Auditing Case Study

This case study explores the meaning and importance of key audit matters in auditing. It discusses the introduction of disclosure requirements for key audit matters and how they improve the quality of audit services. The case study focuses on the key audit matters identified in the audit report of Westpac Banking Corporation and other banking organizations in Australia. It also examines the valuation of financial instruments and assets, and the effectiveness of internal controls in relation to impairment charges.

Auditing Case Study
1

Contents
Contents......................................................................................................................................2
Introduction................................................................................................................................3
Meaning and importance of key audit matters...........................................................................4
Key audit matters.......................................................................................................................5
Lehman Brothers Holding Limited..........................................................................................13
Going concern concept.............................................................................................................14
Conclusion................................................................................................................................15
References................................................................................................................................16
2

Introduction
One of the primary function of auditing authorities all across the globe including Australia is
to make sure that financial statements are presenting the actual value of the business to
investors and other stakeholders. This is one of the primary reason that lease accounting and
auditing authorities are continuously making changes into standards applicable on auditors
and business organizations in relation to financial statements. It is compulsory for every listed
organization to conduct external audit at the end of accounting period to make sure that
financial records are free from any kind of error, mistake or material misstatement. There
have been various cases of management fraud in the past that has forced accounting
authorities to make sure that the quality of audit reporting by auditors is efficient and
effective (Nobes, 2014). As a result of the IASB has made compulsory for every order to
specify key audit matters along with audit opinion presented by them. Before the introduction
of this requirement, auditors were only required to present audit opinion on financial
statements that do not help investors and stakeholders to understand the process or difficulties
faced by the auditor during the audit process. This concept was immediately followed by
Australian accounting standard board and all audit reports issued for Australian organizations
are required to have a separate paragraph titled "key audit matters". The main focus of this
report would be to evaluate the key audit matters identified by auditors in the case of Westpac
Banking Corporation. Westpac banking corporation is an Australian business organization
operating in the banking sector (Higgins, Milne and Van Gramberg, 2015). It is one of the
most popular banking organization in Australia along with Commonwealth Bank of
Australia, ANZ Bank and Bank of Queensland. This report will also discuss the key audit
matters with respect to other four organization in this industry that are ANZ Bank, Bank of
Queensland, Commonwealth bank of Australia and National Australia bank. This report will
also the value at the disclosures in relation to going concern concept in financial statements
ending 2018.
3

Meaning and importance of key audit matters
It is very important for organization and auditors to understand that the role of financial
statements in decisions taken by investors is very high. Therefore it is important to make sure
that the financial statements are accurate and relevant for investment decision-making the
process.
Disclosure requirements in relation to key audit matters were introduced by the International
Accounting Standard Board in the year 2015. The main focus of this disclosure requirement
was to improve the quality of audit services provided by external auditors to business
organization. In the year 2017, this concept was also adopted by the Australian Accounting
Standard Board and from the year 2018, every external auditor was required to disclose key
audit matters in the audit report along with audit opinion (Sirois, Bédard and Bera, 2018).
This requirement has been followed by the majority of countries all across the globe as it will
definitely help investors to make informed decisions.
Key audit matters can be defined as the business transactions or matters that are of significant
impact from the perspective of auditors. According to the skills, opinion, and knowledge of
auditors, key audit matters should be considered by investors before making investment
decisions. For example, a business organization might use Complex method for valuation of
its inventory in the medical industry which might be different from other business
organizations in the same industry. Key audit matters will help auditors to communicate the
complexity in financial accounts to investors. Disclosure of matters in key audit matters
paragraph does not prevent auditors to make audit opinion on such matters (Cordoş and
Fülöp, 2015). In this type of disclosure also, auditors are providing an audit opinion on every
financial transaction including financial transactions discussed in key audit matters.
Audit procedures that are adopted by the auditor to identify the accuracy and relevancy of
key audit matters are also required to be disclosed by business organization along with
classifications of business transactions as key audit matters. An overall evaluation it can be
said that with the disclosure of key audit matters, auditor of the company cannot discharge
himself or herself to execute audit procedures on such key audit matters (Bédard, Gonthier-
Besacier and Schatt, 2014). On the basis of this analysis, it can be said that these transactions
will definitely help in communicating the difficulties that are faced by auditors while
conducting an audit of a particular organization to external stakeholders.
4

Key audit matters
During the financial year 2018, the audit of the organization was conducted by PWC which is
one of the most popular audit organizations all across the globe. Following are the key audit
matters identified by PWC in their audit report-
Provision for impairment charges
According to the auditor of the organization management of the company has used subjective
and complex judgment in determining the estimated impairments in the provision of loans.
Management of the company has identified the fair value of loans data given by the
organization to the clients. Impairment charges are disclosed in profit and loss account in
accordance with their probability of recovery in the future. All the impairment charges are
based upon the skill, knowledge, and experience of the management employee that is taking
such decisions (Christensen, Glover and Wolfe, 2014). Due to the complex nature and
subjectivity of estimation models, this business transaction has been included in key audit
matters. During the financial year under consideration provision for impairment charges has
decreased to $2814 million in 2018 as compared to $2866 million in 2017.
Other business organization operating in this industry have also recorded impairment assets at
the end of financial year 2018-
 Australia and New Zealand bank- $688 million
 Commonwealth bank of Australia- $1079 million
 National Australia Bank- $791 million
 Bank of Queensland Limited - $41 million
It can be said that all the business organizations operating in this industry are following the
accounting principal of identifying impairment in non-current assets to make sure that fair
value of these assets is represented.
Effectiveness of internal controls implied on provisions for impairment charges are examined
by auditor with the help of following procedures-
5

 First of all management of the company identify the governance level of top management
in making decisions in relation to impairment charges for loans at the end of every
financial year.
 Auditors of the organization have also identified by their fixed format of rules and
regulations are followed for making estimations for impairment charges or not. If
management has changed the rules and regulations in a particular accounting period then
auditor is also responsible to identify whether the changes will reflect the impairment
charges in a better manner or not (Westpac Banking Group, 2018).
 Auditor has also examined the factors that are considered by business organization for
identifying the expected cash flow from a particular loan provided by the company to the
clients.
 Auditors also examined if these assumptions and models are very common in the banking
industry of Australia or not.
On the basis of this analysis auditors of Westpac banking corporation have identified that
there are no material misstatements in the manner that business organization is recording
impairment charges (Brasel et.al, 2016).
Valuation of financial instruments
Valuation of financial instrument is also one of the most complex and subjective business
transactions undertaken by any business organization especially a banking organization. This
matter has been included in key audit matters because there are no fixed rules and regulations
that can be used by business organization for valuation of their financial instrument at the end
of the financial year. AASB 9 has provided guidelines that can help the business organization
to make assumptions in relation to valuing financial instruments (Kachelmeier, Schmidt and
Valentine, 2017). Analysis and implementation of rules and regulations provided by AASB 9
are it totally dependent on skill, knowledge, and experience of management. Management of
the company has charged following losses and profits in relation to financial instruments in
other comprehensive income statement during the financial year 2018-
 Gains/ (losses) on available-for-sale securities- Profit of $66 million.
 Gains/ (losses) on cash flow hedging instruments- Profit of $203 million.
 Foreign currency translation- Loss of $3 million.
6

All of these losses and profits are estimated on the basis of experience of management and
fluctuation in market.
Valuation of financial instrument is also recorded by every other business banking
organization as key audit matter due to its complex estimation process.
Bank of Queensland
 Gains/ (losses) on available-for-sale securities- Profit of $66 million.
 Gains/ (losses) on cash flow hedging instruments- Profit of $203 million.
 Foreign currency translation- Loss of $3 million.
ANZ banking corporation
 Gains/ (losses) from other reserves- Profit of $137 million.
 Foreign currency translation- $222 million.
Commonwealth Bank of Australia
 Gains/ (losses) on available-for-sale securities- ($77) million.
 Gains/ (losses) on cash flow hedging instruments- $(77) million.
 Foreign currency translation- $(53) million.
National Bank Australia
 Gains/ (losses) on available-for-sale securities- Loss of $9 million.
 Gains/ (losses) on cash flow hedging instruments- loss of $76 million.
 Foreign currency translation- Loss of $62 million.
These losses and profits recognized by the organization is indication that management has
followed fair value accounting with respect to their financial instruments.
PWC has used the following audit procedures to examine the accuracy and relevance of the
process used by the organization for the valuation of financial instruments-
 Auditor has identified the governance and internal control employed by the business
organization in accordance with AASB 9.
 Auditor has also identified the financial model that is being used by Westpac Limited for
the valuation of financial instruments. This model has been compared by auditors with
7

other banking organizations in the market to identify accuracy and relevancy (Westpac
Banking Group, 2018).
 Auditor has reviewed all the key judgments and assumptions made by business
organization for valuation of financial inventory in the year 2018. These judgments and
assumptions are also compared with assumptions and judgments made in the past three
financial years to identify the major changes in financial models used for valuation.
 Management of the organization has been using "expected credit loss model" for
valuation of financial instruments and the auditor has identified the basic working of
expected credit loss model in order to evaluate the valuation process of the company.
 Auditor has also identified that all the rules and regulations in relation to AASB 9 have
been followed while assigning value to financial instruments (Gimbar, Hansen and
Ozlanski, 2015).
On the basis of this examination, auditors have identified that there are no material
misstatements in valuation models used by Westpac Banking Group.
Valuation of financial assets and financial liabilities
There is an abundance of financial assets and financial liabilities at the end of the financial
year. This type of practice is very common for a business organization operating in the
banking organization (Lennox, Schmidt and Thompson, 2018). Valuation of financial assets
and financial liabilities are required to be done on the basis of the fair value of these assets
and liabilities at the end of financial year rather than valuation on the basis of historical
costing method. This type of evaluation also involves a lot of assumptions on part of
management which increases the complexity of the valuation process.
Value of financial assets and liabilities at the end of 2018 is as follows-
Assets
Trading securities and financial assets- 22134 million
Derivative financial instruments- $24101 million
Available-for-sale securities-$61119 million
Liabilities
Derivative financial instruments- $24407 million
8

Other financial liabilities at fair value- $4297 million
Value of financial assets in other four banking organizations would be as follow-
Bank of Queensland-
Assets
Trading securities- 1385 million
Derivative financial instruments- $135 million
Available-for-sale securities-$3946 million
Liabilities
Derivative financial instruments- $294 million
ANZ banking corporation
Assets
Trading securities and financial assets- $37722 million
Derivative financial instruments- $68423 million
Available-for-sale securities-$74284 million
Liabilities
Derivative financial instruments- $69676 million
Commonwealth Bank of Australia
Assets
Trading securities and financial assets- 32254 million
Derivative financial instruments- $32133 million
Available-for-sale securities-$82240 million
Liabilities
Derivative financial instruments- $28472 million
9

National Bank Australia
Assets
Trading securities and financial assets- $78228 million
Derivative financial instruments- $3840 million
Liabilities
Derivative financial instruments- $30473 million
Trading instruments- $22422 million
Audit procedures used by the auditor for examining the accuracy of the valuation process are
as follows-
 First of all auditor of the organization has identified that all the rules and regulations
applied by banking regulatory authorities in Australia have been followed by the
organization or not. The auditor is also identified that all the principles of accounting
standards are followed for the valuation process (Council, 2018).
 Auditor has also identified the basic assumptions used in the process of financial asset
and liability valuation in order to identify and compare such junctions in accordance with
market conditions.
 Financial models used for valuation process are also examined on the basis of financial
models used by other business organizations in the banking industry (Westpac Banking
Group, 2018).
 Communication has been maintained with the management of the company for evaluating
the skill, knowledge, and experience of employees that are conducting research valuation
of financial assets and liabilities. This is due to the reason that the accuracy and relevancy
of financial models used by the business organization are dependent on the skill,
knowledge, and experience of employees (Martin, 2013).
After concluding all these audit procedures auditor of the organization has concluded that
there are no material statements that can affect the valuation process in a negative manner.
Operations of IT systems and controls
10

Use of technology has become a very integral part of any business organization including the
banking sector organization. Use of Technology helps in decreasing the risk in relation to
human errors and quality of reporting can also be improved with information technology. On
the basis of such valuation, it can be said that the majority of business operations in any
business organization including Westpac banking corporation are dependent on efficiency
and effectiveness of information technology framework (Sneller, Bode and Klerkx, 2017). It
can be said that the business operations of Westpac Banking Corporation are highly
dependent on the use of information technology which is the reason that it has been included
under the heading key audit matters.
Following are the audit procedures used by auditors to examine the efficiency and
effectiveness of IT infrastructure in the company-
 Auditor has examined that business organization is using the latest technology in the field
of information technology that will help in increasing the efficiency of business
operations.
 Auditor has examined all the internal controls implemented by your organization on the
IT infrastructure of the company in order to make sure that external factors will not be
able to affect the information technology framework (Westpac Group Limited, 2018).
 The auditor is also identified that management is using effective and efficient change
model in case any change is made in the information technology framework of the
organization. The main objective of this analysis is to make sure that changes in
information technology are not affecting normal business operations of the company.
 The auditor is also examined physical and logical security measures taken by the
organization to protect the information system from unauthorized access (Martin, 2013).
 System development methodologies used by business organization for the development of
in-house software or system. The main objective of this analysis is to make sure that
internal controls were used for mitigating the impact of any negative factors on the
development process.
 Auditor has also hired a third-party auditor that is expert in the field of information
technology to prepare an assurance report on the design and operational effectiveness of
IT controls.
On the basis of this examination, it can be said that there is no material misstatement in this
key audit matters (Palmrose, 2013).
11

12

Lehman Brothers Holding Limited
Bankruptcy filed by Lehman Brothers Holding Limited was one of the largest bankruptcy
ever recorded in United States of America. Lehman brothers holding Limited was one of the
fourth largest investment banking Organisation in the country and it has significant impact on
overall economy which is the reason that bankruptcy of this organisation resulted in global
economic crisis of 2007-08.
Collapse of US housing market was the primary reason that resulted in bankruptcy of this
organisation as this organisation had made significant amount of investment in subprime
mortgage market. In the year 2003 and 2004 management of the company acquired five
mortgage lenders for securitization of mortgages. This step was undertaken by the
organisation as us housing market at the time was very strong and management was of the
opinion that they will recover the amount by selling their houses if default are made by
borrowers. Over the period of time default on subprime loans increases significantly and
collapse of US housing market resulted in collapse of Lehman Brothers Holding Limited.
To hide actual financial performance of the company management was inflating its revenue
by disguising loan acquired by them against toxic assets from Cayman Islands banks as
revenue. This accounting practice was also not identified by auditor of the company i.e. Ernst
and young. This is one of the prime reason that resulted in different regulations on auditors to
disclose complex accounting assumptions and estimations made by business organisation
during the financial year.
13

Going concern concept
According to this concept, every business organization is required to evaluate whether
operations of the company will continue to operate in a distant future or not. For this purpose,
management is required to identify different external and internal factors that can have a
significant impact on business operations in the future. For example, a global economic crisis
will affect business organizations operating in the banking industry in a significant manner
(Yeh, Chi and Lin, 2014). If this scenario occurs then all banking sector organizations are
required to analyse their existence in the future. According to Australian Accounting
Standard Board, one of the basic accounting concepts that are required to be followed by all
business organizations is going concern concept.
According to the director’s report issued by the management of the company, all the factors
that can have a negative impact on business operations of the company in future are identified
by management of Westpac Banking group at the end of every financial year (Dewi and
Dewi, 2017). This analysis process was also executed at the end of the financial year 2018
and it was identified that there are no external or internal factors that can have a negative
impact on going concern concept of the company.
In addition to management of the organization, auditors at the end of the year 2018 have also
examined going concern concept applicability in the company and identified that the
conclusions made by management are accurate (Amin, Krishnan and Yang, 2014).
14

Conclusion
On the basis of this report, it can be concluded that disclosure of key audit matters is one of
the most important introductions brought in by Australian Accounting Standard Board in
reporting requirements of the auditor. Information provided by auditors in audit reports is
very limited and stakeholders are not able to identify the main problems that might have
affected the audit process during a particular financial year. With the introduction of key
audit matter paragraph, investors will be able to consider these matters in their decision-
making process. The main focus of this report was on conducting an analysis of key audit
matters disclosed by Auditor in the year 2018 for Westpac Banking Group. This report has
identified 4 major key audit matters disclosed by auditors in their audit reports.
15

References
Amin, K., Krishnan, J. and Yang, J.S., 2014. Going concern opinion and cost of
equity. Auditing: A Journal of Practice & Theory, 33(4), pp.1-39.
Bédard, J., Gonthier-Besacier, N. and Schatt, A., 2014, January. Costs and benefits of
reporting Key Audit Matters in the audit report: The French experience. In International
Symposium on Audit Research.
Brasel, K., Doxey, M.M., Grenier, J.H. and Reffett, A., 2016. Risk disclosure preceding
negative outcomes: The effects of reporting critical audit matters on judgments of auditor
liability. The Accounting Review, 91(5), pp.1345-1362.
Christensen, B.E., Glover, S.M. and Wolfe, C.J., 2014. Do critical audit matter paragraphs in
the audit report change nonprofessional investors' decision to invest? Auditing: A Journal of
Practice & Theory, 33(4), pp.71-93.
Cordoş, G.S. and Fülöp, M.T., 2015. Understanding audit reporting changes: introduction of
Key Audit Matters. Accounting & Management Information Systems/Contabilitate si
Informatica de Gestiune, 14(1).
Council, F.R., 2013. Proposed International Standard on Auditing (ISA) 701: Communicating
Key Audit Matters in the Independent Auditor’s Report (2013).
Dewi, I.G.A.A.O. and Dewi, I.G.A.A.P., 2017. Corporate social responsibility, green
banking, and going concern on banking company in Indonesia stock exchange. International
journal of social sciences and humanities, 1(3), pp.118-134.
Gimbar, C., Hansen, B. and Ozlanski, M.E., 2015. Early evidence on the effects of critical
audit matters on auditor liability. Current Issues in Auditing, 10(1), pp.A24-A33.
Higgins, C., Milne, M.J. and Van Gramberg, B., 2015. The uptake of sustainability reporting
in Australia. Journal of Business Ethics, 129(2), pp.445-468.
Kachelmeier, S.J., Schmidt, J.J. and Valentine, K., 2017. The disclaimer effect of disclosing
critical audit matters in the auditor’s report. Working paper.
16

Lennox, C.S., Schmidt, J.J. and Thompson, A., 2018. Is the expanded model of audit
reporting informative to investors? Evidence from the UK. Evidence from the UK (June 18,
2018).
Martin, R.D., 2013. Audit quality indicators: Audit practice meets audit research. Current
issues in auditing, 7(2), pp.A17-A23.
Martin, R.D., 2013. Audit quality indicators: Audit practice meets audit research. Current
issues in auditing, 7(2), pp.A17-A23.
Nobes, C., 2014. International classification of financial reporting. Routledge.
Palmrose, Z.V., 2013. PCAOB audit regulation a decade after SOX: Where it stands and
what the future holds. Accounting Horizons, 27(4), pp.775-798.
Sirois, L.P., Bédard, J. and Bera, P., 2018. The informational value of key audit matters in the
auditor's report: Evidence from an eye-tracking study. Accounting Horizons, 32(2), pp.141-
162.
Sneller, L., Bode, R. and Klerkx, A., 2017. Do IT matters matter? IT-related key audit
matters in Dutch annual reports. International Journal of Disclosure and Governance, 14(2),
pp.139-151.
Westpac Banking Group. 2018. Annual report 2018. Retrievable at:
Yeh, C.C., Chi, D.J. and Lin, Y.R., 2014. Going-concern prediction using hybrid random
forests and rough set approach. Information Sciences, 254, pp.98-110.
17