ABC Learning was a company listed on Australian Stock Exchange. The company had it’s privately owned centres for child-care and it was established in the year 1988. But unfortunately, the company had to face its sudden fall in the market which led to the delisting of company’s name from the stock exchange. The financial statements of the company were falsified to a great extent and the auditor of the company had failed to provide an appropriate opinion about the true and fair view of the financial position of the company as a result of which the investors of the company could not be acknowledged about the company’s actual financial situation. Resultantly this became the reason for the suspension of ABC Learning auditor. If ASA 701 (Communicating the key audit matters in the independent auditor’s report) was introduced at the time company was facing the downfall in its position the investors could get a true picture of company’s standing in the market through the auditor’s report as ASA 701 is an Australian standard of auditing which sets out the responsibility on an independent auditors of the companies to incorporate the important matters as a result of the audit findings in auditor’s report. ASA 701 was introduced by Australian Auditing & Assurance Standards Board on December 1st, 2015 and this standard is in effect for the audits of financial statements of the periods ending on or after December 15th, 2016.
Auditing issues that revolved around the collapse of ABC Learning
- Firstly, the auditor of the company had failed perform his audit engagement duties with due care and independence. Professional scepticism was required of the auditor of ABC Learning to be maintained throughout the work of audit which he did not apply. According to the reports of investigation done by the Australian Securities &Investments Commission the company’s auditor was unable to obtain reasonable level of assurance as to whether the financial report pertaining to the year 1997 was free from all the significant misstatements (Xu, et al.,2011).
- Secondly, the auditor was required to obtain sufficient and appropriate audit evidences by applying detailed audit procedures to check the appropriateness of accounting treatment given by ABC Learning in its financial statements for various transactions such as the development fees of centres that was included as the income of the company which resultantly led to the significant overstatement of revenues of the company.
- Thirdly, the auditor was failed to apply his professional judgement regarding the correctness of entity’s going concern assumption as he was unable to gather appropriate evidences to check the reliability of the assumption made by the company about its ability to operate indefinitely (Ross, Sy & Tinker, 2012).
Moreover, as per the reports of the commission, the auditor was also guilty of negligence towards the duties in the areas of identification and disclosure of company’s transactions with its related parties as he did not apply adequate audit procedures to identify and disclose the related parties of ABC Learning. Since the company had complex transactions with the related parties which required reader’s attention, the auditor failed to disclose those issues in the audit report. At the same time auditor did not pay required attention towards the improper valuation of company’s assets which were the major part of company’s balance sheet (Bita, 2012). The financial statements that were issued to the stakeholders were in conflict with the company’s actual position as the auditor failed to report on this matter it led to the auditor’s suspension for the 5 years (Kruger, 2012).
The issues that led to the development of ASA 701
The basic purpose of development of such standards on auditing is to enhance the quality of audit and to function in accordance with the legislative framework of Australia. ASA 701 was taken into effect with the aim of improving the communication between the auditor of the entity and the intended users of audit report as this will assist the investors and other stakeholders to have a better understanding of the significant matters to take informed decisions in future while engaging with the entity (Coram, Mock, Turner & Gray, 2011). As the shareholders invests huge amounts of funds in the company they expect the company to maintain a higher degree of transparency about its functioning to build up the confidence of the investors in the company. The auditors are expected to justify their independence to the maximum level while providing the opinion as to whether the financial statement of the company are free from any material misstatements due to frauds and errors. Prior to the introduction of the new standards of auditing there was a lack of proper and adequate communication about the matters which are of great significance to the intended users of financial reports of the company.
Key Audit Matters to be disclosed in the auditor’s report.
The auditor has to apply his own judgement in order to determine as to which matters are to be included in his report. Some of the matters that the auditor of ABC Learning needs to incorporate in his report are as follows:
- The going concern assumption of the company:
The auditor of the company has to report on the appropriateness of the going concern assumption which the company is following in the preparation and presentation of its financial statements. And he must provide the details of events that cast significant doubt about the company’s assumption of going concern.
- Any material deficiencies found in the internal control system of the company:
The auditor should report adequately about the significant weaknesses in the system of internal controls that he comes across during his audit engagement which may result in the occurrence of material misstatements at the financial statement level or at the assertion level.
- Regulatory and taxation matters of company:
The auditor of ABC Learning has to consider the laws and regulations that are applicable on the company and then report appropriately on how well the company is adhering to the regulatory requirements. Auditor must ensure that the company has adequately disclosed and accounted for all penalties and litigation fines, if there are any. The auditor must also look to the matters of taxation as to whether the company is regular in paying the taxes or not and if any material discrepancies in the regulatory compliances are found then it must be reported.
- Criteria of recognizing revenue in the financial statements:
The revenue of the ABC Learning was grossly misstated in the financial statements of the company as the development fees of the centres was incorrectly included in the income of the centres. So the auditor has to ensure that the company is following the appropriate criteria for recognizing its revenue in the financial statements.
- Purchase and Sale of investments by the company:
The auditor of ABC Learning should report on the accounting treatment for the investments acquired and disposed off during the financial period after examining the certificates investments made to check whether the investments are correctly classified and valued.
- Risk of impairment of assets of the company:
If during the audit engagement auditor identifies any indications of decline in the market value of assets such as goodwill leading to asset impairment the same must be reported adequately if the company has not provided for the decline in the market values of the assets. Moreover, the auditor of ABC Learning must also report such matters where there is higher degree of risk of misstatements. As per the AUASB the entities which are listed on the Australian Securities Exchanges must not have more than 6 key audit matters.
However, there are certain matters which are sensitive enough to not to be disclosed publicly as it would have adverse impact on the management of the company. So the auditor has to keep in mind several factors while deciding as to what to disclose in his report and what needs to be kept confidential (Audit.tas.gov, 2016). Also, there are some governmental restrictions for certain matters’ disclosures, so the auditors must not disclose them in the report (Council, 2013).
Usefulness of ASA 701
Introduction of ASA 701 was an important initiative towards the improvement of audit quality as it requires the auditor to remain aware of anything unusual that he comes across during the entire audit engagement. As ASA 701 has widened scope of the reporting requirements to be done by an independent auditor of a company assist will result in prevention and control of frauds and errors to an extent. The additional information that is provided by a way of audit report helps the users of financial reports to understand the significant matters more accurately so that they can have the proper knowledge of company’s financial position (Bajada & Trayler, 2010). The Standards of auditing enables the auditors to know well about their responsibilities so that audit can be planned and performed in the best possible manner subject to auditor’s knowledge and expertise. ASA701 defines the key audit matters and also talks about the manner of determination of those important matters to be reported in the audit report. If proper information was imparted through the audit report the stakeholders could get to know well in advance that ABC Learning is going to liquidate soon.
The main objective of an audit of financial statements is to enable the auditor to express the opinion about the truth and fairness of the financial statements of the entity. Since the financial statements of the company are prepared by the management, there remains higher chances of falsification of financial reports made by the entity to mislead the investors and other users of the report (Aasb, 2015). However, if proper audit is conducted by the auditor in accordance with the standards of auditing, the risk of misstatements due to frauds and errors in the statements could be reduced to a reasonable level as the auditors are the independent parties with requisite knowledge and expertise to conduct an audit with due diligence, they can be relied upon by the investors. Once these audit procedures are over, then starts the requirement of reporting about the key findings of the audit function. The auditor’s report shall state that the audit was conduct in accordance with Standards on Auditing (Arens, et al., 2010). The auditor’s report shall state whether the auditor believes that the evidences the auditor has obtained are sufficient enough to provide an opinion. Since the external parties dealing with the company do not involve in the presentation and preparation of financial statements they rely on the third party i.e. the auditor of the company and believes him to be independent enough to present the true and fair view of company’s financial position (Ball, Tyler & Wells, 2015).
Through the above research it is highly recommended for the auditors of the companies to maintain an excellent level of independence in the audit engagement so that true opinion on the preparation and presentation of financial statements of the company can be formed. The auditors are therefore required to follow the ASA 701 in a complete sense while reporting about the audit findings. As ASA 701 requires the auditor to report appropriately all the key and significant findings of audit process on a timely basis, the auditor must follow the standard while communicating with the intended users of financial report of the company to enhance the credibility of audited financial statements in the eyes of intended users.
From the above research it is well demonstrated that the introduction of ASA 701 was brought into the concept to enhance the reporting responsibilities of the auditors of the listed entities so as to increase the level of confidence of the investors of the company as the application of such standards on auditing will help company to maintain a better transparency and it will also help in the prevention and reduction of frauds to a certain extent. Therefore it can be said that if ASA 701 was introduced before the time the company ABC Learning had to face the severe issue of financial crisis it could have reduced the severity of the issue of collapse.
Aasb.gov. 2015. Presentation of Financial Statements. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB101_07-15.pdf(Accessed on 25th August, 2017).
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Bajada, C. and Trayler, R., 2010. How Australia Survived the Global Financial Crisis. The Financial and Economic Crises: An International Perspective, Edward Elgar: Cheltenham, UK and Northampton, USA, pp.139-154.
Ball, F., Tyler, J. and Wells, P., 2015. Is audit quality impacted by auditor relationships?. Journal of Contemporary Accounting & Economics, 11(2), pp.166-181.
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https://www.theaustralian.com.au/news/nation/five-year-ban-slapped-on-abc-learning-auditor/news-story/00525dc8af00cf00989f8e19d750a634 (Accessed on 25th August, 2017).
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Kruger, C., 2012.Lessons to be learnt from ABC Learning's collapse: The Sydney Morning Herald, 2 January, Available at: https://www.smh.com.au/business/lessons-to-be-learnt-from-abc-learnings-collapse-20090101-78f8.html (Accessed on 25th August, 2017).
Kruger, C., 2012.Five-year suspension for former ABC Learning Auditor: The Sydney Morning Herald, 9 August, Available at: www.smh.com.au/business/fiveyear-suspension-for-former-abc-learning-auditor-20120808-23uj8.html(Accessed on 25th August, 2017).
Ross, P., Sy, A. and Tinker, T., 2012. ABC Learning: accounting lessons never learned?. International Journal of Critical Accounting, 4(1), pp.21-29.
Xu, Y., Jiang, A.L., Fargher, N. and Carson, E., 2011. Audit reports in Australia during the global financial crisis. Australian Accounting Review, 21(1), pp.22-31.