ABC Learning: An Analysis of Financial Auditing Failures and Collapse

This report provides an in-depth analysis of the auditing failures that contributed to the collapse of ABC Learning. It examines the company's financial reporting practices, highlighting the absence of relevant issues and negligence in financial statement drafting. The report discusses the role of major instruments, including related party transactions, and the failure to disclose misstated leverage ratios and other crucial evidence. It explores the application of ASA 701, the auditing standard for communicating major audit concerns, and how its absence allowed for concealment of vital information. The report also details how the approval of transactions influenced the financials and the classification of inappropriate resources. The report concludes with recommendations and emphasizes the collective failure of management and auditors in preventing the company's downfall, emphasizing the importance of transparency and effective corporate governance.

Auditing

ABC Learning
Executive summary
The failure of the giant corporate in the past has raised enormous question on the integrity of the
auditors and the audit firms. Thereby, new and improved updates have come to the forefront so
that any pitfalls can be easily negated. The main purpose of this report is to shed light on the
failure of ABC learning. The auditing issues that led to the collapse is mainly discussed in this
current report. The reason for the development of ASA 701 and the application of it is projected.
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ABC Learning
Contents
Introduction.................................................................................................................................................3
Major absence of relevant issues and negligence that must be considered during drafting of financial
statements of the company..........................................................................................................................3
Major instruments coming into movement..................................................................................................3
ASA 707 that relates to the communication of major audit concerns in the independent audit report.........5
Auditing matters that swamps the disintegration of ABC learning..............................................................5
Hiding of misstated leverage ratio of the firm.............................................................................................5
Failure to disclose the evidence...................................................................................................................6
Nondisclosure of wrong transactions in notes to financial statements and audit report...............................6
Approval of the transactions in order to influence the financials.................................................................6
Approval of financial statements that has problem with the transactions....................................................6
Classification of inappropriate resources.....................................................................................................7
Recommendation.........................................................................................................................................8
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10
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ABC Learning
Introduction
In the year 1988, the formation of ABC Learning was done and by the end of the year 2000, the
company gained massive coverage of more than thirty centers. Further, the company attained its
listing status in 2001 and diversified itself to more than 650 centers all across United Kingdom,
Australia, and the United States. However, the collapse of the company can be attributed to the
management’s over-ambitious strategies and failure on the part of auditors. Further, the
emergence of debt in 2007 wherein negotiation with the bankers was necessary also resulted in a
bigger concern (CPA, 2012). As a result, some long-term liabilities of the company were not
paid and this affected the company’s cash flow negatively. Besides, this also resulted in a decline
of the share price of the company. In short, the incident led to the total fall and the reason that
can be cited is the collective failure of the management and the auditor. Even after having the
top-notch audit firm, there was a scenario of collective failure. Nonetheless, if the auditors had
implemented strong choices, then this situation could have been prevented. Moreover, the
ineffective choices of the auditors would not have been caught in the company had not attained
profits from the usual course of activities. In other words, it was a big question as to how any
childcare division could function in such a rapid way (IFAC, 2015). On a whole, the ways
adopted by ABC Learning in order to attain bigger heights is surely noticeable and once must
rethink how it enhanced its operations so rapidly.
Major absence of relevant issues and negligence that must be considered during drafting of
financial statements of the company
An unqualified judgment was offered by the external auditors of ABC since the appointment in
the year 2003. However, Ernst and Young took over the authority of being an auditor in the year
2007 and made an altogether distinct analysis of the profits that was done previously. Further,
KPMG was engaged as a third party of the company in order to settle the differences.
Nonetheless, both these enormous giant firms also failed to track any falsifications on the part of
the management. This gives rise to the fact that both the auditors have offered a distinct opinion
upon the company’s financials and therefore, it must be taken into consideration that the
unqualified judgment by the auditors played a key role in the disintegration of ABC Learning. In
simple words, even after having major firms in the company’s affairs, loopholes or
mismanagement occurred that ultimately crumbled the company.
Major instruments coming into movement
Improper utilization of related party transactions played a key role in creating major problems for
the firm. The major reason behind such decision was to portray an effective and shiny image of
the firm so that the investors and financial institutions could be easily fooled in order to get more
borrowings from them. In addition to this, the obligations and losses of the firm were also
addressed by such borrowings and keeping the securities as collateral. Nonetheless, such related
party transactions played a vital part in decreasing the securities by highlighting the transactions
as a registered sale for securities. Further, the auditing department also assisted the management
in concealing such replication of securities in the financials so that their vulnerabilities were not
exposed. In addition, the loans obtained by the firm were also depicted as ‘Sale Proceeds of
Investment Securities’ and this never formed part of the balance sheet (CPA, 2012). The major
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ABC Learning
intention behind such transaction was to target less risky liabilities and resourceful assets. In
short, the major intention was to reap more profit at the cost of others. ABC learning center made
enormous success and profit in a short time span and this was done at the cost of the innocent
investors.
The company was also being paid an enormous figure of $74 million for the operations
associated with the ABC centers. The company also attempted to sponsor the Brisbane Bullets
team of basketball. All these transactions were unrelated in nature based on the statement of
ABC Learning but in reality, these transactions itself played a major part in disintegrating the
company. Nevertheless, this was both the management and auditors’ failure that resulted in such
a situation. On a whole, such related party transactions must not be endeavor by any company
because it not only creates a situation for hampering of goodwill in the market but also crumbles
the company as a whole (Teen, 2012). The common public and investors perceive that the
management is operating the company for their own benefits and not for the advantage of the
investors. However, in contrast to this, in the case of ABC Learning, it can be easily stated that
the major drawback that resulted in its downfall can be attributed to a poor performance on the
part of auditors and an ineffective corporate governance mechanism. Besides, the real scenarios
of the firm were not revealed in the financial statements at all, and as a result, such financials
represented the financial information in a very distinct manner based on the prevailing situation
of the firm (Cappelleto, 2010). This resulted in the emergence of a major cause of discrepancy in
the financial reporting standards of the company.
Overall, considering the above situation, it can be easily stated that the company could have been
easily safeguarded from such a drastic situation if the auditors had taken relevant steps to
disclose important matters to the stakeholders and common public. However, instead, they tried
to conceal significant concerns from these users so that a tarnished image of the company can be
portrayed. Moreover, even if they warned the management of the hazardous consequences of
such steps, the situation might have been very different. Either the company could be saved or its
disintegration could be delayed to some extent if the auditor took such steps.
ASA 707 that relates to the communication of major audit concerns in the independent
audit report
Such auditing standard was adopted for the purpose of efficient financial reporting in the year
December 15. The prior motive behind the adoption of this standard can be attributed to the fact
that it assists in keeping a trace of major audit matters and after conducting effective assessment
measures, such matters can be reported to the management of the audit firm without wasting any
further time. The users of financial statements can be highly benefitted from such standard
because it allows them to observe the major matters and other situations prevailing in the
financials so that it can safeguard them from encountering significant losses, thereby, in turn,
posing as a very effective way to enhance transparency (Geoffrey et. al, 2016). Moreover, the
financials of the firm would have been real and easy to be interpreted by such users if the
auditors were not negligent of their duties as an auditor. Further, if such standard prevailed in the
situation of ABC learning, the auditors would not be in a position to conceal relevant matters
from the audit report and that would have safeguarded the firm from disintegration as a whole
(Fazal, 2013).
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ABC Learning
On a whole, it is the responsibility of an auditor to emphasize relevant and due care towards
matters that are more significant especially while undergoing the procedure of auditing of the
financial statements.
Auditing matters that swamps the disintegration of ABC learning
The auditing standard of ASA 707 would have played a key role in the disclosure of relevant
facts and figures in the case of ABC learning. Besides, the absence of such standard, in this case,
granted undue advantage to the auditors in concealing significant facts from the audit report that
ultimately played a key role in destroying the firm (Kaplan, 2011). On a whole, it can be stated
that the absence of ASA 707 and other relevant loopholes in the regulatory system at that time
resulted in the failure and collapse of ABC learning.
Hiding of misstated leverage ratio of the firm
. The significant concerns that resulted in the disintegration of the firm have been portrayed by
the points that had to be reported to those who are responsible for the maintenance of
governance. Besides, if ASA 701 was not absent in the case of ABC learning, the auditors would
be strictly bound to comply with all the statutory rules and regulations and concealment of
relevant matters would have been avoided (Kruger, 2015). Further, the firm could be saved from
such a grave scenario as well.
Failure to disclose the evidence
The firm was responsible to acquire a true opinion of sales in order to proceed with their
transactions that can fully adhere to the lawful platform for the transfers. The major reason that
led to the downfall consisted in the deficiency of the system. Going by the ACCC representation,
it is evident that the ABC downfall was not due to the cut-throat competition rather the downfall
happened to owe to many disturbances and financial mismanagement like high debts and
acquisitions. Hence, the fall can be linked to the deficiencies that the financial information
projected. The firm encountered disintegration owing to such borrowings and transactions
(Christensen, 2011). Moreover, the financial institutions also stopped accepting the securities as
collateral in contrast to the short-term borrowings. This resulted in a failure to address the
obligations on the part of ABC learning and all these scenarios occurred after the occurrence of
huge debts and liabilities in the capital structure of the firm that posed a huge threat to its smooth
flow of operations and finally crumbled the firm as a whole.
Nondisclosure of wrong transactions in notes to financial statements and audit report
Owing to the improper transactions, the same was required to be disclosed in the audit report and
financials of the firm. However, it planned to conceal the same because it would then become
vulnerable owing to massive borrowings and other obligations. In addition, the unaltered
leverage ratio would also expose the firm to the investors if they had not concealed the same
(Lapsley, 2012). The major part played by the auditors in such a scenario was concealment of
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ABC Learning
impacts that could be caused because of the transactions entered into by the firm and therefore, it
was decided to hide the same.
Approval of the transactions in order to influence the financials
The financials of the company were based on weak grounds and the management took many
decisions without concerning the auditor. Moreover, the auditor failed to trace such frailties and
proceeded with the same. Many transactions were undertaken as investments in the balance
sheet. Moreover, the auditor must have been aware of the consequences that would occur and it
was their moral responsibility to warn the management about the same (Carcello, 2012). In
addition to all this, the firm also endeavored to portray its equities as collaterals instead of fixed
income securities so that the related party transactions can be easily carried on.
Approval of financial statements that has problem with the transactions
. Besides, both the firm and their auditors were smart enough to depict these relevant transactions
as minimal variations in the financials. In addition to this, the firm also highlighted that the
repurchase of securities was majorly undertaken at a minimal cost and the same was concealed
under major large-scale derivatives (Heeler, 2009). Besides, the firm and their auditors attempted
to show these transactions in the notes to financial statements. On a whole, it can be seen that all
these improper acts were done by the firm in consultation with the auditors who were morally
responsible to stop or disclose the same in their audit report.
Classification of inappropriate resources
All the major short-term financing transactions were inappropriate and the recording was faulty
in nature. Furthermore, the securities were depicted as collateral was later removed from the
financials of the firm. In addition to all this, the firm also endeavored to minimize its liabilities in
order to portray the image that the securities of the firm are being provided to the third parties as
compensation and the leverage is also declined (IFAC, 2015). Further, all the debts acquired by
the firm was also supposed to be shown on the balance sheet of the firm until they were repaid.
However, the transactions were depicted as sales so that the sold securities could be subtracted
from the assets of the firm and there could be no sign of any liabilities (Manoharan, 2011).
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ABC Learning
Recommendation
When it comes to the process of financial reporting, both internal, as well as statutory auditor
plays a leading role in shaping the destiny of the organization. Moreover, the level of
transparency depends on the auditor’s duty. If the compliance is done in accordance with the
company law it leads to better practice. Hence, the auditor needs to assess the books in an in-
depth manner so that the preparation of the financial statement is devoid of any mistakes and
errors. The auditors are responsible for the financial statement preparation and to correctly note
the facts and then provide the independent decision. The auditors are morally liable to depict a
true and fair view of the financials of the company and the society because they rely upon the
judgment offered by the auditors (Blay et. al, 2011). Therefore, in order to adhere to this, the
auditors must comply with the auditing standards so that they can utilize the same in their audit
processes. In the ABC learning case, since the auditors neglected in doing their activities in a
moral way and therefore, the third parties suffered. Hence, without depicting the mistakes of the
company in the financial statements, the auditors cannot adhere to ethics of audit. Further, the
disintegration of ABC learning shows the loopholes in the regulatory system that necessitates
corrective actions and supervision as a whole.
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ABC Learning
Conclusion
The disintegration of Lehman offers illustrations to organizations to adhere to moral standards in
relation to corporate governance practices. Further, the management and auditor must strictly
abide by all the rules because such rules are made for their own advantages so that both the
management and public can be effectively addressed. Moreover, it is the situation’s demand that
there must be a wise and appropriate imaging of the financials of companies so that the
management does not acquire undue advantage to mislead the users of financial statements for
their own benefits. Overall, in such a case, implementation of accounting and auditing standards
is the need of the hour. Nevertheless, the firm failed to disclose all these concerns in their
financial statements because the auditors attempted to conceal the same (Matthew, 2015). This
gives rise to the fact that if the auditors had not been negligent in their activities and tried to
disclose the same, the firm would have been safeguarded from such a drastic situation and
corrective actions would have saved it.
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ABC Learning
References
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Communication of Risk. Auditing: A Journal of Practice & Theory, 30 (2), pp. 77- 102.
Cappelleto, G., 2010. Challenges Facing Accounting Education in Australia. AFAANZ,
Melbourne
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
CPA 2012. ABC learning collapse case study. [online] Available at:
<https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-
study> [Accessed 15 September 2017]
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<http://pakaccountants.com/what-is-intimidation-threat-in-auditing/> [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.
Heeler, D., 2009. Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
IFAC 2015. Strengthening organizations, Advancing Economies. [online] Available at:
<https://www.ifac.org/auditing-assurance/clarity-center/clarified-standards> [Accessed 14
September 2017]
Kaplan, R.S., 2011. Accounting scholarship that advances professional knowledge and practice.
The Accounting Review, 86(2), pp. 367–383.
Kruger, P., 2015. Corporate goodness and shareholder wealth. Journal of Financial economics,
pp. 304-329
Lapsley, I., 2012. Commentary: Financial Accountability & Management. Qualitative Research
in Accounting & Management, 9(3), pp. 291-292.
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ABC Learning
Manoharan, T.N., 2011. Financial Statement Fraud and Corporate Governance. The George
Washington University.
Matthew S. E 2015. Does Internal Audit Function Quality Deter Management Misconduct?. The
Accounting Review 90(2), pp. 495-527
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
14 September 2017]
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