New Auditing Standard ASA 701 Communicating Key Audit Matters In The Independent Auditor’s Report

Global Financial Crisis

The prime reason behind the insolvency of many giant companies all over the world was the accounting scandals undertaken by them with the motive of manipulation of their books of accounts so as to disclose desired financial results to the stakeholders of the company. The profits were inflated and losses were secreted in the financial reports of such companies for the sole purpose of showing their favourable financial performance which was not actually achieved by them. These accounting frauds resulted in the insolvency of such big companies. As a consequence of which the biggest issue of global financial crisis occurred during 2007-2008. The global economy had to suffer immensely from the adverse impacts of financial crisis. The auditors of these companies were blamed as the significant reason for their solvency crisis because they did not reported adequately about the irregularities in dealing the significant accounting matters by the companies. Auditors of the companies are appointed with the responsibility of communicating with the users of Auditor’s report about the true and fair view of financial reports of their client entities and to report on the matters that in their opinion require considerable attention of the users of financial reports. In response to the GFC, new auditing standards have been issued. ASA 701: Communicating Key Audit Matters in the Independent Auditor’s Report, is one of such standards. This standard has been used by Australian Accounting Standard Board after the occurrence of biggest financial crisis in the global world.

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Global financial crisis is the one of greatest economic event that affected many economies of many countries through its severely ill- effects (Summers, 2000). The crisis started coming into existence in mid-2007 when the US investors began losing their faith in the sub-prime lending mortgages. This caused the liquidity crisis and took the worse turn in 2008 when the global stock markets started crashing and became strongly volatile. Afterwards, GFC entered into a new phase when in 2008 Lehman Brothers collapsed because of their insolvency in the market. Various financial institutions faced the issue of liquidity crunch and failed to finance the needs of big corporations (San, 2009). The crisis was mainly market by the widespread financial frauds made in the industry of mortgage securitisation. They securitisation companies and other financial institutions committed numerous white- collar crimes (Davies, 2017). Since 2003, there was a decline in the supply of mortgages and therefore the mortgage originators, issuers of mortgaged backed securities and the underwriters of these securities entering into fraudulent practices with the motive of concealing their malfeasance and enhancing the value of the financial products dealt by them (Shiller, 2012). The auditors of these corporations and institutions neglected their professional responsibilities towards the commitment of such frauds (McKibbin & Stoeckel, 2010). They never disclosed the mal-practices of the fraud making financial corporates to the interested user groups of audit reports (Obstfeld & Rogoff, 2009). The credit rating agencies and the auditors were those third parties that were independent experts to carry out the examination of financial performance and situation of the big corporates so as to generate trust and confidence of the stakeholders of their client companies (Helleiner, 2011). The non-disclosure of fraudulent practices by the auditing professionals due to their high negligence towards their professional duties was counted as the major factor that contributed to the worst economic disaster i.e. global financial crisis (Scott, 2010).

Role of Auditor

Auditors of the companies are appointed with the purpose of providing their independent opinion about the truthfulness and fairness of the financial reports of the company. As a part of their professional duties they are required to report on the matters that requires significant attention of the users of their reports. These are the matters that are generally unusual or impose the risk of material misstatements in the financial reports. As a company has a wide range of its stakeholders who belongs to the industry in direct or indirect manner. The stakeholders are generally categorised in two parts i.e. internal stakeholders and external stakeholders. Internal stakeholders of an entity are its employees and managers who are directly involved in the internal activities of the company. However external stakeholders such as shareholders, providers of finance (banks and financial institutions), government and other regulatory bodies etc. are not involved in the internal activities and important practices such as preparation and presentation of financial reports (Fan & Wong, 2005). These stakeholders, however, are concerned about the financial performance and other information about the company as they are indirectly associated with these companies. The providers of finance such as shareholders and potential shareholders require the financial information about the status of concerned company so as to assess the value of investment or proposed investment in the company. If the company has sound financial performance, then only it would be able to attract and retain the investors (Gul, Fung & Jaggi, 2009). Also, the banks and financial institutions that lend huge sums of monies to the companies require the financial reports of the company to obtain financial information about the financial position of the company and past track credit records so as to assess the credit worthiness of their client corporations. Since the financial reports of the company are prepared and presented by the internal management of the company, there are always the changes of manipulation of financial results to deceive the stakeholders of the company about its unsound financial performance (Taylor, DeZoort, Munn & Thomas, 2003).  Therefore, the stakeholders of the company demands the independent check of the true picture of financial performance of the company and such independent checks can be taken by the professionals who possess substantial knowledge and skills along with proper certifications to provide an opinion on the transparency of financial information contained in the financial reports of the client entity (Geiger & Raghunandan, 2002).

After the major incidence of Global Financial Crisis, shareholders of the companies have started demanding more information disclosures in the audit reports of their investment companies so that they can make informed decisions about their investments (Crotty, 2009). As an outcome of this, the need of enhancing and improving the reporting requirements of audit report has been realised by various regulatory bodies (Benkel, Mather & Ramsay, 2006). The Australian board of auditing standard has issued ASA 701 which sets out the key matters that draws significant attention from the readers, to be reported by the independent auditor of the company through the audit report. This standard is issued to improve the quality of audit reports by enhancing the disclosure requirements on part of auditors. ASA 701 has mandated the communication of key audit matters by the auditors for the listed companies. It enables the auditors of other entities also to decide whether to disclose a particular matter in the audit report. Key audit matters are the matters that have the potential of influencing the decisions of the readers of audit reports provided they have requisite knowledge about entity’s business. This standard also states that the areas where there is higher degree of risk of material misstatement or the areas which are significant enough as per the professional judgement of the auditor, certain events and transactions that are unusual etc. must be reported as the key audit matters as these matters will influence the decisions of the users of annual report of the concerned entity. ASA 701 also provides the guidelines as to how each and every key audit matter is to be described in the audit report. Also, the standard sets out the circumstances when a matter is identified as key audit matte but it must be communicated to the users of the audit report. The documentation requirements for all the matters that are to be included in the report by an independent auditor are also specified in the said standard. The form and content of communication to be made by the auditor with the interested parties is also suggested by this standard. The prime purpose of the including the additional key audit matter in the report is to improve the communicative value of the report of the independent auditor by offering higher degree of transparency related to the audit engagement that is performed by the auditor. The reporting of these matters enables the intended users of the report to better understand these matters and their impact on the financial statements of the company. These matters not only helps the readers in analysing and interpreting the current financial position of the company but also helps them by serving non-financial information that can used as the basis on which they can take their future decisions in relation to maintaining or making an association with the entity in the course of its business.

Introduction of ASA 701

However, communication of key audit matters is not the alternative for the financial report disclosures that are to be made as per the requirements of relevant accounting standards that are applicable on the entity as per the applicable financial reporting framework or for the purpose of fair representation. KAMs are also not the substitute of the issuance of modified audit report by the independent audit report in compliance with ASA 705 Modifications to the Opinion in the Independent Auditor’s Report (Vik & Walter, 2017). Further ASA 701 is not taken into existence to replace the requirements of ASA 570 Going Concern which requires reporting of an event when there exists a material uncertainty from such events and conditions that cast considerable doubt on the ability of entity to continue its business for a foreseeable future. Rather the requirements of ASA 701 are in addition to the requirements of already existing ASAs.  It is also applicable in the situations when the auditor is required to communicate the key audit matters as per the laws and regulations (Azim, 2013). However, ASA 701 imposes a prohibition on the independent auditor of the entity to communicate any key matter when disclaimer of opinion is issued by him in the audit report until or unless, reporting of such matter is the requirement of any law or regulation. Also, when there is possibility of adverse consequences of reporting any matter that outweigh the interest of general public then such matters must not be communicated by the auditor.

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In banking industry where the corporations are involved in the business of depositing and lending of funds and other banking related operations, the reporting requirements on part of auditor must be more specific and stringent. The banking industry is the most significant industry of an economy and it involves the deployment of funds of general public and hence the banking operations are to be carried more transparently to maintain the trust and confidence of the public. To achieve the expected level of transparency about the operations of banks, they must appoint an external party to provide the opinion about the true and fair view of their financial performance (Azim, 2013). The purpose of appointing a professional from outside the banking entity is to give due regards to the audit principle of independence. Only an independent auditor can form the audit opinion that is most suitable to the bank’s financial performance and the manner in which the financial reports are prepared and presented. For the banking industry in general, there are certain matters to be reported as key audit matters in the audit report of an independent auditor. They are: revenue recognition criteria of the bank, the regulatory requirements applicable to the banks, the events and transactions that provide evidence about entity’s plan to not to operate as a going concern entity, the recoverability of loans and other receivables.

There are around 20 companies in the list of the top 100 hundred companies that are ASX listed which operates in the banking industry. From that list four corporations have been chosen to analyse their annual reports that contains the auditor’s report also. The analysis of key audit matters that have been disclosed in the auditor’s report of the respective company for the purpose of their communication with the intended users will be done as follows:

The auditor of ANZ bank has provided a clean report about the financial statements by expressing its true and fair view of its financial reports. The key audit matters that are reported by the auditor of the bank are:

Provision for the impairment credit: it has been reported as KAM because bank has considerable credit risk exposure towards numerous counter parties across various industries and geographies. The loan and advances’ value that is shown on the balance sheet is quite significant and involves high degree of judgement as well as complexity in estimating the credit impairment provisions.

 Valuation of various Financial Instruments which are held at their Fair Values

This is reported as KAM because of significance of financial instruments and the large volume in which such instruments are being traded in various international locations ultimately increases the inconsistency risk leading to their inaccurate valuation. Also, their value determination involves great judgement on part of management.

 IT systems and their control functions:

Since ANZ is a major banking company, it utilises numerous IT systems that are complex and interdependent on each other. These systems are important as they impact the financial reporting of significant banking transactions.

The said matters are addressed in relation to the financial reports of the bank, as a whole. While forming an audit opinion thereon, the auditors have not provided separate reports on these particular matters.  Rather, these matters are reported in details so that the intended users of the report can understand these matters in the better manner (ANZ Annual report, 2017).

The auditor of the bank has issued clean report about the true and fair view of bank’s financial statements. Following are the key audit matters that are reported by the auditor:

Impairment provision for bank’s loans and advances:

Since the assessment of impairment provisions involves higher degree of complexity and judgement to determine their adequacy, they are reported as KAM.

Valuation of goodwill:

Goodwill being an intangible asset, its valuation has been reported as KAM because of involvement of subjectivity of the assumptions that are forward looking in nature and due to the significance of goodwill for the financial position of bank (Annual Report, 2017).

Valuation of computer software that is intangible in nature:

The methodology that is used to estimate the value of computer software that is being internally generated is quite complex and involves making of certain assumptions. Thus it is reported as KAM.

Financial instruments’ fair valuation:

These items involved high management judgements in assessing their fair value and hence it is reported as KAM.

The auditor has issued a clean report for the concerned bank and has reported following matters as the key audit matters:

Provision for bad as well as doubtful debts:

The estimation of amount of provisions of the bank group on specific as well as collective basis involves consideration of various factors that are quite uncertain in their nature therefore it requires exercise of considerable management judgement. Therefore, it is reported as KAM.

Investment in homesafe:

The valuation of homesafe is done at the fair value for which discounted cash flows are identified. The identification of discounting rate involved use of certain key assumptions and hence they are reported as KAM.

Assessment of impairment on goodwill:

Goodwill is an intangible asset. To assess the chances of impairment of goodwill various evidences have been collected and sensitivity analysis has been undertaken to assess the main triggers of impairment. Hence it is reported as KAM (Annual report, 2017).

Valuation of intangible software as well as deferred expenditure assets:

The software component of the company has been amortised over its useful life which has been determined using certain estimations and assumptions. Considering their significance for the financial reports, the auditor has reported them as KAM.

Following key audit matters have been reported by the auditor of:

Impairment provision for lending assets:

It involved subjective judgements on part of management to estimate the amount of these impairment provisions and hence they are reported as KAM.

Fair valuation of financial instruments:

The financial instruments of the banks are not much complex in nature but their valuation involved the assistance of experts. Considering the significance of the financial instruments for bank, they are reported as KAM.

IT systems and controls:

The information technology system have a significance influence over the financial reporting of the major transactions entered into by the bank and its security is highly important for the bank’s survival and hence they are reported as KAM (Annual Report, 2017).


From the above analysis of audit reports of various banking companies that are listed on the Australian stock exchange and belongs to the category of top 100 ASX companies it is observed that those matters which involves exercising of high degree of management’s judgement in the estimation of their amounts for the financial statements and also those matters in which there is high degree of complexity in their measurement, must be communicated by the auditor to the intended users through the means of audit report. These matters are required to be communicated as per the requirements of ASA 701 as this standard aims as increasing the reporting requirement of auditors so that advanced level of transparency in the audit report of the client entity can be achieved.


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