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Auditing and Assurance Program: Auditing Issues In Finance Assessment 2 Answer

Assessment 2

Assessment Type: Auditing case study - 2500 + 10% word report - individual assessment.

Purpose: To allow students to demonstrate their ability to research, critically analyse trends and issues in auditing and assurance services, identifying problems as would arise in a modern organisation.

This assessment relates to learning outcomes a, b and c. Value: 30%

Submission: Upload soft copy of Word .doc or .docx to Turnitin and Moodle via KOI's Moodle subject homepage.

Topic: Research, critically analyse and evaluate key audit matters in independent auditor's report Auditor's report The new auditing standard .4S.4 707 communicating key audit matters in fhe independent aud/ for's report was developed in the wake of the global financial crisis (note: foil( the demise of Lehman Brothers shortly after it received an unqualified audit report, i.e. no prior wai of its demise). This development is in response to calls from shareholders to know more about the companies they invest in

(students would need to explain what happened in Lehman Brothers which would evidently be a key audit matter if such an auditing standard had existed then). Further, investors have also requested earlier warnings of potential issues that may exist with respect to an entity's ability to continue as a going concern which resulted in the revision of ASA 570 (ISA 570) going concern (to include a going concern uncertainty

Note: during  the global financial crisis there was an increase in emphasis of matter paragraph only relating to going concern uncertainty now replaced by a "material uncertainty related to going concern" par Required Students are required to research into the rationale for the new auditing standard ASA 701 and explain clearly what it is. Each student is to select an industry, eg. banking, mining, etc and analyse key audit matters in the independent auditor's reports of all companies in that industry in ASX top 100 listed companies so as to evaluate the efficiency of reporting key audit matters in the independent auditor's report (i.e. does key audit matters disclosure provide more information to users).

The report is to be fully referenced (including the annual reports of companies selected for your assignment) and up to 2,500 words (assignment in excess of 2,500 words will be per marks). There should be a minimum of 8 academic references. 1 0% of the

The report should include title page, executive summary, table of contents, appropriate headings and sub headings, recommendations, reference list (Harvard- Anglia style), attachments if relevant, single spaced, font Times New Roman 12pt.

Answer

Auditing and Assurance Program

Executive summary 

With the changes in the economic condition, every organization needs to focus on strengthening the transparency of the recorded items and books of account. However, the suitability risk of the company is highly dependent upon the transparency and true and fair view of the recorded items in the books of account. In this report, the case of Lehman Brothers has been taken into consideration. The key implication of the failure of the company to maintain the true and fair view of the recorded financial information and its impact on sustainability have been assessed. Lehman Brothers are not the only one that has seen a fall alone. The collapse was faced by the whole of the economy and there had been a downfall in the performance of each organization. The collapse of a giant like Lehman Brothers determined several issues in auditing that were responsible for the collapse. This report deals with the analysis of the chaotic case of Lehman Brothers and to address how auditing standards were introduced in the world of corporate. To make it clear to understand, the audit reports of entities that fall under ASX 100 list in "Utilities Sector" are closely analyzed. The major audit matters that were encountered by the auditors of such organizations have been discussed so that the readers can interpret better. The report highlights the auditing issues that can be encountered in the world of finance and the detailed information about the same.

Introduction

This report reveals the key understanding of the legal compliance of listed companies with a view to preparing the transparent financial statements. It is analyzed that if a company wants to sustain in the market then it will have to maintain proper transparency in the recorded items in the financial statement for its investors. The higher the legal accounting compliance company follow the higher the transparency is maintained by the company. In this report, the scandal of the Lehman Brothers has its impact on the stakeholders have been assessed. It is analyzed that if the company fails to disclose the imperative information then it will result in higher sustainability risk of that company.  Lehman Brothers used to be the fourth largest bank in the United States in the year 2008. The huge revenues of #19.3 billion and net income of $4.2 billion in the year 2007. However, none could imagine that such a great organization can become bankrupt. It came as a shock to all the people including the investors as the demise of such a big firm is not expected. The organization filed bankruptcy in the year 2017 under Chapter 11 bankruptcy in September 2008. It also initiated the Financial Crisis. The conditions of the breakdown started back in the year 2003-04. In this boom period, the organization obtained five mortgage lenders. The boom in the housing sector led them mortgage to the clients heavily. However, the situations didn’t seem intact and the economy took a U-turn. A discussion was done for how different the situation could be for Lehman Brothers and other financial institutions if ASA 701 was introduced before the breakdown (Hanif, 2013). The solid regulations for the auditors enforced by the standard could stop the collapse. ASA 701 has increased the level of accountability of auditors in Communicating Key Audit Matters in the independent report presented by the auditors along with the revision of ASA 570.  The new reform introduced lets the clients to repay the mortgages that are granted to them.

Discussion of the Lehman Brothers Limited

There were many defaults done in the whole country at that time and Lehman Brothers felt the same default and collapsed. The whole of the banking sector faced the consequences after the collapse of the bank along with the economy (Hellman, 2011). The analysis of why Lehman Brother collapsed brought some inefficient practices that were followed. However, the investors were under the impression that the financial statements are efficiently audited but the reality was just the opposite (Walker and Clarke, 2012).

When Lehman Brothers broke down, the financials estimated that there will be a hike in the prices of houses and the market will boom. This was because the auditors promoted this belief and were negligent about the expectations of the future. This was also because Lehman Brothers also encouraged Repo-105 transactions that lead to preventing the disclosure of excessively high leverage ratio which was 31:1 to the public. However, even at that point in time, the acceptable ratio was 15:1. The financial statements were never disclosed and hence never questioned. Therefore, the inefficient operations were never exposed that could prevent the collapse (GRAY, 2018).

ASA 701, Communicating key audit matters in the independent auditor's report: Rationale behind the introduction

As a result, some changes were made for auditing and accounting. This led to the introduction of entirely new standards set up for auditing that enhanced the information quality that was provided by the auditors that led to improving the communication after an audit report. ASA 701, Communicating Key Audit Matters in the Independent Auditor's Report is the standard that has been outed. The standard makes sure that the auditors have enough time for the auditing called key audit matter (Senft, Gallegos, and Davis, 2013). The key audit matters are decided based on the communication being concluded with those that have been charged with governance. No matter what the auditors present no other opinion on such matters, but communication is done for the matters that have high significance as compared to the other financial statements. The auditors only decide whether a matter is a key audit matter or not (Financial reports, 2013).

It is now easy to be understood that the auditors played a major role and did not highlight the erroneous concerns and spread wrong financial information to everyone. There were many audit matters that were introduced as per ASA 701 that were never there at the demise of Lehman Brothers. If such standards were there at the time of the collapse, there could be no way that such negligence would have been shown and hence the collapse could be stopped. The members of the organization would have known the faulty practices and other wrongful recording done in the financial statement of the company that prevail because of the management and hence could be stopped (Arena and Sarens, 2015).

A good audit practice could declare a high leverage ratio along with the risky practices followed by Lehman Brothers (Northington and Gerard, 2011). The investors could make better investments decisions if they had a knowledge of such a collapse or such risky practices being followed. This way the investors would have been saved if they had a knowledge of the real status of the financial statements. The audit that exists now would have exposed the revenue transactions, high leverage ratios as it would have been clearly stated in the financial report fetched by the auditors then (Cullinan, Earley and Roush, 2013). The investors would have been extra cautious having known the real facts and hence the crash of the market could have been saved.

Thus, there is a strong relationship that exists between the collapse of this giant bank and the introduction of the standards of ASA 701. The only reason that the Australian Accounting Standard Board (AASB) introduced ASA 70, Communicating Key Audit Matters in the Independent Auditor's Report is the collapse (Hay, 2014). This is such a powerful standard that now certain principles and guidelines are followed and there is transparency in the report presented by the auditors. This helps investors as well to make better decisions (Chaplin, 2016). It is found that many companies fail to disclose the proper information to its stakeholders due to its failure to comply with the international accounting standard. Nonetheless, in the international companies, management of organization faces issues to set harmonization in the domestic and international reporting framework. Due to the increased complexities, companies fail to follow accounting standards. However, with the introduction of the standards of ASA 701 its compliance, these all the companies could easily mitigate these challenges and set harmonization in their domestic an international reporting framework (Auditing and Assurance Standards Board, 2015b).

Reasons for revision of ASA 570, Going Concern

There are several reasons which could be found for the revision of ASA 570 in the recording of the financial data in the books of account of the company. Going concern is referred to an assumption created by the management of the listed organization and it shows the ability of the organization to continue business in future irrespective of any circumstances. It is quite normal for every organization to assume the future continuation of the business and not ceasing the operations at any point in time. It is the responsibility of the auditors to ensure and analyze the Going concern assumption that must be used by the management while preparing financial statements. In the case of Lehman Brothers, when they demised, going concern was not audited in a proper way by the auditors (Brunelli, 2018). When EY was aware of the wrong expectation of going concern applied on Lehman brothers, it never bothered to inform the same to members or management. If investors got to know early about the wrong interpretation of going concern assumption, then they would have created strategic decision wisely to invest in Lehman Brothers. All the investors were shocked at the time of the collapse of the organization that was easily avoidable.

When the collapse happened, the whole investors asked for measures that can help them to be informed about potential possibilities that can create doubt on the going concern ability of the organization. So due to all this, AASB has created a revision into ASA 570- Going concern. Now, it is mandatory for auditors to mention all the risks as well as warning signs related to the going concern of the organization. It basically protects the investors and helps them in taking wise decision with correct information. There is a separate paragraph for this reporting in audit report with the name "material uncertainty related to going concern" (Bodle, et al. 2018).

Audit report analysis of listed companies of ASX 100 under “Utilities” industry

Below description is all about the key audit matters given in the audit report of the organization operating in "Utilities" sector.  This report is very useful and plays a very important role in creating an understanding for readers related to the auditing issues as well as important information about finance.

APA Group- Deloitte is responsible for conducting the audit for APA group. In the financial year 2018, there were many important audit matters that have been reported by the auditors to provide information to the investors about some important issues. In the audit report, there is information about the value of Plant and Machinery, intangible assets and property in the section of key audit matters so that they can bring all important knowledge to the investors, the way how they allocate cash generating units is also shown. The information has been provided to the investors about management estimations utilize in valuation regarding future renewals, discount rates and inflation (Chaplin, 2016). It is analyzed that financial instruments are also being used by the auditors in this company to assess its business viability because it has high-end use of assumptions related to the future rates, market prices as well as values. By using these, auditors could easily determine the value fluctuation of the company in its business process.  These estimations are judged by management and investors also considered the same based upon the expectations of the market (APA group, 2019)

The calculation of Derivative transactions and balances has been done with the help of Hedge accounting that can be easily implied in business. It is also considered as an important audit matter to inform investors regarding the exposure of foreign currency in which the organization is involved in a similar matter that organization has hedged (Arena and Sarens, 2015).

AGL Energy Limited: 

Audit of AGL Energy Limited is also undertaken by Deloitte.  The main key audit matter given in the audit report is related to the unbilled revenues. Auditor has warned all investors about the judgment taken by the management related to the consumption of gas and electricity. Estimation is only for the reporting period and the last invoice date. It is considered as an important matter that needs to get understood by investors as there is a high use of such estimations in reporting unbilled revenues. A similar thing has reported as an important audit matter for unbilled distribution cost. Financial instruments are also used as key audit matters by the auditors because it has high-end use of assumptions related to the future rates, market prices as well as values.  These estimations are judged by management and investors also considered the same based upon the expectations of the market (AGL energy Group, 2019).

  • Spark Infrastructure Trust: Deloitte is the auditor of Spark Infrastructure. There is a disclosure of the recoverable amount of investments by the auditors in key audit matters and the method used for calculating the same is equity method.  The main investments for which there is a disclosure of the information is related to TransGrid., Victoria Power Networks and SA Power Networks. There is a disclosure of the valuation of investment of $2,326 that is on the account and calculated with the help of the equity method (Spark Infrastructure trust, 2019).
  • Ausnet services- The auditors of this organization are KPMG. The key audit matter is revenue recognition and there are many complex regulatory frameworks included for billing as well as revenue recognition. Another audit matter is related to the valuation of non- current assets.  It is necessary to do a valuation of derivatives in the audit report as it is necessary to inform investors about complexities in the derivative portfolios held by the company (Aunset Service, 2019). It clearly shows that it is very important to communicate in a clear way and create accuracy in the "going concern" assumption taken by the management (Senft, Gallegos, and Davis, 2013). 

Therefore, it could be inferred that these all companies have complied with the applicable accounting standards. Nonetheless, it also has a non-qualified audit report which helps these company to sustain in the market. Thus, there is a strong relationship that exists between the collapse of this giant bank and the introduction of the standards of ASA 701. Therefore, the failure of Lehman brother is a good lesson for the implication of the ASA 701.

Conclusion

As per the changing taking place in the economic condition, it is important for every organization to create transparency.  It is helpful for an organization to adopt efficient audit practices as it helps in determining the leverage and audit risk for the company. An analysis has been done and concluded that high leverage ratio and risky operating practice of Lehman Brother has reflected that it is necessary to keep transparency in the books of accounts. It helps the investors to take the decision regarding important aspects in a transparent environment. The main reason behind the collapse of Lehman Brothers and the introduction of ASA 701 is strong relationships. It explains that there is a need to keep transparency for investors and stakeholders if an organization wants to survive in the market. Information regarding financial statements is also relevant for the investors and it helps them in understanding the real operating environment. There is a requirement for auditors to report everything related to risky transactions as well as events. Follow up of ASA 701 and ASA 570 helps in preventing from future collapse. Now, in the end, it could be inferred that if companies comply with the ASA 701 then it could easily mitigate the issues of the sustainability risk and also strengthen their transparency and true and fair view of the recorded items in the books of accounts. The crux of this report is that the whole of the banking sector faced the consequences after the collapse of the bank along with the economy which resulted to strengthen legal compliance if a company wants to win over stakeholder's trust in the market. This shows that Lehman was collapsed due to the falsified recording and its failure to comply with the accounting standards. 

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