Analysis

Discuss about the Downfall of the ABC Learning Centre.

The  ASA701 Communicating Key Audit Matters in the Independent  Auditor’s Report, is a new standard that has been developed by the IAASB, it deals with the duties of the auditor to comment on key important matters of the financial statements that focuss on the assumption of going concern. It applies to all audits of the general purpose financial statements of all the listed companies. Whnever the auditor is required to communicate the key audit matters to the important entities that ask for the same, or when the auditor does it on voluntary basis, the auditor needs to follow this standard. It applies to the audit of the financial statements for the period ending on or after December 15,2016. It ahs been one of the biggest changes in the overall standards of auditing, since it was first developed in 2004. The main reason behind this change was to help the investors and provide the shareholders of the companya snapshot of the overall audit so that they can comment on important matters in the lieu of the same. This is main reason that this standard was developed. But the first initiation that was taken to develop this standard occurred when the global crisis occurred with the downfall of the ABC learning center. This led to the need of developing a standard that can help the investors in getting an insight into the financial of the company and also with the auditors stating their take on the key audit matters , it helps in development of the effectiveness of the overall report. Thus these standards are very important and it is important that the auditor follows the same to the best of his ability. In cases if he fails to amke his report on the basis of these standards than the auditor will be held liable by the government and can be penalised for the same. The downfall of the ABC learning centre was the major reason that led to the development of this stanadard and we will analyse the overall effect it had on the functioning of the company. And what if the auditors had followed the standard before the crisis, would the global crisis would have been prevented or not (Abbott et al., 2016).

Downfall of the ABC Learning Centre

The ABC learning centre was founded in 1988. By 1996, the company had around 18 childcare centres and was one of the biggest players of the private childcare centre in Australia. By 2201, the company was listed on the Australian Stock exchange and by 2007; the overall market capitalisation of the company grew to about a$2.5 billion. The company reported an after tax profit of A$143.1 million and revenues of A$1.7 billion. However, post that the business was not functioning well and the company had to incur a lot of debt, which led to the delisting of the company from the stock exchange and the went into liquidation. Because of all these, the investors who had invested in the company had to suffer a lot, there was a decline in the share price of the company from the highest bid of A$8.62, to as low as A$0.54. This showed how badly the investor had suffered because of the delisting of the company and its failure to continue as a going concern (Burke & Clark, 2016). Many factors led to the downfall of the company that included the bad business model, regressive accounting policies, large capital expenditures, and poor acquisition policies, low advantage levels all that in combination led to the downfall of the company and had affected the investors of the company. After the collapse of the company, the investors found that the business model of the company was very hard to decipher and the overall operations that the company undertook was very opaque that was where the company failed. If the accounts of the company were properly audited and the key matters were included, then such loopholes would have been identified and that would have helped the investors of the company in taking important decisions and could have saved them from such major losses (Brannen, 2016).

Downfall of the ABC Learning Centre

The major accounting issues that were involved in the downfall of the company involved the need of recognition of certain items in the auditor’s report as key audit matters.  The first was the huge flaws in the intangible assets of the company and the same was not even recognising by the stock exchange on which the company had its account listed. The company had a large number of intangible assets in its financial statements, like goodwill, derivatives, and other biological assets that were hard to value and accounted for. Most of these assets were because of the company’s aggressive acquisition policy rather than the basic operational business model. The problems was not there just in the functioning of the company , but the auditors that were appointed also failed to do their task with diligence. Since 2003, the company had appointed Pitcher Partners Brisbane firm, to audit its account, and the auditor happily obliged with the view of the management and issued unqualified audit report. They failed to identify that the overall payments from the loss making centres were shown as normal revenues and hid the fact that these institutions were merely El Dorado for ABC Learning shareholders. The Pitcher partner supported the same, and this led to the accumulation of millions worth intangible assets on the financial report of the company that was not valued properly and was neither accounted for. Many experts described the situation as the failure of the accounting and regulatory processes and deviation from the standard laws and methods.

When the new auditor Ernst & Young’s took over from the previous auditor, and started the overall auditing process, it found that there were many loopholes in the overall accounting process of the company. It took over the audit from the year ending 2007, and it took seven weeks for the company to provide them with their interim reports. When the new auditor tried to reconcile their findings with those of the previous year, they found that there were many issues involved. When they asked the management of the company to make the requisite changes, the management found that if they inculcate all that the new auditors are telling in their books of account, it would lead to a lot of chaos on part of the management. The Ernst & Young’s audit was able to provide a clearer and true picture of the position of the company apart from what the previous auditor presented that was more of an illusion than a reality. Because of the deadlock of opinion between the two auditors, a third party was roped in to comment on the overall financials of the company. However, as per reports, KPMG was not successful in proving any of the auditors wrong. This raises a very important question to where is this process of auditing heading and what is something that the investors can believe that can help them in taking decisions.

The main points that were concluded were that there elitists an audit expectation gap, a spar which people expect that the auditor goes through everything, every small details related to the business and comments on the proximity of the business. The company appoints the auditors, to check the accounts to have an assurance that the accounts of the company are OK. When they find matters that are fishy, than they look deep into the matter and probe the same, just as the EY team did in case of the ABC (Jones, 2017). It is very well stated that the work of the auditor of the company is to just express an opinion and not certify or justify anything. There are guidelines that have been prescribed to the auditors, but as the we see in the case of ABC that there is many divergent opinions that might affect the overall audit statements and reports. So the main question is whom the investors should rely on and what should be there taking if the audit is not done with the conviction that is required. It has been said that such standards must be developed that helps the accountants and the auditors of the company to give their opinion on unique matters that are related to accompany rather than strict standards that allows them to try to cover everything and fail. Hence, the need for such strong auditing standards have raised that has led to the development of the ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report (Guragai et al., 2017).

The main features of the standards includes that it asks the auditors to comment of the key matters of governance and make an opinion on the same. It is applicable to all the listed companies so that it provides some help to the investors that depends on these reports for their decisions.

• The auditor has the right to decide the key audit matters. The auditor can determine the same, by mandating the matters with those charged with governance and making an opinion on the matters that they feel require special attentions. They must take matters that are more prone to risk, like the intangibles, acquisition, revenue and taxes. These areas will include significant auditors judgment, management judgment, and specific event and transaction that will affect the same
• The auditor describes each of the KAM with utmost precision and proper scrutiny must be done before stating the same in the reports. Proper description with regard to each matter must be given and how is it affecting the overall profit of the company.
• Specific circumstances, in which the matters related to the KAM, cannot be included in the auditor’s report.
• The audit documentation must be related to the key audit matters. In addition, all the documents must be properly stored by the auditor and used as audit evidences(Knechel & Salterio, 2016).

If these standards were developed before the crisis took place, it would have helped the auditors of the company and the auditors those were at fault had to comment on the key matters that were important. Because these standard was not there, the Pitcher Partner firm very easily stated that it still stands with all the opinion that is framed on the financials of the company, and the application and interpretation of the accounting standards is subject to the overall personal judgement and understanding. Hence making it clear that it possible that two auditors can have different opinion on the same company, because there is no specific standards that can ask the auditor to comment on certain specified matters. The auditors will check the accounts or their own assurance that they are ok, and in cases when they find discrepancies, they will probe further. Hence, it allowed the previous auditor to make use of major loophole in the auditing standards (Sonu et al., 2017). If this standard was there beforehand, the company had to include proper details regarding many matters that included the intangibles and the overall revenues from the loss making units. Because of this downfall of the ABC learning centre the need for the new standards has raised so that the investors who are dependent on the audit report, who cannot have an insight in the financials of the company can easily take important decisions. In addition, it also makes the auditor more responsible and they cannot foray into wrongdoing with ease. They have to comment effectively and give their opinion and the management has to provide support to the auditors of the company in whichever very possible (Raiborn et al., 2016).

Conclusion

Hence through the above discussion and analysis we saw how important it is that the audit report that the company is providing to the investors and the auditors who are authenticating and forming the same, must do their work with utmost effectiveness and precision. It is very important that the investors who are relying on these reports gets the facts that can help them in taking important decisions with regard to the company they are investing their money in. In case of the ABC Company, the investor has to face a huge loss because as per the auditor, the company was doing well, had large revenues, and was a going concern entity. However, in reality most of the revenue that was shown was dud, and the company was incurring huge losses (DeZoort & Harrison, 2016). So when suddenly the company went into liquidation, these investors were very terribly affected. This again emphasises the importance of audit and preparation of the financial statements of the company to best of one’s ability, so that all the stakeholders including the investors, government, public, who depends on these reports to take important decisions are able to benefit with the same. The issued new standard will help in solving a large number of issues, it is one of the biggest changes in the accounting standards since 2004, and will give power to the auditor with the abolition of many loopholes that was previously there in the system (Lefkowitz, 2017).

References

Abbott, L.J., Daugherty, B., Parker, S. & Peters, G.F., 2016. INTERNAL AUDIT QUALITY AND FINANCIAL REPORTING QUALITY: THE JOINT IMPORTANCE OF INDEPENDENCE AND COMPETENCE. Journal of Accounting Research, 54(1), pp.3-40.

Brannen, J., 2016. Mixing Methods: Qualitative and Quantitative Research. NY: Ashgate Publishing.

Burke, J.J. & Clark, C.E., 2016. The business case for integrated reporting: Insights from leading practitioners, regulators, and academics. Business Horizons, 59(3), pp.273-83.

DeZoort, F.T. & Harrison, P.D., 2016. Understanding Auditors sense of Responsibility for detecting fraud within organization. Journal of Business Ethics, pp.1-18.

Guragai, B., Hunt, N.C., Neri, M.P. & Taylor, E.Z., 2017. Accounting Information Systems and Ethics Research: Review, Synthesis, and the Future. Journal of Information Systems: Summer 2017, 31(2), pp.65-81.

Jones, P., 2017. Statistical Sampling and Risk Analysis in Auditing. NY: Routledge.

Knechel, W.B. & Salterio, S.E., 2016. Auditing:Assurance and Risk. 4th ed. New York: Routledge.

Lefkowitz, J., 2017. Ethics and Values in Industrial-Organizational Psychology, Second Edition. 2nd ed. NY: Routledge.

Raiborn, C., Butler, J.B. & Martin, K., 2016. The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), pp.10-21.

Sonu, C.H., Ahn, H. & Choi, A., 2017. Audit fee pressure and audit risk: evidence from the financial crisis of 2008. Asia-Pacific Journal of Accounting & Economics , 24(1-2), pp.127-44.