Auditing Theory and Practice

This report explores the concepts of auditing theory and practice, including the rationale for ASA 701, Lehman Brothers, and going concern issues. It analyzes the key audit matters and auditor's efficiency in the banking industry. The report provides recommendations for effective identification and communication of key audit matters.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
Name of the Student
Name of the University
Author’s Note

1AUDITING THEORY AND PRACTICE
Table of Contents
Introduction......................................................................................................................................2
Rationales for ASA 701, Lehman Brothers and Going Concern Issue...........................................2
Analysis of the Key Audit Matters and Auditor’s Efficiency in Banking Industry........................5
Conclusion and Recommendation...................................................................................................8
References......................................................................................................................................10

2AUDITING THEORY AND PRACTICE
Introduction
Auditing is considered as the process of the official inspection of the financial accounts,
financial information and financial statements of the companies in order to ascertain whether
they have been developed in true and fair manner in the absence of any material misstatements in
them (Chui and Pike, 2013). There are certain responsibilities of the auditors that need to be
discharged while auditing the financial statements of the client. There are many instances all
over the world where the auditors failed in discharging their duties in proper manner in the
presence of some reasons and the companies collapsed due to that. For this reason, there has
been major criticism of the audit profession due to its involvement with so many corporate
collapses (Kassem and Higson, 2016). The new auditing standard of “ASA 701 communicates
key audit matters in the independent auditor’s report” was introduced after the demise of
Lehman Brothers and the occurrence of the world financial crisis and it aims to provide the users
of the financial statements with some additional information about the companies. Major
emphasis also has been given to the assessment of the going concern status of the companies.
This report analyzes the major rationale for ASA 701 and the discussion on the key audit matters
of the Australian major banks under ASX top 100 listed companies.
Rationales for ASA 701, Lehman Brothers and Going Concern Issue
It needs to be mentioned that the main purpose of ASA 701 is to ensure the
improvements in the communicative value of the auditor’s report through the implementation of
clear and transparent audit procedures of the financial accounts and statements of the firms
(auasb.gov.au, 2019). Another crucial purpose of ASA 701 that needs to be mentioned in this
case is to ensure that the identified key audit matters are effectively communicated to the users of

3AUDITING THEORY AND PRACTICE
the financial statements so that they can ascertain the level of risk related to the material
misstatement in the financial statements of the firms. In addition, one significant purpose of this
new standard is to make the users aware of the assumptions, judgments and accounting estimates
used by the managements of the companies for the preparation and presentation of the financial
statements. Along with the purpose, ASA 701 has some crucial objectives that are required to be
taken into consideration (Cordoş and Fülöp, 2015). The primary objective of this new standard is
to ensure that the auditors properly identify the key audit matters. Along with the identification
of the key audit matters, another major objective of ASA 701 is to ensure providing the
appropriate audit opinion in line with the identified key audit matters. Correctly communicating
the identified key audit matters is another key objective of the new standard of ASA 701.
The above discussion on the purposes and objectives of ASA 701 indicates towards the
crucial fact that the new standard of ASA 701 has major importance in the audit profession. It is
considered as significant because of the fact that it helps to identify as well as ascertain the key
audit matters and ensures proper communication of the same with the users of the auditor’s
report (Bédard, Gonthier-Besacier and Schatt, 2014). This new standard is important because of
the fact that it puts the obligation on the auditor to determine the transactions as well as events
that have significant doubt on the fact that they can materially misstate the financial statements.
This is considered as a crucial aspect for the application of this auditing standard. At the time of
the application of ASA 701, the auditors are needed to discharge the responsibility of examining
the doubtful transactions and events that can materially affect the financial statements. For the
determination of the areas of material misstatement, the auditors are required to apply the
standard of ASA 315 because this will helps the auditor in determining the extent of material

4AUDITING THEORY AND PRACTICE
misstatement in the financial statements due to the presence of the identified key audit matters
(Köhler, Ratzinger-Sakel and Theis, 2016).
The collapse of Lehman Brothers is regarded as one major corporate collapse that added
major fuel in the 2008 financial crisis since large and illegal use of certain financial instruments
can be seen this company. It needs to be mentioned that the management of Lehman Brothers
was responsible for the illegal use of repurchase agreement transactions, commonly known as
Repos, as sales in order to portray good financial performance as well as position of them so that
the investors do not know about the high leverage nature of the business of the firm (Presley and
Jones, 2014). This illegal accounting practice helped the management of the firm in improving
their balance sheet by large margin. The auditors of Lehman Brothers were aware of this use of
Repos and they did not consider this as a matter of concern and thus, issued unqualified or clean
audit opinion. The company collapsed after few months of the audit. This can be considered as
the main reason why the new standard of ASA 701 was recommended so that the above-
discussed loopholes in the audit can be avoided. The auditors of Lehman Brothers would have
the obligation to consider the use of Repos as a key audit matters and to communicate the same
through the auditor’s report if ASA 701 was available at the time of Lehman Brothers (Czerney,
Schmidt and Thompson, 2014). In addition, the availability of ASA 701 would put the obligation
on the auditor’s of Lehman Brothers to use appropriate audit procedures. In other words, the
collapse of Lehman Brothers could be avoided if ASA 701 was available that time (Sirois,
Bédard and Bera, 2018).
The collapse of Lehman Brothers and 2008 world financial crisis also shows the
importance of going concern status of the companies which indicates towards the ability of the
companies to continue their business operation for unforeseeable future. This assessment

5AUDITING THEORY AND PRACTICE
ascertains the financial stability of the business organizations (Knechel and Salterio, 2016). For
this reason, a revision has been brought in the existing ASA 570 Going Concern standard where
the auditors are now required to express their concern on the going concern status of the
companies if they determine that the company does not have the ability to continue as a going
concern for unforeseeable future (auasb.gov.au, 2019). This puts the requirement on the auditors
for obtaining the needed information and evidence on the fact that whether the management of
the company is using the going concern base of financial reporting in proper manner
(auasb.gov.au, 2019).
Analysis of the Key Audit Matters and Auditor’s Efficiency in Banking Industry
Australian banking industry is considered as a crucial part in the Australian financial
system because this industry largely contributes towards the economic development of the
country. The key audit matters of the Australian major banks are discussed below:
Bank of Queensland (BOQ) – The key audit matters of this bank are specific as well as
collective provision for loan impairment, valuation of goodwill, valuation of intangible computer
software, financial instrument’s value measurement and IT system and control environment
(boq.com.au, 2019). The auditors of this bank have considered these matters as the key audit
matters through the examination of impairment provision, assessment of the applied judgments
in the value in use model, analysis of the used accounting estimation and judgments for cost
capitalization and others. The auditors have adopted the correct audit procedures on the basis of
this analysis.
National Australia Bank (NAB) – There are certain key audit matters in NAB; they are credit
impairment provision on loans, conduct risk as well as provision, provision for restructuring and

6AUDITING THEORY AND PRACTICE
IT system and control (nab.com.au, 2019). The main reason behind considering these aspects as
the key audit matters is the use of significant judgments and accounting assumptions by the
management of the banks in the crucial areas like determination of impairment for interpretation
requirement, identification of exposure, provision restructuring, assessment of the IT control and
system and others. The nature of these identified key audit matters are considered for the
development of the appropriate audit procedures.
Westpac Banking Group – There are five key audit matters in the bank; they are impairment
charges related provision, AASB 9 Financial Instruments, financial asset and financial liability
related fair value, contingent liability related provision and IT system as well as control
(westpac.com.au, 2019). There are certain reasons for considering these matters as key audit
matters such as the involvement of subjectivity in the loan impairment provision’s estimation
process, involvement of significant accounting judgment to determine exposure, high magnitude
of the financial instruments and major reliance of the bank on IT related system. The auditors
have considered these aspects for the development of audit procedures for these key audit
matters.
Medibank Private Limited – The presence of two key audit matters can be seen in this bank;
they are the outstanding claim liability worth $379.8 million estimation and dependency of the
bank on automated controls and processes (medibank.com.au, 2019). The main reasons for
considering these as key audit matters are the application of high level of accounting judgments
in order to estimate outstanding claims for provision and the high extent of dependency of the
bank on the automated control system. Appropriate audit procedures are developed based on
these determined key audit matters.

7AUDITING THEORY AND PRACTICE
Commonwealth Bank – The main key audit matters of this bank are provision for loan
impairment, financial instruments’ judgmental valuation, conduct risk as well as regulatory
action related provision, insurance liabilities valuation and IT system and control for the purpose
of operation and financial reporting (commbank.com.au, 2019). The auditors have considered
these aspects as the key audit matters in the presence of certain major assumptions and
judgments in the areas of determination of complex provision’s value, assessment of the
probability related to the financial outcome of the bank, assessment of the claims as well as
duration of the judgments of the insurance and others.
ANZ Banking Group – There are some major key audit matters in the bank; they are credit
impairment provision as well as impact of AASB 9 disclosure, valuation of financial instruments
held at the fair value, customer remediation provision, divestment accounting and IT systems and
control (shareholder.anz.com, 2019). The main reasons for considering these aspects as the key
audit matters are the presence of major accounting judgments, assumptions and estimations in
the areas of assessment of credit, internal control related to financial reporting, excessive
dependency of the bank on the automated system for banking and financial reporting and others.
These matters are considered for the adoption of the appropriate audit procedures.
It can be seen from the above discussion that the auditors of all these banks have
determined the key audit matters and they have communicated the same under the ‘key audit
matters’ section of the auditor’s report. In this aspect, it needs to be mentioned that the main aim
of the new auditing standard ASA 701 is the appropriate determination of the key audit matters
and the effective communication of the same (auasb.gov.au, 2019). The above discussion
demonstrates that the auditors of these banks have effectively complied with these purposes of
ASA 701 for the determination as well as communication of the key audit matters. At the same

8AUDITING THEORY AND PRACTICE
time, the new auditing standard of ASA 701 puts the obligation on the auditors to provide the
logical reason behind considering the selected aspects as the key audit matters. It can be seen
from the above discussion that the auditors of these banks have clearly mentioned the reasons for
which they have considered those transactions and events as the key audit matters. In addition,
they have also mentioned that use of accounting estimates, judgments and assumptions by the
managements of these banks for dealing with these events and transactions. Moreover, the
auditors have indicated the areas where there is involvement of major subjectivities. Lastly, the
auditors have disclosed in the same section about the audit procedures used to determine the
extent of material misstatements and reduction of risks due to these key audit matters. It implies
that the auditors have reported and communicated the key audit matters in effective as well as
efficient manner (Köhler, Ratzinger-Sakel and Theis, 2016).
Conclusion and Recommendation
The above discussion shows that the main aim behind the recommendation and
implementation of ASA 701 was to address the loopholes in the audit of Lehman Brothers that
led to the collapse of the company. ASA 701 demands the auditors’ commitments towards the
effective identification and communication of the key audit matters. On the basis of the whole
discussion, some recommendations are provided below:
1. At the time of the determination of the key audit matters in accordance with ASA 701,
the recommendation to the auditors is to make effective strategies that ensure the correct
identification as well as communication of the key audit matters.

9AUDITING THEORY AND PRACTICE
2. It is recommended to the auditors of these banks to provide utmost attention to the
effective communication of the key audit matters since this is one of the most vital parts
in the key audit matters as it helps the users know about these issues.
3. Determination as well as communication of the key audit matters is a tough job for the
auditors and thus, they are recommended to maintain professional integrity and ethics in
the whole process to deal with the key audit matters since it will lead to effective results
of the audit process.
4. Lastly, the recommendation to the auditors of these banks is to continue their adherence
with the rules and policies of ASA 701 for the appropriate determination and
communication of key audit matters.

10AUDITING THEORY AND PRACTICE
References
Auasb.gov.au. 2019. Auditing Standard ASA 570 Going Concern. [online] Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_570_2015.pdf [Accessed 24 May
2019].
Auasb.gov.au. 2019. Auditing Standard ASA 701 Communicating Key Audit Matters in the
Independent Auditor’s Report. [online] Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf [Accessed 24 May
2019].
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. Available at: http://documents. escdijon.
eu/pdf/cig2014/ACTESDUCOLLOQUE/BEDARD_GONTHIER_BESACIER_SCHATT. pdf.
Boq.com.au. 2019. 2018 ANNUAL REPORT. [online] Available at:
https://www.boq.com.au/content/dam/boq/files/shareholder-centre/financial-results/2018/
FY2018_Annual_Report.pdf [Accessed 24 May 2019].
Chui, L. and Pike, B., 2013. Auditors' responsibility for fraud detection: New wine in old
bottles?. Journal of Forensic and Investigative Accounting.
Commbank.com.au. 2019. Annual Report 2018. [online] Available at:
https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/results/
fy18/cba-annual-report-2018.pdf [Accessed 13 May 2019].

11AUDITING THEORY AND PRACTICE
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).
Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in
unqualified audit reports indicate increased financial misstatement risk?. The Accounting
Review, 89(6), pp.2115-2149.
Kassem, R. and Higson, A.W., 2016. External auditors and corporate corruption: Implications
for external audit regulators. Current Issues in Auditing, 10(1), pp.P1-P10.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Köhler, A., Ratzinger-Sakel, N.V. and Theis, J., 2016. The effects of key audit matters on the
auditor's report's communicative value: Experimental evidence from investment professionals
and non-professional investors. Available at SSRN 2838162.
Medibank.com.au. 2019. Annual Report 2018. [online] Available at:
https://www.medibank.com.au/content/dam/retail/about-assets/pdfs/investor-centre/annual-
reports/Medibank_Annual_Report_2018.pdf [Accessed 24 May 2019].
Nab.com.au. 2019. ANNUAL FINANCIAL REPORT 2018. [online] Available at:
https://www.nab.com.au/content/dam/nabrwd/documents/reports/corporate/2018-annual-
financial-report.pdf [Accessed 24 May 2019].
Presley, T.J. and Jones, B., 2014. Lehman Brothers: The Case Against Self-Regulation. Journal
of Leadership, Accountability & Ethics, 11(2).

12AUDITING THEORY AND PRACTICE
Shareholder.anz.com. 2019. 2018 ANNUAL REPORT. [online] Available at:
https://shareholder.anz.com/sites/default/files/anz_2018_annual_report_final.pdf [Accessed 24
May 2019].
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.
Westpac.com.au. 2019. 2018 Westpac Group Annual Report. [online] Available at:
https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/
2018_Westpac_Annual_Report.pdf [Accessed 24 May 2019].