Executive Summary
The auditing function is that one function which provides assurance for the company financial reporting and its internal control practices to the investors and public. The use of the auditing function by independent auditor company enables the investors to be confident on the financial reporting done by the companies. The independent audit report allows the companies to provide authenticity of its non-biasness to their financial statements. There have been numerous accounts of the disastrous auditing of companies which has led to the collapse of businesses. The report shows the relatively new auditing standard of ASA 701 and its basis for establishment. The standard was released after the auditing failure of the Lehman brothers led the USA economy to the financial crisis of 2008. The case of Lehman Brothers and the reasons for its failure are shown in the report as well. Following this, the report shows the detail of ASA 701 and ASA 507 in terms of the auditing function. The pharmaceutical company of Australia is evaluated for the auditing of their financial statements as done by their independent auditors. The KAMs for each of the companies are identified as well.
Introduction:
The financial crisis of 2008 had been one of the worst crises that the world has witnessed in a long time. This financial crisis was aroused from the mortgage industry of the US. However, the banking industry was very close to it, as well. The mortgages were mostly offered by banks and financial institutions, which also became a victim of the crisis once the mortgage holders started defaulting. The Lehman Brothers were one of the first financial institutions which became the victim of the financial crisis. It was not expected. Not by the company itself. This shows that the company who failed and filed for bankruptcy was considered as fairly represented in its projects of future cash flows by its Auditor. The failure of the auditing standards was revealed by the Lehman Brothers bankruptcy (Sirois et al., 2018).
Lehman Brother Collapse and Auditing Failure
The audit companies of Lehman Brothers were blamed for the accounting fraud committed by Lehman Brothers as they signed the cleaned audit reports for them when they were committing this fraud. The Attorney General then blamed Lehman for engaging in the fraud crime as the company removed tens of billions of the fixed income securities from their balance sheet to deceive their investors about the liquidity condition of the company. On the contrary, the audit firm, Ernst & Young gave them a clean chit which has been true to the longstanding relationship of the company as they audited Lehman since 2001(Mawutor, 2014). The analysts blame Ernst & Young for at least not blowing the whistle for Lehman brothers on the shady accounts of the organization and their weird accounting practices. The audit company was blamed for alleged help in covering of the ailing state of the company by letting the company use Repo 105 transactions for making its balance sheet look good. As per the Ernst and Young, the transactions were by the GAAP and that the clean audit reports had been justified (Hines et al., 2011). As per the audit company, Lehman was not required to disclose the information on Repo 105 transactions as per the then accounting principles (Madhani, 2009). The details of the case show that the Ernst & Young only agreed to the accounting treatment of the Repo transactions however they did not look at the transactions it and on the reason for such accounting treatment or on their impact on the balance sheet.
Looking at the case against the inefficient auditing of the Lehman Brothers balance sheet is pretty strong because of several reasons. Firstly, it is true that the audit company did not check the transactions and the materiality of these transactions on the statements. The audit company did not rally the professional standards of auditing and only signed off on theoretical conduct of accounting (Azadinamin, 2013). The audit opinions need to have sufficient and competent evidence for its support, which was lacking in the case of the audit opinion on Lehman Brothers reports. The audit reports are only helpful in assuring the financial statements when these are done right (Coenen, 2010).
The company Lehman Brothers used an English accounting firm to approve their accounting treatment and Ernst & Young had allegedly helped them in giving the window dressing to the risky financial structure. The audit firm was paid around $31 million in auditing fees; however, it did little to help Lehman when things went wrong (Inman, 2010). The audit firm has paid $10 million for the settlement of the lawsuit that overlooked the accounting misstatements of the Lehman Brothers for hiding the bad deals of billions of dollars. The auditing opinions of companies that are not reliable and the audit firms help their client companies rather being independent makes it harmful not only for the investors but also for the public, the business and for the economy as well. The audit firm had also paid $99 million in settlement of the case to the investors of the Lehman Brothers as well (Chatterjee, 2015).
ASA 570 | Interpretation
The main purpose of this standard is to ascertain the necessities which are mandatory for the auditing of a company. It also helps to provide the relevant guidance for showing the position of the auditor in the financial reporting auditing of the company and how the going concern assumption is made eligible for the company financial strength. The standard also shows how the auditing is needed to evaluate the capability of the firm as having the ability to carry on its operations as a going concern. The 570 standards are however required by law to be used along with the Permeable of AUASB standards as well. This standard gives the intentions in the context of the Auditing standards understanding and the interpretation and application of it to companies. The standard has been applicable since 2006 (AUASB, 2006).
ASA 701 | Explanation
This is the standard which has been mentioned above in the Lehman brother’s case. The fall of the Legman brothers resulted in the financial crisis, which caused the auditing profession to be reevaluated in items of its practical implementation. This standard was made by AUASB to set up the necessities and provide illustrative material and application linked to the communication of the KAMs as given in the independent audit report. The points covered in this standard include providing the needed mandate for the communicating of the KAMs in the financial report about the audit for the listed organizations. It also helps in enabling the other company’s auditors to be familiar with if it is required to have an account of the KAMs in the audit reports. The technique of finding the KAMs is conducted by; identifying the communicated concerns linked to control of the body for the matter that has considerable significance and involves auditor attention. It also includes identifying the higher risk areas, important auditor decisions, including the necessary judgments and the impact of the important dealings. It helps in finding the imperative matters to include it in the auditor report. It also enables us to understand better how the auditor will explain each of the KAM. It makes the identification of the situations more visible for which the KAMs identified are not reported in the report. It also allows depicting the prerequisites for documentation related to the KAMs. The standard was allowed for application from the last month of 2016. The standard was aimed to provide the public with confidence in the reported financial information of the company and on its independent auditing as well. The establishment of this standard has aided to provide the company shareholders and investors with a choice for bringing transparency in the responsibilities of the auditor and by also yielding the insights that are needed to identify the KAMs. The standard also shows how the auditor will be needed to deal with these audit matters. Moreover, one of the main aims of the standard has also been to yield better disclosures from the company in terms of its main crucial financial information. The new standards have also been an effort to make the confirmation of the companies with ISA 701 as well (AUASB, 2015).
The standard of the ASA 701 has been quite helpful in making significant changes for the auditing firms. The standard was aimed at guiding the judgments of the auditors in terms of what the auditor intended for communicating and also in the context of the form as well as the content of the audit matters identified and handled by these auditors. The purpose of the standard is to progress the value of the knowledge of the report by offering more transparency and better information for the matters of the audit identified in the report (Ifac.org, 2017).
Analysis
Pharmaceutical and Healthcare industry
The health care industry of Australia embodies a diverse range of the companies in the ASX list that includes the main Australian companies of medical practice, biotechnology, and pharmaceutical companies. The ASX 100 index includes six listed healthcare companies. The Healthcare industry represents around 8.6% of the ASX 100 Index, which is the third highest number of companies (ASX 100 List, 2019). The Australian Pharma industry includes the renowned names of the CSL, Cochlear, Resmed, and Ansell along with the other health care operators like Primary, Ramsay and Sonic. The industry also includes companies of smaller capitalizations which usually belong to the biotechnology and the medical devices companies (ASX, 2019).
The six Pharma and healthcare companies listed in the ASX 100 Index are;
- Ansell Limited
- CSL Limited
- Cochlear Limited
- Health scope Limited
- Ramsay Limited
- Sonic Healthcare
Looking at the KAM Part of the Annual Reports of these six companies yielded the following information:
CSL:
Valuation and recording of the Inventories were one of the main KAMs for the CSL. The company inventories for 2018 Annual report shows around $2692.8 million of inventories. The accounting of these inventories and their provisions for recognition of all components of inventories, sale and movement of the inventory and all disclosures related to the inventories were considered as KAM by Ernst and Young. Similarly, the acquisition accounting for Ruide and Calimmune are also identified as important. The judgments used in the valuation of the purchase consideration, the put and call options, the fair valuation for liabilities and assets of the purchased company’s balance sheets, and the recognition of the goodwill were recognized as important audit matter as well. Other than this, the tax complexities were also included in the key auditing matter. The recoverability of the deferred tax assets, the calculations of the deferent and current tax expenses, third party taxation advice, and transfer pricing documentation were evaluated. Moreover, the internal controls, risks of material misstatements, and appropriateness of the accounting estimates, and policies used by directors were evaluated (CSL, 2018).
Ramsay Healthcare:
Ramsay audit has been conducted by Ernst and Young as well. The company gave an unqualified opinion on the audit report of the statements of 2018 of Ramsay. The Key matters of the audit included the consideration of the recoverable quantity of the goodwill. The audit firm evaluated the methodology used for meeting the AAS requirements, the mathematical accuracy of the models of cash flows, the basis of the forecasts of cash flows, growth rates, discount rates, and suppositions and all related disclosures. Other than this, the asset impairment and the onerous lease provisions were also considered as a key matter of audit. Similar evaluations as done for the testing of the goodwill valuations were done for impairment and PPE carrying values. Similarly, the provision for insurance was also considered as another important KAM. The underlying assumptions, qualifications, and competence of the independent actuary and completeness of the provision were evaluated (Ramsay Health, 2018).
Sonic Healthcare:
The audit page of sonic healthcare is conducted by the PricewaterhouseCoopers audit firm. The report of the Sonic healthcare for 2018 does not show any KAMs, while it notifies that these audit matters have been reported to the firm (Sonic Healthcare, 2018).
Health Scope:
The audit for this Pharma Company has been conducted by Deloitte. The audit report of the financial year 2018 shows the key audit matter of the Asian pathology business Divestment as significant. The terms of the biding offer, the accuracy of the liabilities and assets reported as held for sale by Pathology business, the calculations for gain on sale of the disclosed, and the appropriateness of the disclosures related to the divestiture was evaluated. Similarly, another important key audit matter considered by Deloitte has been the outcome of the hospital portfolio review. The decision of the closing of the Geelong and the Cotham hospitals following the portfolio review was evaluated in terms of the lease provisions, the closure costs, and the classification of the assets of the both closing hospitals as held for sale, estimates for the recoverable amount of the hospitals, estimated fair values and judgments of the management for the expected future cash flows, and unavoidable costs were all evaluated (Healthscope, 2018).
Cochlear Limited:
KPMG has conducted the audit for the Pharma Company of Cochlear Limited. The audit report also shows the key audit matters for the company audit. These include the recoverability of the trade receivables and the warranty provisions. The key controls of the credit control processes, the recovering ability of the outstanding trade receivables, the historical patterns of the outstanding trade receivables, and the knowledge of the company on future conditions, and disclosures related to the trade receivables were evaluated. The constant changing portfolio with different attributes, and designs, the warrantable periods, the unprofitable future failures, and the reduced repair costs, and the disclosures related to this area were also evaluated as key audit matter (Cochlear Ltd, 2018).
Ansell Limited:
The Ansell Limited is also audited by KPMG who has included the key audit matter of the brand names and the goodwill as significant. The forecasts of the cash flow, the revenue projections, and the varying market conditions impact on the volatility of the forecast period, the terminal growth rates, and calculations and assumptions used for these are evaluated. Another key audit matter included by KPMG is taxation. The assessment of the completeness of the tax provisions, the outcomes of the last tax audit reviews, the treatment of the tax areas are all evaluated (Ansell Limited, 2018).
The comparison of the six key audit matters reported by the companies (sonic healthcare did not report any key audit matters) shows that goodwill and impairment valuation had been the similar key audit matter among all of the major Pharma companies. The fair values, and the carrying values and the valuations of the acquisitions and divestitures were considered as significant audit matter. Taxation treatment is another similar key audit matter identified by the audit company of the Pharma companies.
The different key audit matters reported by the companies are all different as per the nature of the company current operations. For example, the recoverability of the trade receivables, and provisions of warranty were only reported by Cochlear limited. Health scope audit reported portfolio review as key audit matter, which was another difference among these companies. The provisions of the insurance were another different key audit matter reported by Ramsay Healthcare.
Conclusion:
The report concludes that auditing is very important in terms of conducting it in the right way or it does not serve its purpose. The report starts with the need for the auditing standards to be strengthened and how weak auditing can result in a worldwide financial crisis. The background of the Lehman brothers is given in order to show the need for better auditing practices. The new standard of ASA 701 and the going concern standard of ASA 507 are evaluated to show what aims it fulfills and how it can be used to make auditing more effective. The Lehman brothers case rightfully shows the weakness of the auditing profession where it changes from being an independent audit firm to a business service providing firm for its clients. This problem is rooted in the area where the auditing is not done professionally, and the giant audit firms theoretically confirm the authenticity of the financial information of the company. The resulting fall down of the Lehman brothers is one case, which then became the cause of the financial crisis as well. The Pharmaceutical industry is evaluated in terms of the six Pharmaceutical companies of Ansell Limited, Cochlear Limited, and CSL Limited, Health scope Limited, Ramsay Limited, and Sonic Healthcare. The Pharmaceutical Company’s financial reports and their independent audit reports are evaluated to recognize the key audit matters for every company. The resulting analysis shows how differing are the several key audit matters for each of the company with some similar areas of key audit matters as well.
References:
Ansell Limited, 2018. Ansell Limited Annual Report 2018. [Online] Available at: http://ansell2018anse1163.mdminteractive.com.au/#folio=120 [Accessed 23 May 2019].
ASX 100 List, 2019. ASX 100 List. [Online] Available at: https://www.asx100list.com/ [Accessed 23 May 2019].
ASX, 2019. Health Care & Biotechnology Sector Profile. [Online] Available at: https://www.asx.com.au/documents/resources/00176_Health_Care_and_Biotechnology_Sector_Profile_03_FINAL.pdf [Accessed 23 May 2019].
AUASB, 2006. Explanatory Statement ASA 570 Going Concern. [Online] Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_570_-_Explanatory_Statement.pdf [Accessed 15 May 2019].
AUASB, 2015. Explanatory Statement ASA 701. [Online] Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_Explanatory_Statement_2015.pdf [Accessed 15 May 2019].
Azadinamin, A., 2013. The Bankruptcy of Lehman Brothers: Causes of Failure & Recommendations Going Forward. Social Science Research, 1(1), pp.1-19.
Chatterjee, P., 2015. Ernst & Young Pays $10 Million To Settle Lehman Brothers Audit Failure Lawsuit. [Online] Available at: https://corpwatch.org/article/ernst-young-pays-10-million-settle-lehman-brothers-audit-failure-lawsuit [Accessed 15 May 2019].
Cochlear Ltd, 2018. Cochlear Annual Report 2018. [Online] Available at: https://www.cochlear.com/43d56bcc-d510-4a20-ab70-6208fa5af77e/en_annualreport2018_cochlear2018annualreport_5.69mb.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE-43d56bcc-d510-4a20-ab70-6208fa5af77e-mkRS5RK [Accessed 23 May 2019].
Coenen, T., 2010. Fraud Files: Is Ernst & Young to Blame in Lehman Bros. Fraud? [Online] Available at: https://www.aol.com/2010/12/23/fraud-files-is-ernst-and-young-to-blame-in-lehman-bros-fraud/ [Accessed 15 May 2019].
CSL, 2018. CSL Annual Report 2018. [Online] Available at: https://www.csl.com/-/media/csl/documents/annual-report-docs/csl-ltd-annual-report-2018-full.pdf [Accessed 23 May 2019].
Healthscope, 2018. Healthscope Annual Report 2018. [Online] Available at: http://www.healthscope.com.au/application/files/3915/3481/6104/HSO_Annual_Report_30_June_18_-_LODGEMENT_VERSION.compressed.pdf [Accessed 23 May 2019].
Hines, C., Kreuze, J. & Langsam, S., 2011. An analysis of Lehman Brothers’ bankruptcy and Repo 105 transactions. American Journal of Business, 26(1), pp.40-49.
Ifac.org, 2017. Auditor Reporting Standards Implementation: Key Audit Matters. [Online] Available at: https://www.ifac.org/global-knowledge-gateway/audit-assurance/discussion/auditor-reporting-standards-implementation-key [Accessed 23 May 2019].
Inman, P., 2010. Auditors’ role in Lehmans collapse unites opposition in calls for reform. [Online] Available at: https://www.theguardian.com/business/2010/mar/15/auditors-role-lehman-collapse-critics [Accessed 15 May 2019].
Madhani, P.M., 2009. Bankruptcy of Lehman Brothers: A Pointer of Subprime Crisis. The Accounting World, 9(6), pp.33-39.
Mawutor, J.K.M., 2014. The Failure of Lehman Brothers: Causes, Preventive Measures and Recommendations. Research Journal of Finance and Accounting, 5(4), pp.85-91.
Pinto, I. & Morais, A.I., 2018. What matters in disclosures of key audit matters: Evidence from Europe. Journal of International Financial Management & Accounting, 1(1), pp.1-18.
Ramsay Health, 2018. Ramsay Annual Report. [Online] Available at: http://www.ramsayhealth.com/common/emag/rhc/annualreport2018/RHC-AR2018.pdf [Accessed 23 May 2019].
Sirois, L.P., Jean, B. & Bera, P., 2018. The Informational Value of Key Audit Matters in the Auditor’s Report: Evidence from an Eye-Tracking Study. Accounting Horizons, 32(2), pp.141-62.
Sonic Healthcare, 2018. Sonic Annual Report 2018. [Online] Available at: https://investors.sonichealthcare.com/FormBuilder/_Resource/_module/T8Ln_c4ibUqyFnnNe9zNRA/docs/Reports/
AR/sonic-healthcare-limited-2018-annual-report-online.pdf [Accessed 23 May 2019].
Appendix:
| Company | Audit Company | Key Audit Matters Reported |
| CSL Healthcare | Ernst & Young | Recoverability of the deferred Tax Assets
Tax Complications Acquisition accounting for Calimmune and Ruide |
| Ramsay Healthcare | Ernst & Young | Provisions of Insurance
Asset Impairment and Lease Provisions Recoverable amount of Goodwill |
| Sonic Healthcare | PricewaterhouseCoopers | None |
| Health scope | Deloitte | Outcome of the hospital Portfolio Review
Closing of Cotham and Geelong Hospitals Divestment of Asian Pathology Businesses |
| Cochlear Limited | KPMG | Warranty Provisions
Recoverability of Trade Receivables |
| Ansell Limited | KPMG | Valuation of Brand Names and Goodwill
Taxation |
