Executive Summary
Changes are occurring in investor’s expectations from the listed organizations in the modern business world are changing, which created a need for making certain development in the accounting and auditing standards. This report is based on evaluating ASA 701 by considering how the key audit matters should be disclosed in the reports prepared by auditors. The analysis is performed on the mining industry of Australia, and key audit matters have been assessed by looking at the information provided in annual reports of selected companies. In the end, recommendations are made regarding the key audit matters identified.
Introduction
The key benefit of ASA 701 is that it increases the interaction and communication between the company’s auditors and management. It, in turn, gives better governance. ASA 701 has issued by the AUASB to conventionality with the fresh improvement to auditor reporting established by IAASB. The scope of this standard is that it provided a guideline regarding the way of disclosing the important matters identified by auditors and which have an impact on the audit. This standard has developed for increasing the level of accuracy and transparency of reports prepared by auditors. Three different companies are selected from the mining sector of Australia to perform analysis on KAMs in reports (Brasel et al., 2016).
Overview of Lehman Brothers Case
It is one of the well-known financial investment firms operating at the global level. The company trailed for protection of bankruptcy in 2008, which was shocked for most of the stakeholders, including clients, creditors, and shareholders. All that happened because of the faith in ineffective audit procedures carried in the company. The problem started in Lehman Brothers because the audit procedures were not specific to level that a probable failure could be addressed and detected. The expectations that there would be a market boom and no downwards fluctuations of prices in the housing sector resulted in the commitment of Lehman to subprime loans. Inattention in audit reports was the main reason due to which this happened. The financial reports of Lehman were not able to consider the market risks and uncertainties ineffective way for making long term projections inaccurate way. For example, the repurchase agreement transactions were not communicated and revealed by the independent auditor’s reports. The company’s financial statements were window dressed by the management to deceive the company’s stakeholders. During the process of auditing, the high leverage of the company was hiding by use of Repos. The main purpose of the development of ASA 701 was to establish the requirements regarding the communication and auditing of KAMs in the reports. If this standard of auditing was applicable during the collapse faced by the company, then it might be possible that the situation could be different. For example, in the presence of this standard, the members of the company could have been communicated and noted regarding several KAMs. The area of high risk was one of the important KAMs that could be disclosed in the presence of this standard. The collapse faced by the company could be avoided if this risk had been communicated (De Haas & Van, 2014).
Auditing Standard ASA 701
The need for a review of the auditing standard rose after the financial crisis of 2008 and the matters that encircled the situation faced by Lehman Brothers. A new standard was introduced by the policymaker to tackle those issues in the future. This was ASA 701, which considered the steps of disclosing the important significant aspects and matters in the reports. The main reason for the establishment of this standard was to establish auditing provisions and the provisions regarding KAMs in the reports of the auditor. There are different features of this auditing standard, such as it developed an authorization of communicating KAMs in the audit reports of listed companies (Mališ & Brozović, 2016). It gave authority to the auditors to decide whether or not these important aspects are included in the auditor’s report. A proper guideline was provided to the auditor in respect of the method of defining and describing the KAM (Key Audit Matters). This ASA 701 also identified conditions in which some KAMs should need to be conveyed, and description of proper documents required for audit is also a feature of ASA 701. The auditor can identify and define KAMs from the matters charged with effects of major events, judgments of the auditor, accounting for higher risk areas, and governance. This ASA 701 gives direction to the auditor to determine significant aspects and matters that ought to be comprised in the reports (Carson et al., 2016).
Auditing Standard ASA 570
This ASA 570 is an auditing standard on Going Concern conforms to IAS 570 which is an international standard on auditing. The scope of this standard is that it provided a guideline about the responsibilities of auditor relating to going concern. The basic objective of developing this standard was to reduce the risks for investors. Under the principle of this ASA 570 standard, the financial report of a company is prepared under the going concern basis of accounting. The auditor’s responsibilities under this standard based on find whether there is any substantial ambiguity existed in the company’s aptitude to remain a going concern and to make the conclusion based on evidence obtained (Auasb, 2015).
KAMs in reports of independent auditors
Mining Industry is considered as a well-established sector in the country of Australia because it is a major contributor to the GDP of the country. This industry in Australia is overtrading on minimal processing onshore, and it is strongly export-oriented. There is huge competition among the companies in this industry because Australia is on the fourth number as the largest mining country around the world.in order to assess the key audit matters (Della & Gillespie, 2018). Some of the well-known mining companies are discussed below:
Alumina Limited
Some of the KAMs underlined in the audit report of Alumina Limited are given below:
Equity accounting for the investment of the company in AWAC
The procedure followed by auditors of the company to ascertain the investment of 40% in AWAC. In the context of this audit matter, the auditor of the group tested the appropriateness and extensiveness of the US GAAP based on which all the differences were considered by the auditors that were existed between AAS and US GAAP. The auditors identified that consistent standards of accounting need to be applied for the use of the equity accounting method. They pointed out that there is no need for conversion because financial information by AWAC is already prepared under AAS. The auditors noted that adjustments are required to comply with AAS. The auditors, due to the magnitude of investment and significance of judgment, considered equity accounting as key audit matter (Alumina Limited, 2019).
Impairment indicator assessment for equity investment made by Alumina in AWAC
The auditors pointed out that the investment of $2.1 billion in AWAC is a material amount in the company’s annual report. The company’s auditors evaluated and checked that whether or not this amount of investment made by the company impaired as at 31 December 2018. The auditors performed different procedures for this purpose. The procedures included consideration of long term alumina price and comparing it to forecast at industry and economic analyst level. The auditors also considered the comparison of group value with the value in the market, but no evidence was found by the auditors for the impairment of such investment (Alumina Limited, 2019).
Evolution Mining Limited
Some of the KAMs underlined in the audit report of Evolution Mining are given below:
Valuation of assets at Cowal and Mungari
The auditors observed a certain level of the consequences of the valuation of assets of the company because auditor came to know that the to obtain accurate values of the company’s assets, the valuation by the management were conducted principally based on the objective to support the income tax positions of the group. There were different procedures performed by the auditors for assessing the assets valuation and the related impact of tax and accounting (Sirois et al., 2018). To assess external valuation, the auditor evaluated and read the terms of engagement, capabilities, and competency. Valuation reports were also read for external valuation. Reclassification and recalculation of the accuracy of the balance sheet were performed by the auditors to assess accounting impact. The auditor considered it as KAM because of inherent nature of the judgment made in respect of valuation, relative Mine Development’s size and balance of PPE in the balance sheet of company (Evolution Mining, 2018).
Assessment of the carrying value of assets
The auditor identified by keeping in mind the requirements of AASB 136, the group had not identified indicators for impairment of asset for any of the CGU (Cash Generating Unit). But it is the requirement under AASB 136 to have an assessment of indicating that there is no impairment loss that is recognized in previous periods. If there is an existence of such indication that it is the responsibility of the company to determine the level of previous impairment loss to be reversed. After assessing the assessment performed by the group regarding the previous impairment loss, the auditor pointed out that there is an indicator that mine assets need to be reflected for reversal of impairment. The auditor considered the assessment of asset’s carrying value as KAM because of the involvement of significant judgment for determining whether or not there is a requirement of impairment charge or reversal related to CGU or asset (Evolution Mining, 2018).
CSR Limited
Product liability provision
A product liability provision of $289.0 million was recognized by the company as of 31 March 2018. The auditor pointed out that provision is in respect of reasonably foreseeable and known claims and such provisions were subject to different judgments. The auditors of the company considered the evaluation of the size of the provision and the complexity associated with that provision. The assessment of the capability and individuality of the external experts was the focused area of the auditor in assessing this matter. The auditors also assessed the appropriateness of the methodology and the assumptions used by the company in the preparation of the reports. The complexity and size associated with the assumptions used to determine the result of the provision are the KAM (CSR Limited, 2018).
Asset valuation
Asset valuation was also considered by the auditors as KAM. The assets of the company were recorded by the management at very higher prices that resulted in consideration of different assumptions by the auditors, such as changes in the forecast, growth rates, and inflation. The participation of noteworthy judgment in the assessment of the impairment of the PPE balances, other intangible assets and company’s goodwill is required in respect of certain assumptions such as changes in the forecast, growth rates, inflation, and discount rates to forecast future cash flows. The auditors used different procedures to evaluate the company’s process in the impairment of such assets. The auditors also assessed the key assumptions used by the management of the company. The sample-based approach is also used by the auditor to test some of the rates. The involvement of judgment in the selection of assumptions and forecasting the future cash flows was the main reason due to which auditors attentive on this area as KAM (CSR Limited, 2018).
BHP Group Limited
The auditors identified that there are two important areas that could lead to the material misstatement of reports includes the valuation, cataloging, and presentation of the Onshore US assets because of the significant proposed divestment and judgment. Samarco claim was another KAM because there is an existence of uncertainty in the estimation. Taxation is the third KAM (BHP Group Limited, 2019).
Fortescue Metals Group
The first key KAM was the generation of revenue from eth iron ore sales because the auditors thought that the provisional pricing arrangements of the company had some technicality and another important aspect considered by the auditors was the carrying value of the evaluation and exploration assets because of the involvement of judgment of the management (Fortescue Metals Group, 2019).
Iluka Resources
Rehabilitation and closure provisions were the KAM because the auditor considers that it is based on critical accounting judgment and estimation. The second key matter was the recognition and measurement of the deferred tax assets because of eh involvement of significant judgment of the management (Iluka, 2019).
Newcrest Mining
The first KAM identified in the auditor report was the carrying value assessment regarding the non-current assets of the company because the auditors thought that whether or not the management has made the reversal of previous goodwill and impairment and they considered it as KAM due to the doubt of involvement of significant judgment. The auditor’s felt that there might be a critical aspect associated with the taxation of the company because it is operating in different jurisdictions of taxation (Newcrest Mining, 2019).
OZ Minerals
The first important concern for users identified by the auditors of OZ Minerals was the accounting considered by the management for the acquisition of purchase of Avanco Resources based on the reason that judgment and size of the acquisition and existence of uncertainties regarding the provisional accounting for an acquisition. Valuation of low-grade gold ore stockpiles was the second key concern noticed by the auditors because of the requirement of significant judgment (OZ Minerals, 2019).
RIO Tinto Limited
The auditors identified that there is a higher level of judgment exists in the determination of whether there is a need of a reversal of impairment for finite-lived intangible assets of the company, therefore, they considered the assessment of indicators of reversal and impairment as KAM in the company. Because of the involvement of estimation of management, the provisions for environmental, restoration and close down obligations were considered as KAM (RIO Tinto, 2019).
SOUTH32 Limited
Valuation of assets is an area of attention by the auditor because of the association of sensitivity with the valuation of assets to certain assumptions and second KAM for the company was rehabilitation and closure of the provisions because auditors had a concern regarding the size of the provisions and multiple sites across which the groups were operating. Taxation area was the third KAM by the auditors (South32 Limited, 2019).
Similarities and Differences based on KAMs
Similarities
It has been seen that the auditor reports of most of the companies in the mining sector revealed that taxation is one of the areas where auditor have to focus on. The complexity of taxation was a similar level of KAM for the auditors because most of the companies are trading in different jurisdictions of taxation. Another similar aspect regarding the KAMs in the mining industry is that there were certain companies which were considered as sensitive in the context of accounting of carrying value of non-current assets. For example, the valuation of the asset was one of the common KAM for both the CSR Limited and Evolution Mining Limited
Differences
Evolution Mining Limited was facing a problem of assessment of carrying value of an asset, and this was the reason that auditors were not satisfied with the method of assessment, but in case of CSR Limited, the auditors were not satisfied with the policies and procedure of company regarding the provision of product liability.
Conclusion and recommendations
The procedures considered by the auditors of Alumina Limited for addressing the KAM were good, but by ASA 701, it is recommended to the auditors to keep in mind the stakeholder and users of the prepared report while drafting the KAM. The KAM should be pertinent to the understanding and knowledge of users of audit reports about the objective of communicating the key audit matter. ASA 701 requires timely discussion and engagement from the auditor of Alumina Limited with persons stimulating with authority regarding the process of identifying the KAM of Equity accounting for the investment of company in AWAC and indicator of assessment regarding impairment for investment of equity made by Alumina in AWAC.it is recommended to inform those charged with governance because it could enable them to understand how to address these key audit matters by disclosing them in the financial statements. By keeping in mind the requirements of ASA 701, there should be effective communication among the auditors and engagement team of the group because it will enable the team members to connect with the auditors and inform them about the matters identified
It is recommended to the auditors of CSR Limited to stipulate the consequence of the response of auditor in describing the key audit matter because it helps in avoiding the creation of uncertainty as to whether there is satisfactorily way of resolving the matter. It is very important to present findings and conclusion in understandable language because it will make it easy for the users to understand the KAMs. Another important thing by the ASA 701 that should be considered by the auditor of CSR Limited is to evade giving the imprint that the provision of information and discussion regarding the KAMs in auditor’s report is envisioned to present a personal view on the KAMs. By the ASA701, the top level management of the company should be informed by the auditor about the KAMs of asset valuation because it will enable the management to point out uncorrected misstatements due to error and fraud related to the key audit matter of valuation of assets.
According to ASA 701, the auditors of Evolution Mining should communicate with the management regarding any level of the insufficiencies in company’s internal control due to which the Valuation of assets at Cowal and Mungari and Assessment of the carrying value of assets were considered as KAMs. The identification of deficiencies in internal control will help the management to take proper actions. It is recommended to the management to conduct a discussion with the management of Evolution Mining regarding the approach and tax positions in relation to the valuations performed by the management and in order to tackle the key audit matter of Valuation of assets held at Mungari and Cowal, the auditor should propose certain amendments regarding prior tax returns. It is also recommended to the auditor to ask the management regarding the policies of the company regarding the recognition of impairment losses. It is concluded that the global financial crisis was the main reason for developing new auditing standard ASA 701. This new standard of auditing was developed for the protection of investor’s interests by providing them information regarding important audit matters. It is concluded that disclosure of KAMs has increased the transparency of the auditor’s reports by enhancing communicative value.
References
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