Auditing and Assurance Report: KPMG and Discovery Metals Case Analysis

This report provides a comprehensive analysis of a case involving KPMG and Discovery Metals, focusing on auditing and assurance principles. The report begins by summarizing the facts of the case, including the misleading advice provided by KPMG regarding the valuation of Discovery Metals' assets, leading to shareholder losses and the company's eventual liquidation. It then examines the types of assurance provided, the nature of evidence, and the remedies sought by regulatory agencies. The report also identifies the stakeholders affected by the audit failures and the challenges faced by audit firms in the post-Banking Royal Commission environment. Furthermore, the report discusses the application of the law of tort in the auditing profession, including relevant cases like Royal Bank of Scotland vs. Bannerman Johnstone MacLay. The analysis explores the auditor's responsibilities regarding fraud and the importance of exercising reasonable skill and care while adhering to auditing standards. The report concludes by evaluating the audit firm's actions in the context of professional standards and legal precedents.

Running head: AUDITING AND ASSURANCE
Auditing and Assurance
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Answer to Question 1........................................................................................................2
Requirement 1................................................................................................................2
Requirement 2................................................................................................................2
Requirement 3................................................................................................................3
Requirement 4................................................................................................................4
Requirement 5................................................................................................................4
Answer to Question 2........................................................................................................6
Requirement 1................................................................................................................6
Requirement 2................................................................................................................7
Requirement 3................................................................................................................8
References.......................................................................................................................10

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Answer to Question 1
Requirement 1
KPMG is considered as one of the four ‘Big Four’ accounting firms operating in
Australia and it came to regulatory spotlight when Discovery Metals registered class
actions against it because of providing misleading advise. More specifically, the
accusation on KPMG was that it provided the failed junior miner Discovery Metals with
deceptive advice through inflating the value of the firm’s principles asset as much as
40% (afr.com, 2020). This misleading advice is associated with the Board of Discovery
Metals decision over a joint venture’s off-market takeover offer of buying shares at
$1.70 per share. The worth of Discovery Metals was $1.65 at that time. The Board of
Discovery Metals was advised by KPMG that the offer of $1.70 was not fair or
reasonable as the company’s fair market value at that time was between $1.74 and
$2.22. The advice of KPMG made the shareholders of Discovery Metals rejecting the
offer and the offer was rejected in the absence of adequate number of shareholder’s
vote (afr.com, 2020). After this incident, the share price of Discovery Metals fell to $0.34
and the company had to go into liquidation and there was nothing left in the company
for the shareholders. Due to the advice of KPMG to Discovery Metals, the Board raised
the value of the technical assets by 40% and KPMG failed in providing any justification
of applying such uplift. In case there was not any uplift of the value by 40%, the bid
would have been considered as reasonable for the shareholders. Litigation Capital
Management, an ASX-listed litigation funder, funded this class action against KPMG
(afr.com, 2020).
Requirement 2
There are three types of assurance can be seen in auditing; they are Absolute
assurance, Reasonable assurance and Limited assurance. Reasonable assurance is
considered as a high level of assurance associated with material misstatements. It
consists of the key understanding that there is the presence of remote possibility that
there will not be prevention or detection of material misstatements on a timely basis
(Knechel & Salterio, 2016). Limited form of assurance is provided when the auditors

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believe that there is a material misstatement in the financial statements. Lastly, absolute
assurance is level of assurance where it is concluded by the auditor that there is no
material misstatement in the financial statements. It can be seen in the case of
Discovery Metals that KPMG was absolutely sure about their opinion that the fair market
value of Discovery Metals was between $1.74 and $2.22 and it indicates towards the
aspect that absolute assurance was provided to client by Discovery Metals (William Jr,
Glover & Prawitt, 2016).
The presence of two natures of evidence can be seen in auditing; they are
persuasive nature of evidence and conclusive nature of evidence. Conclusive nature of
evidence is considered as solid evidence that does not require any further proof or
enquiry as the evidence in itself is complete. It can be seen in the case of Discovery
Metals that KPMG firmly provided the advice to the Board and it did not mention any
negative possibility. It proves that conclusive nature of evidence was gathered by the
audit firm for providing this advice (Bumgarner & Vasarhelyi, 2015).
Requirement 3
In this particular case of KPMG and Discovery Metals, there are certain remedies
sought by the regulatory agencies. The first remedy is to have a reviewer for reviewing
the quality of both internal and external audit. This ensures maintaining effective audit
quality (Christensen et al., 2016). The second remedy is to support the findings of the
audit through acquiring the required audit evidence that is necessary to form the
appropriate audit opinion. This ensures that the expressed audit opinion is well
supported by appropriate audit evidences. The next remedy can be seen in the
identification of the root causes of findings from the own quality reviewers; and the
same needs to be reviewed by the audit regulatory inspector so that they can assess
the reasonableness and validation of the obtained audit evidence and developed audit
opinion. After that, the regulatory authorities require the audit firms to develop as well as
implement the required action plans in order to address the audit findings; at the same
time, the audit firm is needed to monitor as well as revise these action plans for
ensuring that they are effective (Cameran, Prencipe & Trombetta, 2016). This is
necessary for preparing the appropriate audit plan for providing the correct audit

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opinion. Lastly, it is the obligation on the audit firms to ensure reviewing the staff
structure in order to ensure that they are appropriately resourced in order to undertake
the increasingly complex audit engagements for the audit clients. These particular
remedies sought by the regulatory agencies are necessary for ensuring the audit quality
(Bell, Causholli & Knechel, 2015).
Requirement 4
In this case of KPMG and Discovery Metals, the main affected stakeholders are
the shareholders and creditors of the company. It is mentioned earlier that Litigation
Capital Management funded the class action against KPMG and was run by Piper
Alderman partner Simon Morris. Since the statement of claim was filed in the Supreme
Court of NSW, Piper Alderman sought damage, compensation, interest and legal costs
from KPMG on the behalf of the shareholders of Discovery Metals. The class action
signed up by majority of the shareholders of Discovery Metals, their aim was to recover
$830 million from Discovery Metals that represented value of the off-market takeover
bid as the remedial action (afr.com, 2020). In this context, it needs to be mentioned that
KPMG is the latest Big Four accounting firm to be involved in a class action due to
improper audit findings which led to the delivery of wrong advice to the Board of
Discovery Metals on a takeover bid. After that, KPMG agreed to pay the term of the
settlement of the class action as demanded by the shareholders of Discovery Metals
and it was approved at a NSW Supreme Court. However, it needs to mention that all the
allegation brought on KPMG were denied by the audit firm without admission of the
liability (afr.com, 2020).
Requirement 5
It needs to be mentioned that the post-Banking Royal Commission environment
has created major challenges for the audit firms in performing audit. The Office of
Enforcement of ASIC has been operationalized and expanded which provides the ASIC
with the power to continue its improved supervision program across large listed entities
in the financial services and other sector. It implies that ASIC has increased its
supervision on the activities of the large audit firms. At the same time, ASIC has given
major input into the program of legislative reform in the initiative of Banking Royal

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Commission. This will increase the number of regulations for the audit firms that they
need to be complied with and complying with increased number of regulations is a
challenging task for the audit firms. Moreover, Royal Banking Commission is going to
implement and use the regulatory powers of ASIC for identifying and addressing
misconduct and poor customer outcome which will create additional pressure on the
audit firms (abc.net.au, 2020). Apart from these challenges, opportunities include
increased transparency and governance in the operations of the audit companies which
will increase the overall audit quality. At the same time, these regulatory actions will
help in enhancing the independence of the auditor which is a key in providing quality
and satisfactory audit services to the clients (ey.com, 2020).

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Answer to Question 2
Requirement 1
The key issue to determine whether the audit firm, Price Yung Andersen, has
acted with reasonable skill and care can be ascertained by referring to the relevant
cases and relevant auditing standards. As per Cooley on Torts, a legal treatise, a
person who offers his/her service to another person and is employed assumes the duty
of exercising in the employment like skills as he/she possesses with reasonable care
and skill. It implies that an auditor needs to possess the level of skill commonly
possessed by other auditor and he/she needs to exercise the same with reasonable
care and skills. Therefore, the auditors are required to be assigned to tasks equivalent
with their level of knowledge, skills and capability so that they can properly evaluate the
audit evidences which they are assessing. Reasonable care and skill also requires the
auditors to acquire knowledge on relevant professional and accounting standards and
he/she should have proper knowledge about the client (pcaobus.org, 2020). The
outcome of the Pacific Acceptance case states that reasonable care and skill refers to
follow and comply with the required auditing standards (Chapple & Mui, 2015).
Moreover, according to the outcome of the case of Kingston Cotton Mill, it is believed
that the auditor has exercised reasonable care and skill in case he/she exercises skill
and care of a reasonable competent member of the audit profession (Chandler, 2019). It
is mentioned in the case of Pacific Acceptance that the court only takes into
consideration appropriate and relevant auditing standards have been followed by an
auditor in order to ascertain whether he/she has acted with reasonable care and skill
(Laing & Hoy, 2018).
It can be seen in the provided case that the auditor performed the audit of ABC
by following all the required auditing standards. Moreover, all the required audit steps
were followed by the auditor in the audit process; and the audit director and audit
partner reviewed all the audit works done by the auditor. Even the outcome of the peer-
review of the audit confirmed the same aspect. It implies that the auditor acted with
reasonable care and skill. The most important audit standard having relevance with this

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case is ASA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of a
Financial Report which requires the auditor to undertake planning the audit in the
presence of an awareness of the likelihood of the occurrence of fraud
(legislation.gov.au, 2020). Therefore, as per the cases of Kingston Cotton Mill and
Pacific Acceptance, the duty of the auditors is to perform the audit with required skill,
care and caution while complying with the required auditing standards and the auditor in
ABC did the same. Therefore, it can be said that the audit firm which is Price Young
Andersen has acted with reasonable care and skill.
Requirement 2
The application of law of tort in the auditing profession can be seen for taking
legal actions against the auditors for being negligent. There are many landmark cases
can be seen in this regard and one of these cases are Royal Bank of Scotland (RBS)
vs. Bannerman Johnstone MacLay (Bannerman) (2002). In this case, it was alleged that
RBS los over £13 million in unpaid overdraft facilities to insolvent client APC Ltd. It was
claimed by RBS that Bannerman, the auditor, was negligent and failed in detecting
fraudulent associated material misstatement in the account of APC Ltd
(accaglobal.com, 2020). RBS provided APC Ltd with the banking overdraft facility based
on the audited financial statements. As per the verdict of the court, Bannerman would
have been aware of the intention of RBS to use the audited financial statements for
issuing overdraft facility to APC Ltd through the audit of the banking facility letter of APC
Ltd. This proved the point that Bannerman owed a duty of care to RBS. Since there was
not any disclaimer of liability to the third party, this majorly caused to the duty of care
owed to RBS (Miglionico, 2016). This aspect brought success to RBS in the legal action
against Bannerman. Outcome of this case can well be used for explaining how the
lawyers of ABC might preset the case against the auditor.
As per the above case, there are four factors associated with tort of negligence
which need to be considered by the lawyers of ABC. These factors are Duty of care,
Breach of duty of care, Damage and Causation. It is required for the lawyers of ABC to
prove all these four aspects in presenting the case.

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Duty of Care – The lawyers must prove that there is a duty of care existed between
ABC and the audit firm. Since there is an audit-client relationship between these two
parties, it implies that ABC would have used the audited financial statements for making
different decisions. In his way, the lawyers can prove that the audit firm owed duty of
care to ABC (Van Ho & Terwindt, 2019).
Breach of Duty of Care – After establishing the presence of duty of care, the lawyers
will have to prove that the audit firm has breached this duty of care. In the provided
case, the audit firm was failed in detecting the fund diversion by the Finance Director of
ABC which contributed to the development of material misstatements in the financial
statements. The lawyer can present this as the violation of duty of care.
Damage – It is needed for the lawyer to prove that ABC has suffered a loss due and the
loss needs to be a real loss. Since the company went into liquidation, it had to face
major business loss which can be presented in monetary value. The lawyers of ABC
can provide this loss amount as the damage (Backof, 2015).
Causation – The lawyers need to prove that the damage is due to the breach of duty of
care. Material misstatements due to the failure of the audit firm to detect the fraud
carried out by the Finance Director was responsible for the liquidation of ABC and the
lawyers of ABC can present this as an outcome of the breach of duty of care. In this
way, the lawyers of ABC can present the case against the auditors.
Requirement 3
The presence of many instances can be seen where the cases are settled before
reaching to their ultimate conclusion. Since the rate of these types of cases is high, this
has encouraged a large number of frolicsome claims against the auditors. However,
there are certain reasons for settling these cases before reaching to conclusion and
they are as below:
 In most of the cases, litigations tend to become lengthy and expensive processes
for the involved parties. Therefore, in order to save both time and money, parties
tend to settle the cases outside the court before going to the conclusion. This is a
major reason that needs to be considered in this case (Grenier et al., 2015).

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 There is always a possibility that bad reputation as well as bad publicity will arise
out of the decisions of the courts that do not go to the favor of the auditors. For
large and medium audit firms, this kind of situation can badly affect the goodwill
and name of the company in market.
 Another possibility is that there could be the development of bad publicity and
reputation due to the involvement of the audit firms with lengthy legal disputes.
This can hamper both the goodwill and money of the audit firms (Maksymov &
Nelson, 2017).
These are the reasons why the audit partner may still offer ABC a major settlement
amount.

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References
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AS 1015: Due Professional Care in the Performance of Work. (2020). Pcaobus.org.
Retrieved 27 March 2020, from
https://pcaobus.org/Standards/Auditing/Pages/AS1015.aspx
ASA 240 - The Auditor’s Responsibility to Consider Fraud in an Audit of a Financial
Report - April 2006 . (2020). Legislation.gov.au. Retrieved 27 March 2020, from
https://www.legislation.gov.au/Details/F2006L01368
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verdicts and damage awards. The Accounting Review, 90(6), 2177-2204.
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auditors. In Social Audit Regulation (pp. 281-299). Springer, Cham.

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(2017). Australian Financial Review. Retrieved 27 March 2020, from
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