ACC707 - ASA 701: Key Audit Matters & Financial Statement Analysis

This report provides an in-depth analysis of ASA 701, focusing on the communication of key audit matters (KAM) in independent auditor's reports, particularly in the context of the global financial crisis and calls for increased transparency from shareholders. The study examines the standard's application to Australian listed corporations, specifically assessing areas of high risk, significant auditor judgments, and the impact of significant events or transactions on financial statements, using BHP Billiton Limited as a case study. The report covers the objectives of auditing, the importance of auditor judgment in areas like inventory valuation and depreciation methods, and the impact of significant events such as business sales or new contracts, ultimately recommending that auditors thoroughly report such matters to provide stakeholders with a comprehensive understanding of the entity's financial performance and position. Desklib provides access to similar solved assignments and past papers.

Running head: AUDIT
Audit
Name of the Student:
Name of the University:
Authors Note:

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Executive summary:
An audit if objectively carried out should be able to bring out all necessary information required
by the investors to assess the financial performance and position of an entity correctly from
independently verified financial statements of the entity. In this case the importance of ASA 701
in conducting an effective audit has been discussed to find out the importance of the standard in
the current economic and financial environment.

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Table of Contents
Introduction:....................................................................................................................................3
Auditing and its objectives..............................................................................................................3
Key Audit Matters to be communicated in the independent auditor’s report..................................4
Areas of financial statements which require auditors to make significant judgment......................5
BHP Billiton financial statements dealing with such matters.........................................................6
Significant events or transactions and their impact on the audit of the financial statements..........7
Recommendations/ Conclusion.......................................................................................................9
Reference.......................................................................................................................................10

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Introduction:
In the wake of global financial crisis the importance of audit have reached its peak.
Considering the number of accounting scandals that the world of business has seen in recent
times the utility of auditing has been reaffirmed. However, the failure of auditing in many cases
such as in case of Enron, Satyam and other such accounting scandals have compelled the
stakeholders to question the auditing standards governing the auditing principles and policies.
With the objective of improving the quality of auditing, ASA 701 Communicating Key Audit
Matters in the independent Auditor’s report has been issued by the Australian Auditing and
Assurance Standards Board (AUSAB). An in-depth analysis on the auditing standard and its
practical implementation in an audit of an entity is provided to help the readers in understanding
the importance of the standard (Segal 2017).
In order to complete the evaluation of ASA 701 and to assess its importance in auditing
of an entity, BHP Billiton Limited has been chosen. BHP Billiton Limited is an Australian
company in involved in the business of mining, petroleum products and metals. The registered
head office of the company is in Melbourne, Australia.
Auditing and its objectives
The objectives of auditing is to provide an unbiased and independent opinion on the
financial statements of an entity to express whether the financial performance reflected in the
income statement of the company is a fair reflection of the financial performance of the entity
and simultaneously whether the Balance sheet of the entity shows the true and fair picture of the
entity as on the date to which these statements relate (Ratzinger-Sakel and Theis 2017).
ASA 701:

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AUSAB has issued number of auditing and assurance standards to guide the auditors in
discharging their duties efficiently as the auditor of different entities. ASA 701 has been issued
by the AUSAB to deal with the matters which are recognized as key audit matters to make it
compulsory for the auditors of listed entities to communicate these matters in the independent
audit reports of such entities (Köhler et al. 2016). Not only the standard is to be followed
mandatorily by the auditors of listed entities but it also recommended for the entities which do
not have their shares listed on a recognized stock exchange in the country. However, it has been
left to the discretion of the auditor to take final decision whether to follow ASA 701 in auditing
of unlisted entities. The standard has described the Key Audit Matters, here in after to be referred
to as KAM in this document, which must be communicated to the stakeholders in the
independent reports of the auditors. Let us have a brief discussion on the KAM to understand the
matters which are to be communicated by the auditors in their reports to attract the attention of
the investors and other stakeholders of the entities (Cordos and Fülöpa 2015).
Key Audit Matters to be communicated in the independent auditor’s report
ASA 701 has prescribed the matters to be communicated in the independent auditor’s
report to ensure that key matters are communicated in the audit reports. In order to take
cognizance of the investors and other stakeholders of an entity to assess the actual financial
performance and position of an entity as on a particular date (McKee 2015). Following are the
KAM which have been mentioned in ASA 701 to be mandatorily disclosed by auditors of listed
entities and also recommended for the auditors of unlisted entities;
Matters which require personal judgment of the accountants:

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The matters and items in the financial statements of an entity which require significant
amount of personal judgment by the accountants and sometimes even that of the management
need to be reported as KAM in the independent auditor’s report. These are the areas in financial
statements which are prone to manipulation. ASA 701 has prescribed these matters to be
reported in the independent auditor’s report to ensure that the investors and shareholders take
note of these matters while evaluating the financial statements of an entity (Afterman 2016).
Areas of financial statements which require auditors to make significant judgment
The inventory valuation method used by the entity:
There are few alternative methods which are allowed to be used in valuing the inventories
of an entity. The accountants have the liberty to use any particular method to value inventories of
an entity. The auditor needs to assess the inventory valuation method used by an entity to
determine whether the same is in accordance with the relevant accounting standard. In case there
is any contravention in valuation of inventories by an entity then the matter must be
communicated in the report of the auditor in accordance with ASA 701 (Bédard et al. 2015). The
inventory valuation technique used by an entity must be in accordance with the prescribed
guidelines provided in the accounting standard AASB 102 to ensure that there is no
contravention in valuation of inventories. This aspect must be evaluated by the auditor and
accordingly, reported in his report to comply with the requirements of ASA 701 (Livne 2016).
The depreciation method used by an entity:
The AASB 116 has been issued by the Australian Accounting Standards Board to guide
the accountants to charge depreciation in accordance with the standard to ensure that the
financial statements reflect the true picture of an entity. However, due to the varied and complex

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economic and business environment under which different entities have to operate it is not
possible to have a single method applicable for charging depreciation on non-current assets.
Thus, there are more than one alternative which have been allowed for the accountants to choose
while charging depreciation on non-current assets (Prasad and Chand 2017). Written down value
method, straight line method of depreciation, sum of years’ digit method are all allowed under
different circumstances to calculate the amount of depreciation in the books of accounts of the
company. The auditors will have to use their knowledge and judgment to evaluate whether the
method that has been used by an entity to ascertain the amount of depreciation is in accordance
with the AASB 116. In case of non-compliance with the provisions of AASB 116 by the entity
which is under audit the auditor must communicate the matter in his report to attract the attention
of the investors and shareholders of the entity (Reid et al. 2015).
BHP Billiton financial statements dealing with such matters
Matters and areas in financial statements of BHP Billiton Limited which require significant
judgment of the auditors as well as that of the management of the company:
Being one of the largest companies in the world as far as in the mining industry is
concerned; BHO Billiton Limited has to deal with numerous aspects in its financial reports
which require significant amount of judgment by the accountants and management of the
company (Boolaky and Quick 2016). A brief description of the areas of financial statements of
the company which have been determined after significant judgment from the management and
the accountant are as following:
Depreciation and amortization:

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The amount of depreciation and amortization provided by the company on its non-current
assets including intangible assets require the management to use substantial amount of
judgement. The auditor of the company must evaluate the method of depreciation followed by
the entity and the amount of amortization provided on intangible assets to assess whether the
same is in accordance with the relevant accounting standards, i.e. AASB 116 for depreciation
and AASB 138 for amortization on intangible assets (Carson et al. 2016).
Valuation of intangible assets of the company:
The company has substantial amount of intangible assets. The management and
accountants judgments are essential in recognition and measurement of intangible assets.
However, the estimates and judgements by the management and the accountants of the entity
should be in accordance with the accounting standard AASB 138 issued by the accounting
standards board in the country. Recognition and measurement of intangible assets are essential to
the preparation and presentation of financial statements in accordance with the conceptual
framework in financial reporting (Reid et al. 2016). The auditor of the company must evaluate
the technique and methods used by the entity to assess whether these are in conformity with the
accounting standards or not. In case there is any contravention with respect to accounting
standards in recognition and measurement of intangible assets of the company then the same
must be reported by the auditors of the company in the independent auditor’s report.
Significant events or transactions and their impact on the audit of the financial statements
The significant events and transactions are those which are irregular in nature and unique
from the point of view of an entity’s regular business. It is important that such events and
transactions are identified separately and reported by the auditors in the audit reports. ASA 701

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prescribes that such significant events and transactions must be reported in the audit report of an
entity to allow the users of the financial statements and audit report of an entity to take note of
such significant events and transactions to appraise the effect of these transactions and events on
the financial performance and position of the entity. Such event includes any significant event
and transaction which might influence the going concern assumption of an entity as envisaged in
ASA 570. Let us have brief discussion on such events and transaction which can be considered
as significant from the stand point of an entity (Carver and Trinkle 2017).
Any transaction involving the sale of a portion of an entity’s business
Transactions which involve sale of a portion of entity’s business such as sale of non-
current assets of the company which are used for the revenue generation purpose of the entity.
Sale of an important portion of an entity’s business will impact the going concern assumption of
the entity as its ability to continue in the long run will be negatively influenced subsequent to the
sale of portion of an entity’s business (Majors 2015).
Any new contract in which an entity has entered
In case an entity has entered into any contract which will significantly influence the
revenue of company in the future will have to be communicated by the auditor in the
independent auditor’s report to ensure that the investors and other stakeholders of the entity are
aware of such contract (Lee 2016).
Severance of any existing contracts:

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In case of severance of existing contracts that is expected to negatively influence the
ability of the entity to generate revenue in the future shall also be reported in the audit report of
the entity.
Other significant events and transactions:
Other significant events and transactions also have to be reported by the auditor in
accordance with the relevant standards on auditing to comply with the requirements of the
standards.
In respect of BHP Billiton Limited:
The significant events and transactions in respect of BHP Billiton Limited is the
expansion plan of the company to invest huge amount of funds to expand its business in the
future with the objective of continue on the path of growth in the future. In order to maintain a
sustainable growth in the future the company has been continuously looking for new markets and
has decided to invest huge amount of funds in the future (McKee 2015).
Apart from that the decision of the company to amortize all of its intangible assets within
a period of 10 years is also something which is to be given due importance by the auditors while
conducting the audit of the company (Livne 2016).
Recommendations/ Conclusion
It is recommended that an entity should follow the accounting standards while preparing
the financial statements and the auditors to follow the relevant auditing standards while
conducting an audit. It is important for the auditor to communicate all KAM by providing such
matters in the independent auditor’s report.

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Reference
Afterman, A.B., 2016. The PCAOB's Proposed New Auditor's Report. The CPA Journal, 86(7),
p.64.
Bédard, J., Gonthier-Besacier, N. and Schatt, A., 2015. Analysis of the Consequences of the
Disclosure of Key Audit Matters.
Boolaky, P.K. and Quick, R., 2016. Bank Directors’ Perceptions of Expanded Auditor's
Reports. International Journal of Auditing, 20(2), pp.158-174.
Carson, E., Fargher, N. and Zhang, Y., 2016. Trends in auditor reporting in Australia: A
synthesis and opportunities for research. Australian Accounting Review, 26(3), pp.226-242.
Carver, B.T. and Trinkle, B.S., 2017. Nonprofessional Investors’ Reactions to the PCAOB's
Proposed Changes to the Standard Audit Report.
Cordos, G.S. and Fülöpa, M.T., 2015. Understanding audit reporting changes: introduction of
Key Audit Matters. Accounting and Management Information Systems, 14(1), p.128.
Köhler, A.G., Ratzinger-Sakel, N.V. and Theis, J.C., 2016. The Effects of Key Audit Matters on
the Auditor's Report's Communicative Value: Experimental Evidence from Investment
Professionals and Non-Professional Investors.
Lee, H., 2016. Financial reporting and audit failures in transition economy: examples of auditors
in China's financial market. Law and Financial Markets Review, 10(1), pp.4-15.
Livne, G., 2016. Are auditors independent of their clients? A review of past research and
discussion of research opportunities in Europe.

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Majors, T.M., 2015. The Interaction of Communicating Measurement Uncertainty and the Dark
Triad on Managers' Reporting Decisions. The Accounting Review, 91(3), pp.973-992.
McKee, D., 2015. New external audit report standards are game changing. Governance
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Prasad, P. and Chand, P., 2017. The Changing Face of the Auditor's Report: Implications for
Suppliers and Users of Financial Statements. Australian Accounting Review.
Ratzinger-Sakel, N.V. and Theis, J.C., 2017. Does Considering Key Audit Matters Affect
Auditor Judgment Performance?.
Reid, L.C., Carcello, J.V., Li, C. and Neal, T.L., 2015. Are auditor and audit committee report
changes useful to investors? Evidence from the United Kingdom.
Reid, L.C., Carcello, J.V., Li, C. and Neal, T.L., 2016. Impact of auditor and audit committee
report changes on audit quality and costs: Evidence from the United Kingdom.
Segal, M., 2017. ISA 701: Key Audit Matters-An exploration of the rationale and possible
unintended consequences in a South African. Journal of Economic and Financial
Sciences, 10(2), pp.376-391.