Auditing Failures and Corporate Governance: ABC Learning Case Study

This report provides an executive summary of the ABC Learning collapse, a significant case of corporate failure. It highlights the deficiencies in management, weak corporate governance, and the role of auditors, particularly Ernest & Young and KPMG. The report explores the company's expansion, debt issues, and unethical practices, including the manipulation of financial statements and the hiding of misstated leverage ratios. It discusses the importance of ASA 701 in addressing auditing concerns and the impact of non-disclosure of crucial information. The analysis emphasizes how faulty transactions, related party transactions, and a lack of ethical auditing practices contributed to the company's downfall. The report concludes with recommendations and a call for improved corporate governance and stricter adherence to auditing standards to prevent similar failures in the future.

AUDITING

Auditing ABC Learning
Executive summary
Corporate failure is an eye opener because it stresses upon the deficiencies of the management
and projects the shortfalls that a company contains. There are apt cases of corporate failures such
as ABC Learning, Lehman brother, Satyam fraud, OneTel, HIH, etc. Such failures highlight the
deficiencies on the part of the management and the auditors. Moreover, in all the cases the
mechanism of corporate governance was a weak link. In the present report, the center point of
attraction is the ABC learning collapse and the role of the auditors in it. Further, the presence of
new auditing standard ASA 701 is discussed. The wrong practices of the auditor are remarked
and the reason for the downfall of the giant is provided that is owing to the faulty practices and
weak governance.
2

Auditing ABC Learning
Contents
Introduction.................................................................................................................................................3
The important issue to be considered while preparing the financial statements...........................................3
Major instructions coming into movements.................................................................................................3
ASA 707 that relates to the communication of major audit concerns in the independent audit report.........4
Auditing matter that swamps the disintegration of ABC Learning..............................................................5
Hiding of misstated leverage ratio of the firm.............................................................................................5
Failure to disclose the evidence...................................................................................................................5
Non-disclosure of wrong transactions in notes to the financial statement and audit report..........................5
Approval of transactions in order to influence the financials.......................................................................6
Classification of inappropriate resources.....................................................................................................6
Faulty transaction in the financial statements and approval provided..........................................................6
Recommendation.........................................................................................................................................7
Conclusion...................................................................................................................................................8
References...................................................................................................................................................9
3

Auditing ABC Learning
Introduction
The ABC Learning was established in the year 1988 and the company had a dominating position
with thirty outlets at the end of the year 2000. The company was obliged with its listing in the
year 2001 and this caused it expand its dominating structure by setting up over 650 centers
distributed over United Kingdom, Australia, and the United Kingdom. Such a dominating
company did collapse dreadfully whose credit can be given to the high expectations of the
management and the failure of the auditor to show them the reality. 2007 was the year of the
emergence of an emergency debt which had to settle on with the bankers which were also a
leading cause of the dreadful collapse. This type of negotiation failure had resulted in non-
payment of some of the long-term liabilities. These liabilities took serious figures and started
affecting the cash flows in a way so as to decrease its value. All this also resulted in the decrease
in the share price of the company. All this can be collectively summarized as a bunch of flaws
that were prominent on the part of the management and the auditors which played the key role in
the collapse (CPA, 2012). Despite inviting the best in a class auditing firm, these flaws were
prominent and repeated excessively. If the auditing firm had taken correct and potentially strong
steps to handle the above situations, the company would have been saved from the collapse could
have been prevented. But the unethical means of the auditors started to fetch the company some
small profit gains which absolutely hid the unauthorized steps of the auditors. It was not at all
clear that what procedure did the company followed to lure such expansion so fast though being
a childcare division (Kruger, 2015). The steps followed by them could be an example for the
companies in the same field to dominate the market and to enhance one’s business.
The important issue to be considered while preparing the financial statements
It was seen that the auditors of the ABC always made ill-equipped decisions from the date they
came into action in 2003 for the company’s audit. Any profits gathered by the company before
the year 2007 were strictly analyzed and taken into serious attention by the audit firm of Ernest
& Young in the year 2007. It was also seen that the KPMG Company stood up along with the
ABC learning as a third party for the settlement of the demarcations. Both the dominating
auditing firms worked in away so as to detect the flaws of the management. Both the companies
worked as an audit company for the ABC Learning and represented different conclusions and
decisions which was a clear-cut symbol of the ill-equipped judgment of the auditors which lead
to the collapse of the company (CPA, 2012). Thus, despite having such auditing giants involved
in the company’s affairs, the company fell down dreadfully in a way unrecoverable.
Major instructions coming into movements
The transactions going on within the parties are depicted in the financial statements that were not
done and this was also a major reason for the collapse of the company. All this was done so as to
as to represent a clear and respected picture of the company which would hide its financial
conditions and would help in the borrowing of funds from other sources without hindrance
(Matthew, 2015). Finally, all this led to the reduction in the securities of the company which
opened the manipulative gate of the depiction of the general transactions of the company to be
shown as the sale of the securities which are legally registered in nature (Geoffrey et. al, 2016). It
was also seen that the auditors took a different way and helped the management in hiding the
factors that would degrade their respect in the market. “Sales Proceed of the Investment
Securities” was the manipulated term which was given to the borrowings of the company and
4

Auditing ABC Learning
this is the reason why it was never recorded in the book of accounts. Such procedures were
followed so as to eliminate liabilities which are weak in nature (Ghandar & Tsahuridu, 2013).
The cleverness of the company was on the part to earn more and more profits and as fast as
possible to eliminate the loopholes that were prominent in the company (Gilbert et. al, 2005).
The company also paid a massive amount of $74 million to the other third-party companies
which were involved in the operations of the company’s affairs. It was also a trial from the
company to sponsor the Brisbane Bullets Basketball Team. All these transactions didn’t hold any
place in the major affairs of the company but in actual reality, these were also playing a crucial
role in the collapse of the company. It was as per the records of the company. All this was due to
the unethical means followed by the management and the team of the auditors. Non-handling of
the related party transaction with care surely led to a situation of disrespect in the market which
also led to its collapse (Teen, 2012). It was thought by the investors and the general public that
the means followed by the management was done so as to benefit them individually. But the
actual case depicts that the inconvenient use of the corporate governance mechanism and the
steps undertaken by the audit team led to this disintegration. In short, he concept of corporate
governance was altogether neglected and the innocent investors were duped by the management
of the company. The above situation explains that the financial conditions and other facts were
not exposed in the financial statements and the sheet contained data in a limited amount which
the company wanted to depict (Mock, et. al, 2013).
Thus, it can be said that if the auditors were strict enough to follow the ethical laws of auditing
and would have warned the company then the collapse could have been prevented. Even the
presence of big two giants in the field of auditing failed to prevent the collapse of ABC learning.
Concealment of facts was done in order to present the company as a profit-making one. It can
also be thought that if the auditors commented on the risks prevailing in the company than with
the help of the management, the collapse could have been prevented or would have been delayed
to some extent. (Tepalagul & Lin, 2015)
ASA 707 that relates to the communication of major audit concerns in the independent
audit report
It is a very important set of rules set up for increasing the clarity and the potential of the annual
financial reporting which was released in the year December 15. The most important work of the
this set of rules is to track and record all the crucial affairs of the company and to see that it is as
per the ethical and legal rules which have been set up and if any emergency occurs then without
wasting any time report it to the chief auditors and to the headquarters. This set of rules is very
much important and acts as a boon to the users of financial statements which rely on these
statements to decide their investments (Heeler, 2009). This helps the shareholders to check the
financial position and the internal conditions of the company so as to save them from the losses
that would occur because of the misstatements of the concealed facts and figures. This is a very
effective way to offer clarity to the financial statements. But in the case of ABC Learning, it was
evident that many of the facts and figures were hidden which could have prevented y the auditors
of the company (Ruhnke & Schmidt, 2014). If in the case of the ABC Learning the ASA rules
would have existed then the auditors would have been bound to follow all the ethical rules and
there would have been zero concealments of the facts about the financial position and the
internal affairs of the company which totally led to its dreadful collapse.
5

Auditing ABC Learning
Auditing matter that swamps the disintegration of ABC Learning
If the ASA 707 would have been taken into attention as in the case of the ABC Learning then
many concealed facts and figures about the company could have been exposed to the public,
which would not only depict the financial position of the company but also its survival in the
future. It should be now clear that the absence of the ASA 707 way a dominating factor in the
collapse of the ABC Learning which could have been prevented. Flaws of the management,
unethical means of the regulatory system in that sensitive span of time led to the major collapse
of the ABC Learning. All this acts as a boon to the users of the financial statements of the
company in a better way.
Hiding of misstated leverage ratio of the firm
The departments and the individuals that have been responsible for the collapse of the ABC
Learning can be the crucial one in depicting points that have led to the total dreadful collapse of
the company. It is clear from the above explanation that if the ASA 701 existed and was applied
successfully in the company’s auditing then the company could have been saved because it
would bound the auditors to drop all unethical means and carry on the works genuinely (Coram
et. al, 2011). The loss of respect for the auditing firm could have also been prevented.
Failure to disclose the evidence
Going through the ACCC interpretation, it is noticeable that the ABC downfall was not due to
cut-throat competition instead the collapse had occurred due to financial blunders such as large
acquisitions and high debt. The main reason behind the downfall was due to inefficiency in the
system displayed by the management. The company was subject to provide true information
about sales proceeds with their transactions in a manner that can comply with the provisions in
the law for the transfers. Owing to large borrowings and transactions the company comes across
its failure (Hoffelder, 2012). Therefore, the fall of the entity can be associated due to the flaws
that the financial information projected. In addition to that, the financial institutions also stopped
leading to the entity for short-term borrowings against securities as collateral. This culminated in
the failure to respond to the business obligations on part of ABC work culture and all these
situations take place after the existence of massive debt and liabilities in the financial framework
of the entity resulting in big complications in operating the business to the situation and
ultimately the entity disintegrated at the end (Teen, 2012). The financial framework rested on a
very weak ground and the same was ignored by the auditing firms that lead to the major issue.
Non-disclosure of wrong transactions in notes to the financial statement and audit report
The company on its part indulged in inappropriate transactions which are obligatory to be
mentioned in the financial statement and audit report. Instead, the management has made
arrangements to hide the same because it would be sensitive due to huge borrowings and other
constraints (Messier, 2013). Apart from this, the unaltered leverage ratio would also bring to
light in the eyes of the investors in the firm if they had not camouflaged the same. The auditors
played a vital role in concealing the information in improper transactions done by the firm that
would have caused major influence, ultimately decided to conceal the same in the audit report
(Holland & Lane, 2012).
6

Auditing ABC Learning
Approval of transactions in order to influence the financials
The management had taken many compromises without concerning the auditors as the financials
of the company were based on sticky grounds, leaving no scope for the auditors to identify the
irregularities and continued with the same information’s whereas many transactions were
provided as investments in the financial report. It was the fundamental duty of the auditor to
cautioned the management of the company about the same and the consequences that would arise
out of this (Carcello, 2012). Moreover, the management of the company aspired to characterize
its equities as collateral instead of fixed income securities so as to smoothly carry out related
party transactions.
Classification of inappropriate resources
In the company, the bulk of short-term transactions were improper and accounting was not in
accordance with the provisions. Moreover, the securities were interpreted as collateral and were
later removed from the records (Jubb, 2012). To add to this, the company also undertaken the
exercise to reduce its liabilities to reflect the image that the securities are being provided to the
parties as compensation resulting in a decline in the leveraged portfolio. All the debt
accomplished by the entity was also supposed to be reflected in the financial statement of the
company until they are repaid (Christensen, 2011). Nonetheless, the transactions were illustrated
as sales so that the securities sold could be deducted from the assets and there could be no
liabilities reflected in the financial statements.
Faulty transaction in the financial statements and approval provided
The management and the auditors in the company were shrewdly illustrated the significant
securities transactions as nominal alterations in the financial statements. The company also
restores to emphasize that the repurchase of the securities was done at a nominal cost and the
same was camouflaged under large-scale derivatives. Further, the management and the auditors
of the company restored to reflect those transactions in the notes attached to the financial
statement (Blay et. al, 2011). To sum up, the auditors are morally responsible to point out all
irregularities done by the company to carry out the business and disclose the same in their audit
report.
7

Auditing ABC Learning
Recommendation
When it comes to the transparency of the company in terms of financial reporting, it is important
that both the internal, as well as a statutory auditor should have a strong presence of mind and
ensure that all the activities are directed in the correct direction. Hence, the auditors must act in
the best interest of the company because it enhances the functioning of the company. Further,
the auditors should ensure that the auditing process must be strong so that any misstatement can
be easily reflected and the stakeholder interest can be safeguarded (Bedard et. al, 2014).
Moreover, the auditor must ensure a compliance with the relevant accounting standard and this
aid in presenting a better picture of the company. There must be strict control and supervision of
the ethical system that will lay a foundation of strong governance and presentation.
8

Auditing ABC Learning
Conclusion
To attain the best practices and to ensure better compliance it is essential that the organization
must follow the accounting policies that have been laid down. The reporting and compliance
should be done considering the impact of each and every financial procedure. It needs to be
noted that the failure to adhere to the regulations will have a negative impact on the organization.
The facts and figures of ABC learning is an apt example of the collective failure. Further, it
projects that the status of the company is immaterial. However, the big might a company be, if
the company fails to adhere to the regulations and the auditors are ineffective then the collapse is
bound to happen.
9

Auditing ABC Learning
References
Bedard, J. N, Gonthier, B, & A. Schatt 2014. Costs and Benefits of Reporting Key. Harvard 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.
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
Coram, P, Mock, T. J, Turner, J. & Gray, G 2011. The communicative value of the auditor’s
report. Australian Accounting Review 21(3), pp. 235-252.
CPA 2012. ABC learning collapse case study. [online] Available at:
<https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-
study> [Accessed 14 September 2017]
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.
Ghandar, A & Tsahuridu, E 2013. The Auditing Handbook 2013. Australia: Pearson.
Gilbert, W. Joseph J & Terry J. E., 2005. The Use of Control Self-Assessment by Independent
Auditors. The CPA Journal, 3, pp. 66-92
Heeler, D., 2009. Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
Hoffelder, K., 2012. New Audit Standard Encourages More Talking. Harvard Press.
Holland, K. & Lane, J 2012. Perceived auditor independence and audit firm fees. Accounting and
Business Research. 42(2), pp. 115-141.
Jubb, C 2012. Auditing: A Business Risk Approach. Australia: Cengage
Kruger, P., 2015. Corporate goodness and shareholder wealth. Journal of Financial economics,
pp. 304-329
Matthew S. E 2015. Does Internal Audit Function Quality Deter Management Misconduct?. The
Accounting Review 90(2), pp. 495-527
10

Auditing ABC Learning
Messier, F. W 2013. Auditing and Assurance Services - A systematic approach. Australia:
McGraw Hill.
Mock, T. J, Bédard, J, Coram, P., Davis, S, Espahbodi, R. & Warne, R 2013. The audit reporting
model: Current research synthesis and implications. Auditing: A Journal of Practice and Theory,
32, pp. 323-351.
Ruhnke, K & Schmidt, M 2014. The audit expectation gap: existence, causes, and the impact of
changes. Accounting and Business Research 44(5), pp. 572-601.
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
16 September 2017]
Tepalagul, N. & Lin, L 2015. Auditor Independence and Audit Quality A Literature Review.
Journal of Accounting, Auditing & Finance, 30(1), pp. 101-121.
Wright, M.K. & Charles, J 2012. Auditor independence and internal information systems audit
quality. Business Studies Journal 4(2), pp. 63-84.
11