ASA 701 Analysis: Key Audit Matters in Independent Auditor's Report

This report provides an in-depth analysis of ASA 701, the auditing standard concerning the communication of Key Audit Matters (KAMs) in independent auditor's reports. The report begins by outlining the context of ASA 701's development, highlighting the global financial crisis and the collapse of Lehman Brothers. It examines the rationale behind the standard, emphasizing the need for greater transparency and communication with investors regarding significant audit matters. The report then delves into the specifics of ASA 701, explaining the definition and importance of KAMs. It analyzes the Lehman Brothers case, discussing how the implementation of ASA 701 might have altered the outcome. Furthermore, the report provides practical examples, evaluating KAMs in the context of four utility companies: AGL Energy, APT Management Services, Ausnet Services Limited, and Spark Infrastructure. These examples illustrate the application of ASA 701 in real-world scenarios, including unbilled revenue, goodwill valuation, derivative transactions, and revenue recognition. The report concludes by summarizing the implications of ASA 701 for auditors and investors, emphasizing its role in promoting financial transparency and investor confidence.

Auditing Theory and Practice
2019

ASA 701
Executive Summary
The following report will shed light on the issues pertaining to auditing which ultimately led
into the disintegration of Lehman Brothers along with the KAM that were needed to be
portrayed in the audit report of the company if ASA 701 was implemented prior to the
demise of the same. The report not only highlights the issues pertaining to the audit function
of the company that ultimately led to the collapse of the same but also states the reasons as to
why such material aspects were not projected in its Audit report.
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Contents
Introduction...........................................................................................................................................3
Case of Lehman Brothers.......................................................................................................................3
Auditing Standard ASA 701- Communicating Key Audit Matters in the Independent Auditor’s Report 4
Key audit matters..................................................................................................................................4
1. AGL Energy....................................................................................................................................5
2. APT Management Services............................................................................................................7
3. Ausnet Services Limited.................................................................................................................7
4. Spark Infrastructure.......................................................................................................................8
Conclusion.............................................................................................................................................9
References...........................................................................................................................................10
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Introduction
Lehman Brothers ranked number four prior to September 2008 in the investment banking
sector of the US. The company was into the international investment banking business. The
company filed itself for Chapter 11 bankruptcy and declared itself completely bankrupt in the
month of September 2008. The management of the company did not opt for assessment of its
potential and underlying risks was one of the major reasons attributing to the company’s
failure (Elder, Beasley & Arens, 2010). The auditors of the company too didn’t bother about
informing the management about the impact of such underlying risks which further
aggravated the problem. The auditors were unprofessional enough in conducting audit
function in the Lehman Brothers as it is easily reflected from the audit report that significant
aspects and numbers were not disclosed in the financials of the company, which otherwise
would have saved the same from its untimely demise (Goergen, 2012).
Case of Lehman Brothers
Lehman Brothers made huge investments risky projects without even evaluating the risks
associated with the same. As the housing industry was booming at a fast pace between 2001
and 2008, the management of the company considered investing in the housing industry
owing to its huge returns and therefore, the same began heavy borrowing so as to invest in the
housing industry. The company also invested all its proceeds apart from borrowings in the
housing industry (Viney, 2010). The company also invested a huge amount in Real Estate and
private financing. Therefore, the company failed majorly due to its impulsive decisions
regarding making huge investments in various risky projects and also due to heavy
borrowings for the same purpose. The sudden demise of Lehman Brothers was a shock for
the United States economy. On account of the GFC, the banking institutions in the United
States suffered a huge set back with respect to losses borne by the same. The Lehman
Brothers also suffered heavy losses as the price of the same went below 27% of its former
value (Wiggins, Piontek & Metrick, 2014). The role of the auditors raised eyeballs due to this
sudden disintegration of Lehman Brothers and the global financial crisis. Several auditing
standards were newly formulated due to the prevalence of global financial crisis such as ASA
701 that deals with key audit matters communication (Baldwin, 2010).
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ASA 701- Key Audit Matters in the Independent Auditor’s
Report
ASA 701 was applicable on or after December 15, 2016. This new auditing standard was
formulated so as to evaluate significant audit matters. Once these matters were assessed, the
same was required to be communicated to the company’s management. The key audit matters
of the company once addressed must be conveyed to the top level executives of an
organization without the presence of any influence or any biases (Fazal, 2013). ASA 701 is
implemented with a purpose to facilitate transparency and genuineness in the audited
financials of the company. This will ultimately allow the investors to get an insight into the
functioning of the company and make necessary decisions based on the presented information
and their overall evaluations (AUASB, 2015). If ASA 701 was implemented in Lehman
Brothers, then the auditors of the company would have refrained from hiding the significant
audit matters in that led to the issue.
It is a known fact that KAM are those aspects that require the auditor to exercise more focus
upon while conducting his audit function for an organization. The auditors must look for the
areas that are prone to or constitutes higher risks of material misstatement. The auditors must
also look for such areas that have high uncertainty and must also assess the impacts of all the
transactions that took place in his audit period.
ASA 710 – Key Audit Matter
KAM are aspects that are considered significant by the auditor of an organization for a
particular audit period. ASA 701 of the AUASB Committee describes key audit matters as
such aspects that are crucial in the eyes of an auditor with respect to a specific audit period.
The management of the company is conveyed the key audit matters which are selected out of
several aspects so that the same can make necessary rectifications and reduce or eliminate the
impact arising out of these matters (AUASB, 2015). ASA 701 has allowed the directors and
audit companies to provide more focus on the key audit matters so that the annual reports of
the organization is free from any inconsistency.
The IASB introduced ASA 701 so as to make it necessary for the companies to adhere not
only with the necessary statutory requirements but also with the recent enhancements at the
same time. ASA 701 has several new features. ASA 701 allows the auditors to construe
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decision pertaining to the presence of KAM in the audit reports. It is mandatory for the
auditors of the listed companies to include KAM communication in their reports (Gay &
Simnet, 2015). The auditors must look for such areas of risk that require immediate
assessment. The ways are identified through which an auditor can assess such key audit
matters that need to be immediately identified. ASA 701 also explains the ways in which the
auditor can define KAM’s. ASA 701 also highlights the judgments of the management with
respect to significant matters along with the judgment of the auditors on the basis of material
events that needs to be inculcated in the auditors’ report. ASA 701 also seeks mandatory
disclosures with respect to the absence of matters related to the KAM in the annual report of
the company (Hoffelder, 2012). ASA 701 seeks for all such necessary documentation that is
required to behold for the purpose of KAM.
ASA 701 is applicable in the annual reports for all the utility companies that have to submit
their financial statements for the period falling after December 15, 2016. ASA 701 is
implemented so as to protect the interests of the investors from getting deceived as a result of
false representation of information in the financial statements of an organization. ASA 701 is
implemented with an objective of maintaining the integrity of the financial statements of an
organization so as to disallow the interests of the investors from getting deceived. ASA 701
safeguards the interests of the investors through the facilitation of transparency in the
financials of a company and by offering an insight into the key audit matters of the same and
how the auditors have taken care of such aspect. ASA 701 aims at offering the investors
required disclosures of the company’s true state of affairs and its current financial well being
and hence, we are considering four utility companies for the purpose of our report.
Key audit matter
1. AGL Energy
Unbilled revenue
The unbilled revenues disclosed by the company in Note 11 amounted to $938 million and
this has been completely checked by the auditors. The unbilled revenues were generated as a
result of electricity and gas supplied to consumers for the period existing between the last
date of invoice and the date of reporting where AGL hasn’t issued any bill to its consumers
at the completion period. The estimates of unbilled revenues are computed on the basis of
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detailed financial models which further incorporate the estimates and applicable pricing for
the consumed gas and electricity of AGL consumers (AGL, 2018). Evaluation of the
consumption of consumer between the last meter reading and the completion of the period of
reporting is necessary in order to construe the unbilled revenues concerning the gas and
electricity consumption as on a reporting date which is only possible in the prevalence of
appropriate management (Kieso et. al, 2010).
Unbilled distribution costs
As provided by the auditors, the unbilled distribution costs disclosed by the company are
accrued at $412 million. These costs were generated as a result of energy consumption for the
period existing between the last invoice date from the distributor to AGL and the completion
of the period of reporting for the financial year. The estimated unbilled distribution costs are
determined on the basis of detailed financial models which further uses estimates of the
energy consumption of AGL’s consumers along with the applicable tariff rates of distribution
(AGL, 2018).
Financial instruments
The fluctuations in the foreign currencies, interest rates, and energy prices have the tendency
to influence the prospect of the company and therefore, it is why the same has opted for such
financial instruments that also comprises of derivative financial instruments. It needs to be
disclosed because the investors needs to have a proper grasp of the matter. As disclosed in
Note 22, the derivative financial liabilities of the company amounted to $615 million out of
which the non-current liabilities stood at $256 million and the remaining were the figures for
current liabilities (AGL, 2018). As per Note 13, the derivative financial assets of the
company was at $640 million out of which non-current assets amounted at $384 million and
the remaining were the numbers for current assets. Hence, the exposure are reflected clearly.
2. APT Management Services
The goodwill of the company was around $1.2 billion, carrying a value of the property, plant
and equipment were at $9.7 billion, and other intangible assets were at $3 billion as reflected
in the balance sheet of the same for 30 June 2018. Note 11 and 12 reflected that all these
assets were apportioned across all the CGUs. Significant judgment is required with respect to
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carrying value of the company’s PPE, goodwill and other intangible assets on the basis of
inflation, discount rates, future contract renewals and contracting of spare capacity (AusNet
Services Ltd., 2015). The auditor ensured that the measurement has been aptly stated in the
annual report.
Derivative transactions and balances including the application of hedge accounting
The company has a total borrowing of $9.7 billion as on June 30, 2018, which shall be
extended until 2035. As per Note 18, the borrowings of the company comprises of both fixed
and variable borrowings and these are denominated not just in Canadian, Australian and US
dollars but also Euros and British Pounds as well. The company is highly prone to suffer as a
result of movements in the interest rate and foreign exchange rate and takes up interest rate
swaps to deal with the risks pertaining to foreign currency denominated borrowings and
eliminates the risk of rising interest rates (Niemi & Sundgren, 2012). Hence, the auditors
have clearly provided the exposure of the company.
3. Ausnet Services Limited
Recognition of revenue (AUD$1,909.8million)
The feature of the regulatory structure for the purpose of ascertaining revenue and
expenditure that needs to apportioned to each CGUs and the difficulty faced in auditing the
forward-looking assumptions that are again apportioned to the discounted cash flows for each
CGUs are the reasons as to why the valuation of non-current assets is a key audit matter
(AusNet Services Ltd., 2015). The assumptions are based on inflation, discount rates, growth
rates, etc and by indicating it in the report, the auditors has highlighted the revenue
recognition.
Project-related expenditure – accounting for it
The total number of ongoing projects, the difficulty faced in auditing judgements with respect
to determining whether future benefits of the company are defined by the capital projects and
the segregation of operating and capitalized expenditure, and the importance of operating and
capital expenditure pertaining to the development and maintenance of better networks are the
few reasons as to why the project related expenditure is deemed as key audit matter.
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Valuation and accounting for derivatives (AUD$502.5million assets; AUD$270.7million
liabilities)
The underlying differences in the application of accounting principles for the purpose of
valuation and disclosures of hedging activities, the size and complexity of the company’s
cross currency and swaps hedging foreign currency and dollar transformed fixed and floating
rate debt and implementation of such activities with respect to capital management for the
year are the reasons as to why valuation, as well as accounting for derivatives is a key audit
matter (AusNet Services Ltd., 2015).
4. Spark Infrastructure
The amount of investments accounted for utilization of the equity period sums to $2326
million as of December 31, 2018. The sources of all these investments are SA Power
Networks, TransGrid and Victoria Power Networks. It was later realized by the management
that the investments from all these networks are required to be impaired. This is why the
management of the company presented an FV less cost to ensure impairment model is sold
with respect to its investments in SA Power Networks, TransGrid and Victoria Power
Networks (Sparkinfrastructure, 2018).
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Conclusion
The significance of key audit matter is huge and there are various reasons behind the
communication of the same to the management of the utility companies. It facilitates
transparency in the auditors’ reports and therefore, the same is considered desirable by the
users. It also allows the presence of various significant disclosures in the financial statements
of the company which helps the users in developing an insight into the financial well being of
the same. It enables the users to take appropriate decisions upon investing in the company.
The new auditing standard named ASA 701 is implemented so as to safeguard the interests of
the investors from getting deceived by giving them an insight of the financial well being of
the company.
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References
AGL. (2018) AGL Energy 2018 Auditor’s report. Available from:
https://www.2018annualreport.agl.com.au/xmlpages/tan/files?p_file_id=18 [Accessed 14
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 14 May 2019].
AusNet Services Ltd. (2018) AusNet Services Ltd. 2018 Auditor’s report. Available from:
https://www.ausnetservices.com.au/Misc-Pages/Links/Investor-Centre/Company-reports
[Accessed 14 May 2019].
Baldwin, S. (2010) Doing a content audit or inventory. Pearson Press.
Elder, J. R., Beasley S. M., & Arens A. A. (2010). Auditing and Assurance Services. Person
Education, New Jersey: USA
Fazal, H. (2013) What is Intimidation threat in auditing?.[online]. Available from:
http://pakaccountants.com/what-is-intimidation-threat-in-auditing/ [Accessed 14 May 2019]
Goergen , M. (2012). International Corporate Governance. Prentice Hall.
Gay, G. and Simnet, R. (2015) Auditing and Assurance Services. McGraw Hill
Hoffelder, K. (2012) New Audit Standard Encourages More Talking. Harvard Press.
Kieso, D., Weygandt, J., Warfield, T., Young, N and Wiecek, I . (2010) Intermediate
accounting, Toronto: John Wiley & Sons Canada.
Niemi, L. and Sundgren, S. (2012) Are modified audit opinions related to the availability of
credit? Evidence from Finnish SMEs. European Accounting Review. [online]. 21(4), p. 767-
796. Available from: https://doi.org/10.1080/09638180.2012.671465 [Accessed 14 May
2019]
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Sparkinfrastructure. (2018) Sparkinfrastructure 2018 Auditor’s report
https://www.sparkinfrastructure.com/investor-centre [Accessed 14 May 2019].
Viney, C. (2010) McGrath’s Financial Institutions, Instruments and Markets, Sydney
Wiggins, R.Z., Piontek, T., & Metrick, A. (2014). The Lehman Brothers Bankruptcy A.
Available from: http://som.yale.edu/sites/default/files/files/001-2014-3A-V1-
LehmanBrothers-A-REVA.pdf [Accessed 14 May 2019].
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