/Internet/mgl/global/shared/about/investors/results/2018/
Macquarie-Group-FY18-Annual-Report.pdf? [Accessed 21 May 2019]
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Matthew, S. E. (2015) Does Internal Audit Function Quality Deter Management Misconduct?.
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Wood, D A. 2011. The Effect of Using the Internal Audit Function as a Management Training
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