In recent years ASIC has dealt with numerous audit failures where financial reports did not properly inform the market as to the poor financial condition of entities. Here are some lessons from that process.
In addition to regular audit firm inspections, ASIC reviews audits based on specific concerns that may lead to action against auditors. These reviews reinforce the need to improve audit quality and the consistency of audit execution, particularly in relation to the adequacy of audit evidence, the exercise of professional scepticism, and the use of experts and other auditors.
Lessons for auditors from these reviews include:
Complex groups: Groups may have a significant number of entities with complex financial and operational interrelationships. Entities may be controlled, subject to significant influence, or owned by common individuals. Some entities may not present audited financial reports. Auditors should understand the reasons for a complex group, and the financial and operational interrelationships between group entities. Auditors should identify, assess and respond to risks, and apply appropriate scepticism in auditing group entities.
Different auditors in group: Before accepting an engagement, auditors should understand why group entities have different auditors. Where management restricts communications between the auditors, additional work may be required and greater scepticism applied. An auditor must gain assurance on financial information of subsidiaries, associates and joint arrangements, and should consider reviewing or re-performing work of their auditors with regard to any risks or concerns.
Related parties: Auditors must identify the existence and terms of related party transactions, including those on non-arm’s length terms. Auditors should assess the risk of unidentified related parties, the effectiveness of controls to detect transactions, the impact of transactions, the recoverability of investments or receivables, and the ability of related parties to provide any necessary financial support. Additional work on the existence or value of underlying assets may be necessary, particularly where parties or assets are located overseas, where there are no audited financial reports, or the party is audited by another firm.
Foreign operations and assets: The work of auditors of foreign operations and investments may require increased review. It may be necessary to obtain direct audit evidence of the existence and value of underlying assets and operations. Cultural differences may affect the reliability of audit evidence in some countries, including third party confirmations.
Management integrity: Where there is reason to doubt the integrity of management, an auditor should respond to the risk of material misstatements by increasing the extent of audit procedures, and applying heightened scepticism.
Dominant CEOs: Dominant CEOs may override controls or compromise corporate governance. Risks or concerns may not be properly disclosed to, or considered by, the directors. Accounting policies, valuations and other estimates may be inappropriate or disclosures inadequate. The auditor may also have insufficient access to information or officers. Auditors should apply heightened scepticism, and challenge and corroborate management representations with other evidence.
Client mismatch: Smaller audit firms must ensure that they have the necessary experience and expertise to audit larger and more complex entities, and be mindful of circumstances where their independence may be perceived to be compromised by dependence on audit fees. Auditors should be able to consult on complex transactions and issues, and have access to expert advice on accounting treatments, asset valuations and other estimates. Auditors should be mindful that company growth may outstrip the ability of the auditor to conduct an effective audit.
Business models: Auditors need to understand business models. Where there is rapid growth internally or from acquisitions, additional attention may be needed on the recoverability of any assets acquired, the treatment of start-up costs, the company’s ability to manage and integrate new businesses, and the ability to meet borrowing commitments and loan covenants. Some property developer and debenture issuer auditors did not understand the risk of impairment of loans receivable, apply sufficient professional scepticism or perform adequate audit work. Debt may pay above market rates and equity may be minimal. Some property developers inappropriately capitalised interest, fees and commissions paid to related parties.
Going concern: There have been cases where an entity has failed shortly after the auditor gave an unmodified opinion on its financial report, or gave an emphasis of matter when a qualified opinion should have been issued. Auditors need to be sceptical of optimistic cash flows and growth assumptions by management, as well as the ability to meet loan covenants and commitments.
Special purpose financial reports: In determining compliance with accounting standards, the auditor must consider whether classification as a non-reporting entity is appropriate with regard to financial report users. For example, financial reports of internal group investment vehicles may be used by investors in the entities that fund those vehicles. Financial instrument, related party and consolidated information may be necessary to understanding underlying risks, exposures and performance.
CAAA Audit and Assurance
CAAA Audit and Assurance has been in existence since July 2014. The establishment of this audit division has been phenomenal in terms of bringing together common synergies and a high level of audit experience.
As the managing director of CAAA Audit and Assurance Pty Ltd, I have a strong background in audit and assurance, with over fifteen years of experience acquired both overseas and in Australia. I hold a MBA degree in Finance and I’m a member of the Institute of Public Accountants (MIPA) and CPA Australia (CPA).
I am grateful to be supported by a competent team of other professional auditors who between them possess extensive knowledge and experience, working with companies with different industry background ranging from retail and industrial businesses to insurance, hospitality, logistics and other service industries.
The team prides itself in risk assessments and due diligence and believe in partnering with audit clients to deliver value added service. While an audit report is vital it is equally important to educate and keep the clients abreast of latest developments and changes within the legislative framework.This is what differentiates us from the other auditing firms. If you have any questions or concerns, please contact Commercial Associates on 02 9299 1200 or click Email Firm below to arrange a complimentary discussion with myself of our expert advisors.