Analysis of Key Audit Matters in the Banking Industry and ASA 701

This report provides a comprehensive analysis of Key Audit Matters (KAM) as outlined in the independent auditor's report, particularly in the context of the new auditing standard ASA 701. The report begins with an executive summary emphasizing the importance of financial statement disclosures and the role of the auditor in assessing and reporting on significant matters. It then delves into the rationale behind ASA 701, highlighting the case of Lehman Brothers and how the lack of disclosure of key financial issues contributed to its collapse. The report further examines KAMs within the banking industry, using examples from Westpac, National Australia Bank (NAB), Commonwealth Bank of Australia (CBA), and Bank of Queensland Limited (BOQ) to illustrate how auditors identify and report on critical areas such as loan impairment provisions, the adoption of new accounting standards, and the valuation of financial instruments. The analysis underscores the significance of transparency and the importance of auditors communicating potential risks to stakeholders, ensuring a clearer understanding of a company's financial position and future prospects. This assignment highlights the practical application of ASA 701 and the impact of KAMs on financial reporting within the banking sector.

AUDITING
user
[Pick the date]

Key audit matter
Executive Summary
As per ASIC 2001, the company must ensure that it release the financial statements together
with the notes and disclosures. This means that the financial statements should be explanatory
in nature so that a clear cut understanding of the company can be done. further, the presence
of auditor report and director report must be present that helps in knowing the authenticity of
the company. In this, we will try to understand what is Key Audit matter and why it should be
reported. The Auditors has the responsibility to report his opinion to its shareholders about
the working and operations of the Company. His work includes identifying areas of
importance and sample checking of the management work. So we have chosen the Banking
industry to understand its Key Audit matters by choosing Four major Banks of Australia.
Further, the key audit matter of the company is discussed in an elaborated manner where it
comes to the forefront that disclosure of the information is appropriate.
2

Key audit matter
Contents
Introduction...........................................................................................................................................4
Case of Lehman Brothers & Relevance of ASA 701 in the case.............................................................5
Key Audit Matter projected in the Banking Industry.............................................................................6
Westpac banking corporation...............................................................................................................6
National Australia bank (NAB)...............................................................................................................7
Commonwealth Bank of Australia- CBA................................................................................................7
Bank of Queensland Limited (BOQ).......................................................................................................8
Conclusion...........................................................................................................................................10
References...........................................................................................................................................11
3

Key audit matter
Introduction
As per the standard, the Key Audit Matters (KAM) are defined as those matters which are to
be given significant attention by the auditor while auditing the financial statements and
related reports. For finding out such matters, the auditors need to focus on those transactions
which have high risks of material misstatements and such misstatements could have affected
the financial accounts during the audit period (AUASB, 2018).
The main object of this standard is that the key matters should be assessed and once such
matters are assessed, the same should be conveyed to the management along with the opinion
of the auditor. The key matters are of huge importance as these help the users of the financial
statements to know such transactions which can affect the company and such users in the
near future (Baldwin, 2010). The audited financial statements should be transparent enough
for its stakeholders to know the actual financial position of the company at large. Hence the
KAM should be disclosed in the audit report (Moroney & Trotman, 2016). It is now the
responsibility of the auditors to disclose the key audit matters in the audit report (Cappelleto,
2010). They should also mention therein that which of the matters were disclosed to the
auditor prior to the completion of an audit and which were disclosed after the audit was
completed.
This standard explains how an auditor should make disclosures of Key Audit Matters while
preparing his audit report. It further has the following features:
• In the case of listed companies, this standard has mandated the communication of Key
Audit Matters by the auditors in their audit report (Ruhnke & Schmidt, 2014).
• In the case of other companies, the standard helps the auditors in deciding whether or not
to include KAMs in their audit report.
• As per the standard, the auditor can decide how to determine the key audit matters. It
depends on the judgment of auditors and management together and those transactions and
accounts are considered to be included in the auditor’s report as key matters which show high
risk and which can have huge effects on significant transactions and events (Christensen,
Kent, Routledge & Stewart, 2015).
• This standard defines the documentation required by the auditor in relation to KAMs.
4

Key audit matter
• In case the auditor is unable to communicate the KAMs to the management, the auditor
should have suitable justification for the same. The justifiable circumstances are defined in
this standard (Lakis & Masiulevicius, 2017).
Case of Lehman Brothers & Relevance of ASA 701 in the case
In the case of Lehman Brothers, the auditors concealed some material facts which were key
audit matters and would have been disclosed if ASA 701 was to be followed. The
nondisclosure of such key facts led to huge loss to the stakeholders and hence the demise of
Lehman Brothers (Kaplan, 2011).
Following were the facts that led to the loss of Lehman Brothers due to non-disclosure in the
auditor’s report:
i. The leverage ratio for Lehman Brothers showed a considerable decrease in the year 2008
as compared to the year 2007. The reason behind this decrease was the loans borrowed by the
firm for which repayment was done after the fiscal quarters ended. This was done to show the
securities in the balance sheet on the reporting date. Such transactions were not disclosed in
the audit report (Cohen & Simnett, 2014). If ASA 701 had been there, the auditors would
have disclosed all the key matters in the audit report and this would have saved Lehman
Brothers from drowning.
ii. Another reason was the use of Repo 105 & other repo transactions. With the help of
these transactions, the financial statements were window dressed. This was in notice of
auditors but no reporting for the same was given (Geoffrey, Joleen, Kelli & David, 2016).
iii. One more reason was that the firm was supposed to buy back the securities of the firm
which was of a huge amount. This was not disclosed in the financial statements properly. The
buy-back was shown at a minimum rate as derivatives. Hence a completely different picture
was shown to the users of financial statements mainly investors.
Such concealment of facts from the audit report kept the actual position of the firm hidden
and gradually led to its collapse. If ASA 701 had been there, the auditors would have
disclosed all the key matters in the audit report and this would have saved Lehman Brothers
from drowning (Hoffelder, 2012).
5

Key audit matter
Key Audit Matter projected in the Banking Industry
We have chosen here Banking Industry for analyzing the Key Audit Matters specified in the
Auditor’s Report to evaluate the importance of disclosing the Key Audit Matters from the
financial statements which are of utmost importance to the users. We have chosen 4 banking
companies for the analysis which are as under:
Westpac banking corporation
Some of the Key Audit Matters are as under for Westpac:
i. The Auditors have chosen “Impairment provisions of Loans” as key Audit Matter and
have tried to disclose the rationale of the management in determining impairments
provisions, the underlying judgments, assumptions, and their working. The auditor firstly
assessed how the management is identifying the impairment in the loans and the concerned
Controls in place to identify, assess and define the impairment. After the analysis, the auditor
assessed that to understand how the management had divided the loans among Loans liable to
Impairments and Other loans (Westpac Bank, 2018). It was of utmost importance to know the
criteria to find out the impairment by the management and specifically choose the loans out
of different samples (risk, tenure, amount, etc.) and recalculate the impairment of Loans. This
way the Auditor can fairly understand the impairments losses and provisions done.
ii. The Group transitioned from AASB 139 to AASB 9 during the relevant financial year.
The new standard AASB 9 has introduced a new model called Expected Credit Loss model
which focuses on the information of Group’s future economic events. As the ECL provisions
are to be made for the financial instruments, it is a very complex procedure requiring
considerable judgment, hence the auditors have considered it a KAM. As per the
management reports, the implementation of AASB 9 was expected to reduce the retained
earnings of the group by the $ 709m net of tax as at 1st October 2018 which is a very
substantial amount (Westpac Bank, 2018). This is expected due to an increase in the
impairment provisions. The auditors have applied their judgment in determining the
methodology used for assessing ECL, impairment losses for future events, check the
adherence to the new standard AASB 9, tested the accuracy and completeness of data by
sampling methods, etc to justify the KAMs mentioned in their reports.
iii. The operation of IT Systems & Control is another key audit matter as the company is
heavily dependent on the complex IT systems for its workings. The authorized access to staff
6

Key audit matter
to the IT System is the main reason for potential fraud as a result of changes to the underlying
data. The auditors did an assessment of the design and key controls of the IT system to be a
KAM.
National Australia bank (NAB)
Some of the Key Audit Matters are as under for NAB:
i. The core function of any bank is to Lend money and its safety & security should be of
prime importance. This bank follows Australian Accounting Standard AASB-9, Financial
Instruments for provisioning of impairment in Loans. The Auditor has considered this as a
Key Audit matter as this involves Judgement & Assessment of Provisions and its amount.
The Bank has various types of Loans which have different levels of risk and returns. Every
Loan is being checked and assessed upon various parameters and then is subject to
categorization for Loss provisioning (NAB, 2018). This involves management understanding
and judgment about the provisioning of impairment of Loans. The auditor should assess &
identify the process used by the management to identify the risk and its provisioning
accordingly. In case, Auditor feels that the provision amount is less he should suggest the
management to raise the provision.
ii. The Bank is also subject to contingent Liability in respect to conduct related matters in
various jurisdictions primarily in Australia. The management has to take some assumptions
and judgment as to what risk may materialize and in that vent what amount of Loss may
arise. The Auditor has also considered this matter as key Audit matter. The auditor has to take
legal advice on this matter and suggest the number of provisions to be made in this regards.
The management cannot predict the outcome of any proceedings against them and any
negative result may heavily cost them in terms of money & reputation (NAB, 2018).
Commonwealth Bank of Australia- CBA
Following are the key Audit Matters as reported by the Auditor:
i. The Bank did not adopt Australian Accounting Standard AASB-9, Financial Instruments
for provisioning of impairment in Loans till 01st July 2018. The provisioning of Impairment
of Loans is most important Key audit matter because management uses its subjective
judgment in ascertaining the timing and the amount of the provisioning (CBA, 2018). The
loans may be evaluated individually or in a group of loans but in both the cases, the auditor
7

Key audit matter
should check in samples the adequacy of classifications and its amount. This being an
important matter, Controls in place to suitable assess the risk and its timely reporting should
also be checked. After AASB-9, Expected credit Loss (ECL) impairment model has to be
implemented which takes into account the future economic events.
ii. Another Key Audit matter is the Valuation of Financial instruments. The policy to
measure derivative assets and liabilities is at fair value. These financial assets constitute about
17% of total assets while financial liabilities is about 5% of total liabilities. Ex: derivative
assets & liabilities, Investments available for sale, Life insurance assets & liabilities and Bills
Discounted, etc (CBA, 2018). Most of the valuation is either at quoted prices decided by the
market or at fair market prices. The left overvaluation is done as per Australian standards.
This involves valuation as per additional judgments keeping in mind market liquidity and
product complexity. This requires a fair amount of judgment.
iii. Contingent nature of liability arising out of Conduct based matters is also a key Audit
matter as it is contingent in nature and can easily wipe off the company`s profits if not
provisioned timely (CBA, 2018).
Bank of Queensland Limited (BOQ)
Following are the key audit matters of the bank.
i. Specific and collective impairment provisions for loans and advances at amortized cost:
This point is common for most of the banks and is considered as key Audit matter. The bank
has to individually assess each of its loans and impart it a risk rating and accordingly give it a
provisioned amount of impairment (Bank of Queeensland, 2018). The auditor should check
on a sample basis the procedure to identify, assess and amount and timing of provisioning.
ii. Valuation of goodwill: This is again a key audit matter because it involves subjective
judgment and assumptions of the value of Cash generating units (CGU). This is done by
relatively checking the past and the current performance i.e. cash flows and making
predictions of future earnings (Bank of Queeensland, 2018).
iii. Valuation of intangible computer software: The software which is inbuilt within the
company is to be valued and to be shown in the balance sheet. However, its total cost and life
can`t be predicted correctly. Moreover, it is constantly worked upon and the cost is incurred
8

Key audit matter
regularly. The company will always want to increase its value and life to gain tax benefits in
the form of depreciation. This is an area of judgment and prediction by the management.
iv. Fair value measurement of financial instruments: the financial assets and Liabilities are
to be recorded at fair value which is sometimes available in the market and sometimes to be
observed at market value. Few assets are to be classified using AAS also. This is a complex
and tedious task and hence is a Key Audit matter (Bank of Queeensland, 2018).
v. Information Technology (IT) systems and the control environment: Entire company`s
database and soft data like Clients data, Loans data, Deals, Agreements, Lease deeds, etc are
stored on Server with appropriate Back-ups. Due to human errors or sometimes malafide
intentions the data can be Lost, Hacked or compromised in somewhat way which might not
be predicted at all. The data of the Bank is sensitive and confidential and its loss may be a
serious threat to the bank. The bank might become bankrupt as well.
9

Key audit matter
Conclusion
So here we have seen that the banking industry is prone to various risks and threats which are
to be treated properly otherwise it may lead to the closure of banks like Lehman Brothers.
There can be other matters as well which may be product, area, and country-specific but
majorly every bank has to deal with such matters hence it becomes Key Audit matters to
check assess and to report in his Audit report. The effectiveness of the auditors’ report can be
seen in the banking industry. The auditors have effectively audited the financial statements of
the company with due care and professionalism and have adhered to all the required statutory
requirements. The auditors simply highlighted the key audit matters and the steps that were
undertaken. The auditors were professional enough to offer necessary explanations of the
processes in their reports keeping in mind the relevance of key audit matters which seems to
be a positive side of the story as well. This might have allowed the users to make appropriate
decisions.
10

Key audit matter
References
AUASB., 2018. Auditing Standard ASA 701 Communicating Key Audit Matters in the
Independent Auditor’s Report [online]. Available at <www.auasb.gov.au> [Accessed 18 May
2019]
Baldwin, S., 2010. Doing a content audit or inventory. Pearson Press.
Bank of Queeensland., 2018. Bank of Queeensland Annual report & accounts. Available at
<https://www.boq.com.au/Shareholder-centre/financial-information/Annual-Report>
[Accessed 19 May 2019]
Cappelleto, G., 2010. Challenges Facing Accounting Education in Australia. AFAANZ,
Melbourne
Christensen, J., Kent, P., Routledge, J. and Stewart, J., 2015. Do corporate governance
recommendations improve the performance and accountability of small listed
companies?. Accounting & Finance, 55(1), pp.133-164.
Cohen, J.R. and Simnett, R., 2014. CSR and assurance services: A research agenda. Auditing:
A Journal of Practice & Theory, 34(1), pp.59-74.
Commonwealth Bank., 2018. Commonwealth Bank Annual report & accounts. Available at
https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/results/
fy18/cba-annual-report-2018.pdf [Accessed 19 May 2019]
Geoffrey D. B, Joleen K, K. Kelli S. and 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. Available at https://doi.org/10.2308/acch-51309 [Accessed 19
March 2019]
Hoffelder, K., 2012. New Audit Standard Encourages More Talking. Harvard Press.
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
11

Key audit matter
Lakis, V. And Masiulevicius, A., 2017. Acceptable audit materiality for users of financial
statements. Journal of Management. [online]. 2(31). Available at
<https://www.ltvk.lt/file/zurnalai/16.pdf> [Accessed 18 May 2019]
Moroney, R. and Trotman, K.T., 2016. Differences in Auditors' Materiality Assessments
When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting
Research, 33(2), pp.551-575.
NAB., 2018. NAB Annual report & accounts. Available at
<https://capital.nab.com.au/docs/2018_NAB_Annual_Financial_Report.pdf> [Accessed 19
March 2019]
Ruhnke, K. and Schmidt, M., 2014. Misstatements in financial statements: The relationship
between inherent and control risk factors and audit adjustments. Auditing: A Journal of
Practice & Theory, 33(4), pp.247-269.
Westpac Bank., 2018. Westpac Bank Annual report & accounts. Available from:
https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/
ASX_2018_Full_Year_Profit_Announcement.pdf [Accessed 19 May 2019]
12