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Resources

1 - Accountants

Resources for accountants.

1.1 - Value In Use Impairment Models

We are putting the spotlight on common errors that arise in the application of AASB 136 Impairment of Assets in a four-part series.

In this month’s issue, being Part 1, we look at the common errors in value in use models relating to a failure to:

  • Reflect expectations about possible variations in the amount or timing of future cash flows;
  • Base cash flow projections on reasonable and supportable assumptions;
  • Apply a maximum period of 5 years for cash flow projections or if greater than 5 years, subject to the specific restrictions within AASB 136;
  • Exclude the effect of capital improvements or restructuring; and
  • Include the cost of servicing the asset.

Failure to comply with the requirements of AASB 136 is one of the principal reasons for litigation against company directors, management, and their auditors of failed companies.

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1.2 - Going Concern - Double Jeopardy

In this month’s issue of Spotlight on Accounting Errors we consider errors that can arise when dealing with an entity’s going concern disclosure obligations.

Following a corporate collapse, it is common for the failed company directors and management to be in the spotlight regarding their failure to adequately disclose the uncertainties and risk about the ability of the entity to continue as a going concern and the key judgements applied in making their assessment that the entity could continue as a going concern. Typically, when entities consider their going concern disclosure obligations, they address the issue of whether there are material uncertainties that require disclosure in accordance with AASB 101 paragraph 25, failing to provide information regarding management’s evaluation of the significance of those conditions or events and plans that led them to conclude that those uncertainties were not material as required by AASB 101 paragraph 122.

Failure to disclose the key judgements applied in determining that there were no material uncertainties regarding the entity’s ability to continue as a going concern, can be a reason for litigation against company directors, management, and their auditors of failed companies.

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1.3 - Business Combinations - Overpayment on Acquisition

Basford Consulting is excited to announce the launch of our new series, “Spotlight on Accounting Errors,” which aims to draw attention to common errors made by directors, management, and accountants that often go unnoticed by auditors and can result in significant inaccuracies in financial statements.

Our inaugaral spotlight deals with the failure to impair goodwill arising from a business acquisition where the acquiror overpaid on acquisition. Typically, accountants assume that the purchase price represents the fair value, supporting the recoverable amount of acquired goodwill, and as AASB 3 Business Combinations allows an acquiror to adopt provisional accounting for a period up to 12 months after the acquisition, that no impairment loss is required to be recognised in the year of acquisition. We consider the requirements of AASB 136 Impairment of Assets and its application to goodwill arising from business combinations in the year of acquisition.

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1.4 - Removal of special purpose financial statements - consolidation requirements

In this publication we consider the impact of the removal of special purpose financial statements for entities preparing consolidated financial statements for the first time.

When preparing consolidated financial statements, entities need to determine:

  • Whether to apply AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors or AASB 1 First-time Adoption of Australian Accounting Standards to its transition; and
  • How subsidiaries were acquired.

1.5 - 2022 the Horizon for Accountants

This article is to help accountants in Australia, both preparers and auditors, identify the changes to Australian accounting standards over the next 3 years.

The significant changes are for those entities:

  • currently preparing special purpose financial reports, 2022 means the end of special purpose reporting, heralding the application of complex measurement and disclosure requirements; and

  • entities previously applying the reduced disclosure regime, 2022 sees the introduction of new disclosures with the introduction of AASB 1060.

The amendments to accounting standards applicable to Australian for-profit entities with 30 June financial reporting year-ends are:

2022 2023 2024 2025
Removal of Special Purpose Financial Statements for Certain For-Profit Private Sector Entities (AASB 2020-2) AASB 116 Property plant and equipment – proceeds before intended use (AASB 2020-3) AASB 101 - Classification of Liabilities as Current or Non-current(AASB 2020-1) Disclosure of Accounting Policies and Definition of Accounting Estimates (AASB 2021-2)
General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities (AASB 1060) AASB 9 Financial Instruments – fees in the ‘10% test’ for derecognition of financial liabilities (AASB 2020-3) NEW STANDARD AASB 17 -Insurance Contracts
AASB 16 Covid-19 Related Rent Concessions (AASB 2021-3) AASB 137 Onerous Contracts (AASB 2020-3)
Interest Rate Benchmark Reform—Phase 2 Amendments to AASB4, AASB7, AASB9, AASB16 and AASB 139 AASB 141 Agriculture -taxation in fair value measurements. (AASB 2020-3)

Accounting changes applicable for 30 June 2022 Reporting

The following new pronouncements have application to annual financial reporters with a year-ending on or after 30 June 2022 except for the Interbank Offered Rates (IBOR) Phase 2 reforms which apply to 31 December 2021 year-ends:

Removal of special purpose financial statements AASB 2020-2

For-profit entities that prepare financial statements in accordance with the Corporations Act 2001, other legislation, their constitution, or other agreements will no longer be allowed to prepare special purpose financial statements.

Practical implications

Affected entities will have to apply the full recognition and measurement requirements of Australian accounting standards.

Interest rate benchmark reform Phase 2 – Amendments to AASB 9, 139 and 7

The Phase 2 amendments, which respond to the impact of IBOR reform, relate to address issues that might affect financial reporting when an existing interest rate benchmark is replaced. Phase 1 deals with issues arising before the reform takes effect. The Phase 2 amendments deal with replacement issues, relating to the modification of financial assets, financial liabilities, lease liabilities and specific hedge accounting requirements.

Practical implications

IBOR is not commonly used in Australia, so the impact is not expected to be significant for Australian entities. For those affected, transparent disclosure of the impact of IBOR reform on risk management is required.

Accounting changes applicable for 30 June 2023 Reporting

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2022:

AASB 116 Amendments - proceeds before intended use

Sale proceeds will no longer be allowed to be deducted from the cost of property, plant, and equipment before its intended use. Instead, an entity recognizes the sale proceeds and the cost of producing those sales in its profit or loss.

Practical implications

Determining the costs of production may be difficult. Companies in the natural resources industry are likely to be impacted by this amendment.

AASB 137 Amendments - costs of fulfilling an onerous contract

In assessing whether a contract is onerous an entity is required to include both the incremental costs of fulfilling that contract and an allocation of other costs that relate directly to fulfilling contracts, such as depreciation of equipment used to fulfil the contract and contract management and supervision costs.

Practical implications

Entities that applied the incremental cost approach will see provisions increase to reflect the inclusion of costs related directly to contract activities.

Accounting changes applicable for 30 June 2024 Reporting

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2023:

AASB 17 Insurance Contracts

AASB 17 is a comprehensive new accounting standard for insurance contracts covering recognition and measurement, presentation, and disclosure. Insurance contracts combine features of both a financial instrument and a service contract. The objective of AASB 17 is to provide an accounting model for insurance contracts that provides useful information about these features.

Practical implications

AASB 17 is a complete overhaul of accounting for insurance contracts and for entities that issue insurance and reinsurance contracts, it will require significant changes to accounting systems and processes.

AASB 101 Amendments to classification of current and non-current liabilities

Currently entities classify a liability as current when they do not have an unconditional right to defer settlement of the liability for at least 12 months after the end of the reporting period. Under the amendment:

  • the AASB has removed the requirement for a right to be unconditional and now requires that a right to defer settlement must have substance and exist at the end of the reporting period;

  • rights are in existence if covenants are complied with at the end of the reporting period; and

  • introduces a definition of ‘settlement’ to make it clear that settlement refers to transfers of cash, equity instruments and other assets or services.

The existing requirement to ignore management’s intentions or expectations for settling a liability when determining the classification remains unchanged.

Practical implications

The revised definition needs to be considered in relation to compliance with loan covenants. In addition, the amendments may impact the classification of convertible instruments that are settled with the transfer of equity instruments.

Accounting changes applicable for 30 June 2025 Reporting

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2024:

Disclosure of Accounting Policies and Definition of Accounting Estimates

Unfortunately, too many financial reports contain boiler plate disclosures of accounting policies and accounting estimates that simply reproduce the content of the applicable accounting standard and therefore provide little benefit for users of the financial statements.

Similarly, many financial reports contain accounting policies that are either not relevant or relate to non-material transactions.

Under the amendment the following changes are made to the disclosure of accounting policies:

  • The term ‘significant accounting policies’ has been replaced with ‘material accounting policy information’.

  • An entity is required to disclose material accounting policy information.

  • Accounting policy information is material if, when considered together with other information included in an entity’s financial statements, it can reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements.

  • Accounting policy information that relates to immaterial transactions, other events or conditions, is immaterial and need not be disclosed.

  • If an entity discloses immaterial accounting policy information, such information shall not obscure material accounting policy information.

Under the amendment the following changes are made to accounting estimates:

  • Accounting estimates are monetary amounts in financial statements that are subject to measurement; and

  • The effects on an accounting estimate of a change in an input or a change in a measurement technique are changes in accounting estimates unless they result from the correction of prior period errors.

Practical implications

The amendments should improve the usefulness of accounting policy disclosures to users of financial reports. The transparency required by providing material accounting policy disclosure may lead to questioning from regulators and increase the risk of litigation.

Amending standards impacting reporting for 30 June 2022 Reporting

Standard Title Date issued Effective date for reporting periods
AASB 2020-2 Removal of Special Purpose Financial Statements for Certain For-Profit Private Sector Entities Mar 2020 beginning on or after 1 Jul 2021
AASB 1060 General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities Mar 2020 beginning on or after 1 Jul 2021

Amending standards impacting reporting post 30 June 2022 Reporting

Standard Title Date issued Effective date for reporting periods
AASB 2020-1 Classification of Liabilities as Current or Non-current Mar 2020 beginning on or after 1 January 2022.
AASB 2020-3 Annual Improvements 2018–2020 and Other Amendments Jun 2020 beginning on or after 1 Jan 2022.
AASB 2020-6 Classification of Liabilities as Current or Non-current – Deferral of Effective Date Aug 2020 beginning on or after 1 January 2022.
AASB 2021-2 Disclosure of Accounting Policies and Definition of Accounting Estimates Mar 2021 beginning on or after 1 January 2023.
AASB 2021-3 Covid-19-Related Rent Concessions beyond 30 June 2021 Apr 2021 beginning on or after 1 April 2021.
AASB 2021-5 Deferred Tax related to Assets and Liabilities arising from a Single Transaction Jun 2021 beginning on or after 1 Jan 2023.
AASB 2021-6 Disclosure of Accounting Policies: Tier 2 and Other Australian Accounting Standards Dec 2021 beginning on or after 1 January 2023.
AASB 2021-7 Amendments to AASB 10 and AASB 128 Dec 2021 beginning on or after 1 January 2025.

AASB 1060 General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities

AASB 1060 sets out a new, separate disclosure standard to be applied by all entities that are reporting under Tier 2 of the differential reporting framework in AASB 1053. AASB 1060 has been developed based on a new methodology and principles to be used in determining the Tier 2 disclosures that are necessary for meeting user needs, to replace the existing reduced disclosure requirements (RDR) framework.

AASB 2020-1 Classification of Liabilities as Current or Non-current

AASB 2020-1 amends AASB 101, refining the conditions that would permit an entity to classify a liability as non-current.

The key amended paragraphs in AASB 101 are:

Paragraph Details
69 An entity shall classify a liability as current when:
69 d it does not have the right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period.
72A An entity’s right to defer settlement of a liability for at least twelve months after the reporting period must have substance and, as illustrated in paragraphs 73–75, must exist at the end of the reporting period. If the right to defer settlement is subject to the entity complying with specified conditions, the right exists at the end of the reporting period only if the entity complies with those conditions at the end of the reporting period. The entity must comply with the conditions at the end of the reporting period even if the lender does not test compliance until a later date.
73 If an entity has the right, at the end of the reporting period, to rollover an obligation for at least twelve months after the reporting period under an existing loan facility, it classifies the obligation as non‑current, even if it would otherwise be due within a shorter period. If the entity has no such right, the entity does not consider the potential to refinance the obligation and classifies the obligation as current.
74 When an entity breaches a condition of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand, it classifies the liability as current, even if the lender agreed, after the reporting period and before the authorisation of the financial statements for issue, not to demand payment as a consequence of the breach. An entity classifies the liability as current because, at the end of the reporting period, it does not have the right to defer its settlement for at least twelve months after that date.
75A Classification of a liability is unaffected by the likelihood that the entity will exercise its right to defer settlement of the liability for at least twelve months after the reporting period. If a liability meets the criteria in paragraph 69 for classification as non-current, it is classified as non-current even if management intends or expects the entity to settle the liability within twelve months after the reporting period, or even if the entity settles the liability between the end of the reporting period and the date the financial statements are authorised for issue. However, in either of those circumstances, the entity may need to disclose information about the timing of settlement to enable users of its financial statements to understand the impact of the liability on the entity’s financial position (see paragraphs 17(c) and 76(d)).
76 If the following events occur between the end of the reporting period and the date the financial statements are authorised for issue, those events are disclosed as non-adjusting events in accordance with AASB 110 Events after the Reporting Period:
76a refinancing on a long-term basis of a liability classified as current (see paragraph 72);
76b rectification of a breach of a long-term loan arrangement classified as current (see paragraph 74);
76c the granting by the lender of a period of grace to rectify a breach of a long-term loan arrangement classified as current (see paragraph 75); and
76d settlement of a liability classified as non-current (see paragraph 75A).

AASB 2020-2 – Removal of Special Purpose Financial Statements for Certain For-Profit Private Sector Entities

The removal of special purpose financial reports is the key issue for 2022. Entities that previously prepared special purpose financial reports to fulfill the requirements of the Corporations Act or other legislation (because they deemed themselves not to be a reporting entity), will for 30 June 2022 year ends have to apply the full measurement and consolidation requirements of the relevant AASB standard.

We envisage this will cause significant difficulties for a number of large unlisted entities, due to the application of:

  • AASB 10 (identifying subsidiaries);

  • AASB 15 (revenue recognition);

  • AASB 9 (measurement of financial assets and liabilities);

  • AASB 136 (impairment of goodwill and other non-current assts);

  • AASB 2 (identifying share-based payments); and

  • AASB 112 (recognising and measuring deferred tax assets and liabilities).

AASB 2020-2 amends:

  1. the Conceptual Framework for Financial Reporting;

  2. the Framework for the Preparation and Presentation of Financial Statements;

  3. Statement of Accounting Concepts SAC 1 Definition of the Reporting Entity;

  4. AASB 1 First-time Adoption of Australian Accounting Standards;

  5. AASB 10 Consolidated Financial Statements;

  6. AASB 1048 Interpretation of Standards;

  7. AASB 1053 Application of Tiers of Australian Accounting Standards; and

  8. AASB 1057 Application of Australian Accounting Standards.

AASB 2020-2 amendments to the Conceptual Framework

AASB 2020-2 amends the following key paragraphs in the Conceptual Framework:

Paragraph Details
Aus1.1 This Conceptual Framework applies to:
(a) for-profit private sector entities that are required by legislation to prepare financial statements that comply with either Australian Accounting Standards or accounting standards;
(b) other for-profit private sector entities that are required only by their constituting document or another document to prepare financial statements that comply with Australian Accounting Standards, provided that the relevant document was created or amended on or after 1 July 2021; and
(c) other for-profit entities (private sector or public sector) that elect to prepare general purpose financial statements.

AASB 2020-2 amendments to AASB 1

AASB 2020-2 permits entities that elect to apply AASB 1060 General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities to periods beginning before 1 July 2021 (i.e., early application) to also elect to apply the short-term exemptions from restating comparative information set out in AASB 1053 Application of Tiers of Australian Accounting Standards Appendix E, where applicable. For entities that apply that relief, references to the ‘date of transition to Australian Accounting Standards’ in this Standard shall mean the beginning of the first Australian-Accounting-Standards reporting period.

Short-term exemptions for entities applying Tier 2 – Simplified Disclosures for periods beginning before 1 July 2022 Appendix E of AASB 1053

Appendix E of AASB 1053 sets out optional short-term exemptions for for-profit private sector entities applying AASB 1060 General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-For-Profit Tier 2 Entities to periods beginning before 1 July 2022, as follows:

(a) relief from distinguishing the correction of errors and changes in accounting policy, for periods beginning before 1 July 2022;

(b) relief from providing comparative information not previously disclosed in the notes, for periods beginning before 1 July 2021; and

(c) relief from restating comparative information, for periods beginning before 1 July 2021.

If an entity applies one or more of the exemptions set out in Appendix E, it shall disclose that fact.

AASB 2020-3 – Annual Improvements 2018–2020 and Other Amendments

AASB 2020-3 impacts:

  • AASB 1 (first time adoption relief for subsidiaries);

  • AASB 3 (business combinations reference to Conceptual Framework);

  • AASB 9 (accounting for fees on a modified financial liability);

  • AASB 116 (sales revenue earned when testing property, plant and equipment);

  • AASB 137 (assessment of whether a contract is loss making); and

  • AASB 141 (excluding tax in determination of fair value).

Main requirements of – Annual Improvements 2018–2020

AASB 2020-3 amends:

  1. AASB 1 to simplify the application of AASB 1 by a subsidiary that becomes a first-time adopter after its parent in relation to the measurement of cumulative translation differences;

  2. AASB 3 to update a reference to the Conceptual Framework for Financial Reporting without changing the accounting requirements for business combinations;

  3. AASB 9 to clarify the fees an entity includes when assessing whether the terms of a new or modified financial liability are substantially different from the terms of the original financial liability;

  4. AASB 116 to require an entity to recognise the sales proceeds from selling items produced while preparing property, plant and equipment for its intended use and the related cost in profit or loss, instead of deducting the amounts received from the cost of the asset;

  5. AASB 137 to specify the costs that an entity includes when assessing whether a contract will be loss-making; and

  6. AASB 141 to remove the requirement to exclude cash flows from taxation when measuring fair value, thereby aligning the fair value measurement requirements in AASB 141 with those in other Australian Accounting Standards.

AASB 2020-3 amendments to AASB 9

The key amendment to AASB 9 is:

Paragraph Details
B3.3.6 For the purpose of paragraph 3.3.2, the terms are substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10 per cent different from the discounted present value of the remaining cash flows of the original financial liability. In determining those fees paid net of fees received, a borrower includes only fees paid or received between the borrower and the lender, including fees paid or received by either the borrower or lender on the other’s behalf

AASB 2020-3 amendments to AASB 116

The key amendments to AASB 116 are:

Paragraph Details
17 Examples of directly attributable costs are:
17e Costs of testing whether the asset is functioning properly (i.e., assessing whether the technical and physical performance of the asset is such that it is capable of being used in the production or supply of goods or services, for rental to others, or for administrative purposes).
20A Items may be produced while bringing an item of property, plant and equipment to the location and condition necessary for it to be capable of operating in the manner intended by management (such as samples produced when testing whether the asset is functioning properly). An entity recognises the proceeds from selling any such items, and the cost of those items, in profit or loss in accordance with applicable Standards. The entity measures the cost of those items applying the measurement requirements of AASB 102 Inventories.
Disclosure
74A If not presented separately in the statement of comprehensive income, the financial statements shall also disclose:
74a The amount of compensation from third parties for items of property, plant and equipment that were impaired, lost or given up that is included in profit or loss; and
74b The amounts of proceeds and cost included in profit or loss in accordance with paragraph 20A that relate to items produced that are not an output of the entity’s ordinary activities, and which line item(s) in the statement of comprehensive income include(s) such proceeds and cost.

AASB 2020-3 amendments to AASB 137

The key amendments to AASB 137 are:

Paragraph Details
68A The cost of fulfilling a contract comprises the costs that relate directly to the contract. Costs that relate directly to a contract consist of both:
(a) The incremental costs of fulfilling that contract—for example, direct labour and materials; and
(b) An allocation of other costs that relate directly to fulfilling contracts—for example, an allocation of the depreciation charge for an item of property, plant and equipment used in fulfilling that contract among others.

AASB 2021-2 amendments Disclosure of Accounting Policies and Definition of Accounting Estimates

AASB 2021-2 amends:

  1. AASB 7: to clarify that information about measurement bases for financial instruments is expected to be material to an entity’s financial statements;

  2. AASB 101: to require entities to disclose their material accounting policy information rather than their significant accounting policies;

  3. AASB 108: to clarify how entities should distinguish changes in accounting policies and changes in accounting estimates;

  4. AASB 134: to identify material accounting policy information as a component of a complete set of financial statements; and

  5. AASB Practice Statement 2: to provide guidance on how to apply the concept of materiality to accounting policy disclosures.

AASB 2021-2 amendments to AASB 101

The amendments switch from the term ‘significant accounting policies’ to ‘material accounting policy information’.

Paragraph Details
10 A complete set of financial statements comprises:
10(e) notes, comprising material accounting policy information and other explanatory information.
Disclosure of accounting policy information
117 An entity shall disclose material its significant accounting policy information (see paragraph 7). Accounting policy information is material if, when considered together with other information included in an entity’s financial statements, it can reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements.
117A Accounting policy information that relates to immaterial transactions, other events or conditions is immaterial and need not be disclosed. Accounting policy information may nevertheless be material because of the nature of the related transactions, other events, or conditions, even if the amounts are immaterial. However, not all accounting policy information relating to material transactions, other events or conditions is itself material.
117B Accounting policy information is expected to be material if users of an entity’s financial statements would need it to understand other material information in the financial statements. For example, an entity is likely to consider accounting policy information material to its financial statements if that information relates to material transactions, other events or conditions and:
117B(a) the entity changed its accounting policy during the reporting period and this change resulted in a material change to the information in the financial statements;
117B(b) the entity chose the accounting policy from one or more options permitted by Australian Accounting Standards—such a situation could arise if the entity chose to measure investment property at historical cost rather than fair value;
117B(c) the accounting policy was developed in accordance with AASB 108 in the absence of an Australian Accounting Standard that specifically applies;
117B(d) the accounting policy relates to an area for which an entity is required to make significant judgements or assumptions in applying an accounting policy, and the entity discloses those judgements or assumptions in accordance with paragraphs 122 and 125; or
117B(e) the accounting required for them is complex and users of the entity’s financial statements would otherwise not understand those material transactions, other events, or conditions—such a situation could arise if an entity applies more than one Australian Accounting Standard to a class of material transactions.
117C Accounting policy information that focuses on how an entity has applied the requirements of the Australian Accounting Standards to its own circumstances provides entity-specific information that is more useful to users of financial statements than standardised information, or information that only duplicates or summarises the requirements of the Standards.
117D If an entity discloses immaterial accounting policy information, such information shall not obscure material accounting policy information.
117E An entity’s conclusion that accounting policy information is immaterial does not affect the related disclosure requirements set out in other Australian Accounting Standards.
122 An entity shall disclose, along with material accounting policy information or other notes, the judgements, apart from those involving estimations (see paragraph 125), that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements.

AASB 2021-2 amendments to AASB 108

AASB 2021-2 amends the definition of an accounting estimate as:

Accounting estimates are monetary amounts in financial statements that are subject to measurement uncertainty.

Paragraph Details
32 An accounting policy may require items in financial statements to be measured in a way that involves measurement uncertainty – that is, the accounting policy may require such items to be measured at monetary amounts that cannot be observed directly and must instead be estimated. In such a case, an entity develops an accounting estimate to achieve the objective set out by the accounting policy. Developing accounting estimates involves the use of judgements or assumptions based on the latest available, reliable information. Examples of accounting estimates include:
32(a) A loss allowance for expected credit losses, applying AASB 9 Financial Instruments.
32(b) The net realisable value of an item of inventory, applying AASB 102 Inventories.
32(c) The fair value of an asset or liability, applying AASB 13 Fair Value Measurement.
32(d) The depreciation expense for an item of property, plant, and equipment, applying AASB 116 Property, Plant and Equipment.
32(e) A provision for warranty obligations, applying AASB 137 Provisions, Contingent Liabilities and Contingent Assets.
32A An entity uses measurement techniques and inputs to develop an accounting estimate. Measurement techniques include estimation techniques (for example, techniques used to measure a loss allowance for expected credit losses applying AASB 9) and valuation techniques (for example, techniques used to measure the fair value of an asset or liability applying AASB 13).
32B The term ‘estimate’ in Australian Accounting Standards sometimes refers to an estimate that is not an accounting estimate as defined in this Standard. For example, it sometimes refers to an input used in developing accounting estimates.
34 An entity may need to change an accounting estimate may need revision if changes occur in the circumstances on which the accounting estimate was based or as a result of new information, new developments or more experience. By its nature, a change in an accounting estimate does not relate to prior periods and is not the correction of an error.
34A The effects on an accounting estimate of a change in an input or a change in a measurement technique are changes in accounting estimates unless they result from the correction of prior period errors.
38 Prospective recognition of the effect of a change in an accounting estimate means that the change is applied to transactions, other events, and conditions from the date of that change in estimate. A change in an accounting estimate may affect only the current period’s profit or loss, or the profit or loss of both the current period and future periods. For example, a change in a loss allowance for expected credit losses affects only the current period’s profit or loss and therefore is recognised in the current period. However, a change in the estimated useful life of, or the expected pattern of consumption of the future economic benefits embodied in, a depreciable asset affects depreciation expense for the current period and for each future period during the asset’s remaining useful life. In both cases, the effect of the change relating to the current period is recognised as income or expense in the current period. The effect, if any, on future periods is recognised as income or expense in those future periods.
48 Corrections of errors are distinguished from changes in accounting estimates. Accounting estimates by their nature are approximations that may need changing as additional information becomes known. For example, the gain or loss recognised on the outcome of a contingency is not the correction of an error.

AASB 2021-2 amendments to AASB 7

Paragraph Details
21 In accordance with paragraph 117 of AASB 101 Presentation of Financial Statements, an entity discloses material accounting policy information. Information about the measurement basis (or bases) for financial instruments used in preparing the financial statements is expected to be material accounting policy information.

AASB 2021-2 amendments to AASB Practice Statement 2

Practice Statement 2 has been amended to provide examples and guidance on determining whether accounting policy information is material.

AASB 2021-3 – Covid-19-Related Rent Concessions beyond 30 June 2021

AASB 2021-3 amends AASB 16 Leases to extend by one year the application period of the practical expedient added to AASB 16 by AASB 2020-4 Amendments to Australian Accounting Standards – Covid-19-Related Rent Concessions.

The practical expedient permits lessees not to assess whether rent concessions that occur as a direct consequence of the covid-19 pandemic and meet specified conditions are lease modifications and instead, to account for those rent concessions as if they were not lease modifications. AASB 2021-3 extends the practical expedient to rent concessions that reduce only lease payments originally due on or before 30 June 2022, provided the other conditions for applying the practical expedient are met.

AASB 2021-5 – Deferred Tax related to Assets and Liabilities arising from a Single Transaction

AASB 2021-5 amends AASB 112 to clarify the accounting for deferred tax on transactions that, at the time of the transaction, give rise to equal taxable and deductible temporary differences. In specified circumstances, entities are exempt from recognising deferred tax when they recognise assets or liabilities for the first time. The amendments clarify that the exemption does not apply to transactions for which entities recognise both an asset and a liability and that give rise to equal taxable and deductible temporary differences. This may be the case for transactions such as leases and decommissioning, restoration, and similar obligations. Entities are required to recognise deferred tax on such transactions.

AASB 2021-7 -Amendments to AASB 10 and AASB 128 (deferral of effective date)

AASB 2021-7 defers the mandatory application date of amendments to AASB 10 and AASB 128 that were originally made in AASB 2014-10 – Sale or Contribution of Assets between an Investor and its Associate or Joint Venture so that the amendments are required to be applied for annual reporting periods beginning on or after 1 January 2025 instead of 1 January 2022.

1.6 - 2021 the horizon for Accountants

After nearly 10 years of constant change to accounting standards, including the introduction of the “triple whammy” of AASB 9, AASB 15 and AASB 16, the accounting horizon is very calm for those entities already preparing general purpose financial reports, unless they are In the insurance sector with AASB 17 being introduced in 2024. The situation is definitely not as calm for those entities having previously prepared special purpose financial statements, with special purpose being removed in 2022.

This article is to help accountants in Australia, both preparers and auditors, identify what changes they need to be aware of over the next 4 years.

The amendments to Accounting Standards applicable to Australian for-profit entities with 30 June financial reporting year-ends are:

December year ends – application of these standards are 6 months earlier, for example 2021 amendments apply on 31 December 2020, except for AASB 2020-2 Removal of Special Purpose Financial Statements which will apply to 31 December 2022 for December reporters.

Good news for Accountants

Accountants can breathe a sigh of relief that the period of significant change in key accounting standards is over. From 2017 to 2020 the adoption of three significant new accounting standards had widespread application and transformed corporate financial reporting. These being:

  • AASB 9 Financial Instruments;
  • AASB 15 Revenue from Contracts with Customers; and
  • AASB 16 Leases.

There are some changes that Accountants need to be aware of in 2021 and future years, but these are not of the size or scale to cause concern for most. Looking forward to 2024, there are no significant new standards on the horizon other than AASB 17 Insurance Contracts. AASB 17, whilst significant for insurance companies, does not have the wide reach of AASB 9, 15 and 16 and for most entities will have no impact on their financial reporting.

Accounting changes applicable for 2021

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2020:

Revised definition of a business – Amendments to AASB 3 (AASB 2018-6)

The IASB and AASB amended the definition of a business in AASB 3 to resolve difficulties that arise when an entity determines whether it has acquired a business or a group of assets.

The amendments clarify:

  • In order to be considered a business, an acquired set of activities and assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs.
  • Remove the assessment of whether market participants are capable of replacing any missing inputs or processes and continuing to produce outputs;
  • Add guidance and illustrative examples to help entities assess whether a substantive process has been acquired;
  • Narrows the definition of a business and of outputs by focusing on goods and services provided to customers and by removing the reference to an ability to reduce costs; and
  • Adds an optional concentration test that permits a simplified assessment of whether an acquired set of activities and assets is not a business.

Practical implications

The introduction of the optional concentration test is of particular interest for acquisitions of entities where the purchase price is mainly attributable to underlying acquired assets rather than goodwill, which often occur in acquisitions in the natural resources and real estate industry sectors.

Covid-19 related rent concessions – Amendments to AASB 16 (AASB 2020-4)

Many entities have been granted rent concessions such as deferral of lease payments and payment holidays as a result of Covid-19 business disruptions. The International Accounting Standards Board published an optional practical expedient for lessees to account for such concessions as a lease modification, accounting for the rent concession as a variable lease payment in the financial reporting period. The lessee would also make a corresponding adjustment to the lease liability, in effect derecognising the part of the lease liability that has been forgiven or waived.

AASB 16 paragraph 46B provides strict criteria that must be met before a lessee may apply this practical expedient. Lessees’ rental concessions must occur as a direct consequence of the Covid-19 pandemic and where the following conditions are met:

  • The change in lease payments result in revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease immediately preceding the change;
  • Any reduction in lease payments affects only payments due on or before 30 June 2021; and
  • There is no substantive change to other terms and conditions of the lease.

Practical implications

This concession provides relief and is likely to be taken up by entities with many property leases, as otherwise the rent concession would likely be considered a lease modification, triggering recalculation of the lease liability.

Definition of material – Amendments to AASB 101 and AASB 108

The definition of material has been deleted from AASB 108, with the revised definition provided in AASB 101. The amendments ensure that the definition of material is consistent across all Accounting Standards.

The new definition states that

“information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, with provide financial information about a specific reporting entity.”

Changes in the definition:

  • Introduces “could reasonably be expected to influence” – rather than the old wording could influence
  • Obscuring information is a concept that has been introduced with guidance provided on the ways that information can be obscured in financial statements
  • Primary users are a change from the old definition which simply referred to users.

Obscuring

Material information can be obscured in the following ways:

  • If the language regarding a material item is vague or unclear;
  • If information regarding a material item is scattered in different places in the financial statements;
  • If dissimilar items are inappropriately aggregated;
  • If similar items are inappropriately disaggregated; and
  • If material information is hidden by immaterial information to the extent that it becomes unclear what information is material.

Practical implications

The introduction of the requirement to not ‘obscure information’ places emphasis on how information is reported in financial statements.

Interest rate benchmark reform Phase 1 – Amendments to AASB 9, 139 and 7

The Phase 1 amendments, which respond to the impact of Interbank Offered Rates (IBOR) reform, provide temporary relief enabling hedge accounting to continue during the period of uncertainty before the replacement of an existing interest rate benchmark with an alternative nearly risk-free interest rate.

Without these amendments, some hedge accounting requirements in AASB 9 and AASB 139 may be affected by uncertainties arising from the impact of the reform on the timing and amount of designated future cash flows. Due to such uncertainties, entities could be required to discontinue hedge accounting. Entities may also not be able to designate new hedging relationships.

The reliefs have the effect that IBOR reform should not generally cause hedge accounting to terminate. Any hedge ineffectiveness should continue to be recognized in profit or loss as required by AASB 9 and AASB 139.

Practical implications

IBOR is not commonly used in Australia, so the impact is not expected to be significant for Australian entities. For those affected, transparent disclosure of the impact of IBOR reform on risk management is required.

The conceptual framework for financial reporting

The revised Conceptual Framework for Financial Reporting is not a standard. Its purpose is to assist the IASB and the IFRS Interpretations Committee in developing standards and interpretations. The Conceptual Framework is also applied by preparers of financial reports where there is no applicable accounting standard in place.

The IASB issued the Conceptual Framework in March 2018, it includes some new concepts, provides updated definitions and recognition criteria for assets and liabilities.

Practical implications

Entities should refer to the Conceptual Framework when accounting in situations where no standard applies to the transaction or where there is a choice of accounting policy that may be applied.

Beyond 2021

Accountants need to consider future amendments for two reasons:

  1. Whether the amendment should be early adopted; and
  2. Disclosure of the potential impact of issued but not yet effective new Accounting Standards and amendments in the Annual Financial Statements as required by AASB 108.

Accounting changes applicable for 2022

The following new pronouncements have application to annual financial reporters with a year-ending on or after 30 June 2022 except for the IBOR Phase 2 reforms which apply to 31 December 2021 year-ends:

Removal of special purpose financial statements AASB 2020-2

For profit entities that prepare financial statements in accordance with the Corporations Act 2001, other legislation, their constitution, or other agreements will no longer be allowed to prepare Special Purpose Financial Statements.

Practical implications

Affected entities will have to apply the full recognition and measurement requirements of Australian Accounting Standards.

Interest rate benchmark reform Phase 2 – Amendments to AASB 9, 139 and 7

The Phase 2 amendments, which respond to the impact of Interbank Offered Rates (IBOR) reform, relate to address issues that might affect financial reporting when an existing interest rate benchmark is actually replaced. Phase 1 deals with issues arising before the reform takes effect. The Phase 2 amendments deal with replacement issues, relating to the modification of financial assets, financial liabilities, lease liabilities and specific hedge accounting requirements.

Practical implications

IBOR is not commonly used in Australia, so the impact is not expected to be significant for Australian entities. For those affected, transparent disclosure of the impact of IBOR reform on risk management is required.

Accounting changes applicable for 2023

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2022:

AASB 116 Amendments - proceeds before intended use

Sale proceeds will no longer be allowed to be deducted from the cost of property, plant and equipment before its intended use. Instead, an entity recognizes the sale proceeds and the cost of producing those sales in its profit or loss.

Practical implications

Determining the costs of production may be difficult. Companies in the natural resources industry are likely to be impacted by this amendment.

AASB 137 Amendments - costs of fulfilling an onerous contract

In assessing whether a contract is onerous an entity is required to include both the incremental costs of fulfilling that contract and an allocation of other costs that relate directly to fulfilling contracts, such as depreciation of equipment used to fulfil the contract and contract management and supervision costs.

Practical implications

Entities that applied the incremental cost approach will see provisions increase to reflect the inclusion of costs related directly to contract activities.

Accounting changes applicable for 2024

The following new pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2023:

AASB 17 Insurance Contracts

AASB 17 is a comprehensive new accounting standard for insurance contracts covering recognition and measurement, presentation and disclosure. Insurance contracts combine features of both a financial instrument and a service contract. The objective of AASB 17 is to provide an accounting model for insurance contracts that provides useful information about these features.

Practical implications

AASB 17 is a complete overhaul of accounting for insurance contracts and for entities that issue insurance and reinsurance contracts, it will require significant changes to accounting systems and processes.

AASB 101 – Amendments to classification of current and non-current liabilities

Currently entities classify a liability as current when they do not have an unconditional right to defer settlement of the liability for at least 12 months after the end of the reporting period. Under the amendment:

  • the AASB has removed the requirement for a right to be unconditional and now requires that a right to defer settlement must have substance and exist at the end off the reporting period;
  • rights are in existence if covenants are complied with at the end of the reporting period; and
  • introduces a definition of ‘settlement’ to make it clear that settlement refers to transfers of cash, equity instruments and other assets or services.

The existing requirement to ignore management’s intentions or expectations for settling a liability when determining the classification remains unchanged.

Practical implications

The revised definition needs to be considered in relation to compliance with loan covenants. In addition, the amendments may impact the classification of convertible instruments that are settled with the transfer of equity instruments.

Bad news for Auditors in professional practice

For Auditors, although accounting changes that they have to understand are minimal in 2021 the introduction of ASA 540 revised, applicable for 31 December 2020 audits, heralds a new era of complexity and a drive for quality which we discuss in our article “2021 the horizon for Auditors”.

2 - Lawyers

Resources for lawyers.

2.1 - Errors in applying Accounting Standards that misstate financial reports

Investors need to be able to rely upon the information provided to them by Directors of the entities in which they invest. Unfortunately, misstatements of financial reports occur due to either fraud or error. In this publication, we consider the accounting errors that we encounter when providing expert evidence on disputed accounting treatments and misstatements in financial reports and the relevant accounting standards that have not been correctly applied.

The key areas of misstatement that we consider relate to:

  • Inappropriate assessment of the entity’s ability to continue as a going concern
  • Overstatement of revenue and income
  • Understatement of costs and expenses
  • Impairment of assets
  • Overvaluation of assets
  • Incorrectly capitalising expenses as assets
  • Understatement of liabilities
  • Failure to recognise liabilities and obligations
  • Incorrect measurement of fair value and recoverable amount
  • Incorrect consolidation and assessment of control of an entity
  • Incorrect equity accounting and assessment of significant influence of an entity
  • Failure to make the appropriate classification of presentation
  • Failure to disclose information that is material to the understanding of the financial report

Please check out our downloadable document.

2.2 - Accounting standards and interpretations for litigators

In recent years director and auditor performance has become the subject of numerous litigation matters. These matters usually involve claims that:

  • the directors issued a financial report that was materially misstated and not in accordance with the relevant Australian Accounting Standards; and
  • the auditor issued the wrong audit opinion on financial statements having failed to perform the audit in accordance with the requirements of Australian Auditing Standards (ASAs).

Our guide to the accounting standards and interpretations relevant to these litigation matters

In our publication we set out the key accounting standards and their relevance to accounting failures often claimed in litigation matters.

Please check out our downloadable document.

2.3 - Auditing failures that result in litigation

Most auditing failures centre on circumstances where the auditor has expressed an unqualified audit opinion on a financial report that was materially misstated and did not comply with the relevant accounting standards.

In these circumstances the auditor either failed to obtain sufficient, appropriate audit evidence to identify a material error or obtained evidence to identify the error but ignored or misinterpreted that evidence.

The Australian Auditing Standards (ASAs) require an auditor to undertake various procedures that if not performed appropriately can result in the auditor being exposed to litigation.

In this publication, we set out common auditing failures that expose auditors to litigation and the relevant ASAs outlining the auditor’s obligations in relation to these failures.

Please check out our downloadable document.

2.4 - Auditing standards applicable to litigation matters

In recent years auditor performance has become the subject of numerous litigation matters . These matters usually involve the claim that the auditor issued the wrong audit opinion on financial statements that were materially misstated and not in accordance with the relevant Australian Accounting Standards (AASBs).

Such matters involve the claim that the auditor failed to perform the audit in accordance with the requirements of Australian Auditing Standards (ASAs) and that if they had have performed the audit correctly they would have issued a modified audit opinion.

Our guide to the auditing standards relevant to auditor litigation matters

In our publication we set out the key auditing standards and their relevance to audit failures often claimed in auditor litigation matters.

Please check out our downloadable document.

2.5 - Auditing FAQ

Do auditors have to comply with Accounting Standards?

No

Directors of the entity being audited are responsible for ensuring the financial statements comply with applicable accounting standards “AASB’s” as issued by the Australian Accounting Standards Board.

An auditor performs their audit to obtain sufficient and appropriate evidence to allow them to opine as to whether the financial statements are prepared in accordance with applicable accounting standards.

An auditor is required to perform their audit in accordance with Australian Auditing Standards “ASA’s” as issued by the Australian Auditing Standards Board “AuASB”.

What should an auditor do when they identify an error?

When an auditor identifies an error, they are required to communicate the identified error to management and those charged with governance, that is, the audit committee or Board.

In most cases, when a material error identified by the auditor is communicated to management and those charged with governance, the error is corrected before the financial report is issued.

What should an auditor do when they cannot obtain sufficient appropriate audit evidence?

Directors of an entity being audited are responsible for providing sufficient and appropriate audit evidence to the auditor to support the accounting positions adopted in the financial report being audited.

In the event that the auditor cannot obtain sufficient appropriate audit evidence as required by ASA 260 and ASA 330, the auditor is required to communicate these difficulties to the entity’s management and those charged with governance.

The communication should make it clear that if evidence is not provided in a timeframe that would allow the auditor sufficient time to review and analyse it, the auditor is required to issue a modified audit opinion in accordance with ASA 705.

What does a modified audit opinion mean?

There are three different types of modified audit opinions issued by auditors: qualified opinion, an adverse opinion, and a disclaimer of opinion.

A qualified audit opinion is issued when either the misstatement is known, but the material misstatement is not pervasive (for example, it is known that a property is carried above its fair value, but the entity does not want to write the asset down to its recoverable amount) or where sufficient audit evidence is not available, but the potential material misstatement is not pervasive.

An adverse audit opinion is issued when material misstatements are pervasive.

A disclaimer of opinion is issued when sufficient audit evidence is not available and the potential material misstatements are pervasive.

The inclusion of an emphasis of matter paragraph in the auditor’s report is not a modified audit opinion. An emphasis of matter paragraph is included in the auditor’s report when a matter is appropriately presented or disclosed in the financial report that, in the auditor’s view, is of such importance that it is fundamental to user’s understanding of the financial report.

How common are modified audit opinions?

Auditors regularly identify accounting errors. Management and Boards generally act upon the advice of the auditor to correct identified errors and provide the auditor with sufficient and appropriate audit evidence to enable the auditor to issue an unmodified audit opinion.

If an entity refuses to correct a known error identified by the auditor what should the auditor do?

If Directors fail to act on the auditor’s advice to correct identified errors and provide the auditor with sufficient, appropriate audit evidence to support the error correction, then the auditor is required to assess whether the error is pervasive and issue a modified audit opinion.

Where an audit is performed in compliance with the Corporations Act 2001 (Cth) and the Directors have failed to correct a known error, the auditor is required under s 311 of the Corporations Act 2001 (Cth) to notify the Australian Securities and Investments Commission that the Financial Report is materially misstated.

A group audit involves numerous audit firms, auditing various subsidiaries in the group. If an error occurs in a subsidiary not audited by the same firm as the head office auditor, is the head office auditor at fault?

Yes

In order to comply with the overall objective of an audit as set out in ASA 200, an auditor is required to obtain sufficient and appropriate audit evidence so as to opine on the group financial report.

The head office auditor is required to be satisfied that those performing the group audit engagement, including component auditors, collectively have the appropriate competence and capabilities to perform the group audit. ASA 600 paragraph 4 sets out that the head office auditor is responsible for the direction, supervision, and performance of the group audit engagement.

Can management representation alone be sufficient and appropriate audit evidence?

No – this is explicitly dealt with in ASA 580 which states that: Although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable written representations does not affect the nature or extent of other audit evidence that the auditor obtains about the fulfilment of management’s responsibilities, or about specific assertions.

Should post balance sheet events be used to test the validity of an estimate made at the year end?

Yes, where the subsequent event provides additional information about pre-existing conditions that existed at the balance sheet date. For example, if the company faced a legal claim before the balance sheet date and the legal claim is settled in the subsequent period before the financial report is signed, the estimated loss would be adjusted to reflect the actual settlement loss.

No, where the subsequent event provides new information about a condition that did not exist on the balance sheet date – for example post balance sheet date a fire destroys a company’s warehouse and the warehouse and inventory stored within the warehouse are lost. This is a post balance sheet event which should be disclosed in the financial report but would not adjust the value of the inventory and property asset included in the financial report.

What is an assertion?

The preparation of financial statements are the responsibility of the client’s directors and management. Financial statements contain the assertions about the transactions, events, and account balances.

Audit assertions provide areas of potential misstatement that may occur in financial statements. Audit assertions can be summarised as:

  • Existence or occurrence – assets and liabilities exist, and recorded transactions occurred.

  • Rights and obligations – The entity has the right to control and use its assets and has the obligation to pay its liabilities.

  • Completeness – all transactions that should have been recorded have been recorded in the financial statements.

  • Accuracy – amounts related to transactions have been recorded appropriately.

  • Cut-off – transactions have been recorded in the correct accounting period.

  • Classification – transactions are correctly classified in the financial report.

  • Presentation and disclosure – sufficient disclosures have been made in the financial statements.

What is materiality?

Materiality is a convention within accounting and auditing relating to the significance of an amount, transaction, or discrepancy. In considering whether an item is material AASB 108 requires entities to consider whether investors would be misled if the accounting treatment were incorrect.

Materiality is a key concept within Auditing. ASA 320 requires the auditor to consider materiality in the context of an Audit and notes that the auditor’s determination of materiality is a matter of professional judgement and is affected by the auditor’s perception of the financial information needs of users of the financial report. The concept of materiality is applied by the auditor both in planning and performing the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial report and in forming the opinion in the auditor’s report.

What is an audit plan?

ASA 300 requires an auditor to plan an audit of a financial report. Planning an audit involves establishing the overall strategy for the engagement and developing an audit plan. The audit plan is a document or documents that includes a description of:

  • The nature, timing and extent of planned risk assessment procedures;

  • The nature, timing and extent of planned audit procedures at the assertion level;

  • Other planned audit procedures that are required to be carried out so that the engagement complies with Auditing Standards.

Planning is not a discrete phase of an audit, but rather a continual and iterative process that continues until completion of the engagement. As a result of unexpected events, changes in conditions, or the audit evidence obtained from the results of audit procedures, the auditor modifies the overall strategy and audit procedures performed based on the revised consideration of assessed risks.

Must an auditor consider an entity’s ability to continue as a going concern?

Yes

Financial statements are prepared on a going concern basis unless the Directors and management determine that they intend to liquidate the entity, cease trading, or have no realistic alternative but to do so. The assessment of the entity’s ability to continue as a going concern involves making a judgement, at a particular point in time about inherently uncertain future outcomes of events or conditions.

Auditors need to ensure that the client has performed an appropriate assessment with respect to going concern. ASA 570 requires the auditor to exercise professional judgement when evaluating the client’s assessment, identifying critical assumptions and data, considering whether sufficient appropriate audit evidence has been obtained to support those key assumptions.

What must an auditor do, if there is uncertainty as to an entity’s ability to continue as a going concern, and that uncertainty is not adequately disclosed?

ASA 570 requires the auditor to express an adverse opinion if the financial report has been prepared using the going concern basis of accounting but, in the auditor’s judgement, management’s use of the going concern basis of accounting in the preparation of the financial report is inappropriate.

If in the auditor’s opinion the use of the going concern basis is appropriate but adequate disclosure of a material uncertainty is not made in the financial report, the auditor shall express a qualified opinion or adverse opinion, as appropriate. In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, the auditor states that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the financial report does not adequately disclose this matter.

Must an auditor consider the risk that management are biased in making accounting estimates?

ASA 540 is explicit in its requirement for the auditor to consider whether management have appropriately considered estimation risk, and if not, to request that management adjust their estimate.

The auditor is required to “stand back” and consider and evaluate evidence that both supports and contradicts management’s estimate and emphasises professional scepticism as a response to management bias.

Must an auditor consider events after an entity’s year end?

Yes

ASA 560 requires the auditor to perform audit procedures designed to obtain sufficient appropriate audit evidence that all events occurring between the date of the financial statements and the audit or the auditor’s report that require adjustment of, or disclosure in the financial statements have been identified.

What is an analytical review?

Analytical review is the evaluation of financial information through analysis of relationships among both financial and non-financial data.

Auditors perform analytical procedures in all phases of the audit. Where analytical procedures identify fluctuations or relationships that are inconsistent with other relevant information or differ from expected values by a significant amount, the auditor is required to investigate such differences and perform other audit procedures as necessary in the circumstances.

What is the difference between an audit and a review?

An audit provides a higher level of assurance than a review.

The purpose of an audit is to provide financial report users with an opinion by the auditor on whether the financial report is prepared in accordance with accounting standards and interpretations as issued by the AASB.

A review engagement is conducted to provide limited assurance that there are no material modifications that should be made to the financial report. Review engagements provide less assurance to the user of the financial report because the auditor performs mainly analytical procedures to understand key relationships as to the reasonableness of the financial information presented in the financial report.

Are ASAs the same as ISAs?

Australian Auditing Standards (ASA’s) conform with International Standards on Auditing (ISA’s). In certain instances, application and other explanatory paragraphs are added to the Australian Auditing Standards which do not appear in the text of the equivalent ISA and are identified with the prefix ‘Aus”.

Where can I find a copy of the auditing standards?

Copies of Australian Auditing Standards can be obtained from the Auditing and Assurance Standards Board at Australian Auditing Standards (auasb.gov.au)

What is involved in the risk assessment process?

The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial report and assertion levels thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement.

ASA 315 requires the auditor to obtain an understanding of the client’s risk assessment process relevant to the preparation of the financial report and to assess the effectiveness of those processes in order to determine the risk of material misstatement.

Who takes responsibility for audit quality?

The signing audit partner takes responsibility for audit quality. ASA 700 requires the auditor’s opinion to include a section with the heading “Auditor’s Responsibility”. The auditor states whether they believe that the audit evidence they have obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

3 - Auditors

Resources for auditors.

3.1 - The horizon for Auditors – January 2022

The horizon for auditors is driven by the desire to improve audit quality, resulting in the introduction and implementation of:

A challenging horizon ahead for auditors

The audit profession has come under significant pressure in recent years, having to audit new and complex accounting standards against a background of increasing criticism from regulators globally and an increasingly litigious environment.

The IAASB have released a series of revised auditing standards (ASA 540, ASA 500 and ASA 315) to improve audit quality, emphasizing the need for auditors to apply professional scepticism. Concurrently, the IAASB introduced a new standard in respect of quality management for audit firms (ISQM1).

The fundamental requirements of an audit, being to obtain sufficient appropriate audit evidence to opine whether the financial report is free of material misstatement, has not been changed or been enhanced. Nor has the requirement to understand the entity and the environment it operates in, so as to identify the risk of material misstatement through error or fraud. The revised auditing standards will however make it clearer for reviewers, regulators, and litigators to identify when the auditor has failed to properly identify risk and failed to obtain sufficient audit evidence.

Key amendments to auditing and ethical standards applicable to Australian auditors

The key amendments to auditing and ethical standards applicable to Australian auditors are:

2022 2023 2024
ISQM1 to be in place system by 15 December 2022 First year of implementing and quality under ISQM1 Review of ISQM1 application
Readiness for ASA 315 (revised) Identifying and Assessing the Risks of Material Misstatement First year of ISQM2 Review of ISQM2 application
First year of ASA 315 (revised) applying to the planning of 31 December 2022 year ends First year of ASA 315 (revised) applying to the planning of 30 June 2023 year
Amended APES 110 Code of Ethics for Professional Accountants to Promote the Role and Mindset Expected of Professional Accountants in place from 1 January 2022 First year of ASA 220 (revised) applying to half year reviews for 30 June 2023 and full year audits 31 December 2023 First year of ASA 220 (revised) applying to half year reviews for 31 December 2023 and full year audits 30 June 2024
Application of ASRS 4400 (revised), Agreed-Upon Procedures Engagements, applicable from 1 January 2022
Review of: ASA540(revised) application ASA 500(revised) application Review of: ASA540(revised) application ASA 500(revised) application Review of: ASA 220(revised) application ASA 315(revised) application ASA540(revised) application ASA 500(revised) application

2022 Another challenging year for auditors

2022 is the year in which an audit firm implements ISQM1, (this needs to be completed by 15 December 2022) and prepares to implement ASA 315 (revised). 2022 also sees the application of revisions to APES 110, which will implement both assurance and non-assurance arrangements, and the introduction of ASRS 4400 (revised) Agreed-Upon Procedures Engagements.

2022 will involve an audit firm implementing and applying:

2022 will involve an audit firm preparing to implement:

ISQM1 represents a fundamental change as to how Australian audit firms address quality management, Australian audit firms are required to implement an ISQM1 Quality Management process by 15 December 2022.

Practical implications

Audit firms need to determine as soon as possible, their plan and timeline for implementing ISQM1.

This plan must include:

The individual and team who are responsible for implementation.

A realistic time frame for implementation, considering peak audit workloads, staff turnover, training requirements and the need to rectify deficiencies.

The firm’s quality management plan will form the basis for future inspections by regulators and professional bodies. Therefore, a robust and well considered plan is crucial.

Amendments to APES 110 Code of Ethics for Professional Accountants to Promote the Role and Mindset Expected of Professional Accountants

The amendments to APES 110 are effective 1 January 2022.

The revisions to APES 110 promote the role and mindset expected of accountants and include a new requirement for accountants to have an inquiring mind when applying the conceptual framework of the Code of Ethics.

The amendments include:

  • Definition of professional judgement

  • Further explanation of the requirement to act in the public interest

  • Revisions to the five fundamental principles of ethics for accountants

  • Definition of what integrity involves

  • Guidance on compliance with the principle of objectivity

  • Requires an accountant to have an inquiring mind

  • Requirements to consider the source, relevance and sufficiency of information obtained

  • Definition and examples of bias

Key Requirements of APES 110 amendments

The revisions to APES 110 clarify that the mindset of Professional Accountants and auditors in Australia is to be impartial when performing:

  • An audit

  • Agreed upon procedures

  • Providing technical advice

  • Preparing financial statements

  • Providing taxation advice

  • Providing valuations

The key theme being that a Professional Accountant, when performing accounting services cannot simply provide their client with the advice or outcome their client desires, ignoring the interest of others or potential contradictory evidence.

The amendments to APES 110 set out that all Professional Accountants and auditors are required to:

  • consider not only the preferences or requirements of an individual client or employing organisation, but also the interests of other stakeholders when performing Professional Activities

  • to be straightforward and honest in all professional and business relationships

  • to exercise professional or business judgements without being compromised by undue influence of, or undue reliance on, individuals, organisations, technology or other factors

  • attain and maintain professional knowledge and skill at the level required to ensure that a client or employing organisation receives competent Professional Activities, based on current technical and professional standards and relevant legislation

  • behave in a manner consistent with the profession’s responsibility to act in the public interest in all Professional Activities and business relationships

  • avoid any conduct that the Professional Accountant knows or should know might discredit the profession

  • have the strength of character to act appropriately, even when facing pressure to do otherwise or when doing so might create potential adverse personal or organisational consequences

  • have an enquiring mind

  • consider the source, relevance and sufficiency of information obtained, taking into account the nature, scope and outputs of the Professional Activity being undertaken

  • be open and alert to the need for further investigation or other action

  • consider whether the information or its source might be influenced by bias or self-interest

  • consider whether there is reason to be concerned that potentially relevant information might be missing from the facts and circumstances

  • consider whether there is an inconsistency between the known facts and circumstances and the Professional Accountant’s expectations

  • consider whether the information provides a reasonable basis on which to reach a conclusion

  • consider whether there might be other reasonable conclusions that could be reached from the information obtained

APES 110 amendments – Bias

APES 110 defines bias as:

Conscious or unconscious bias affects the exercise of professional judgement when identifying, evaluating and addressing threats to compliance with the fundamental principles.

APES 110 sets out the following examples of potential bias that Professional Accountants are required to be aware of when exercising professional judgement:

  • Anchoring bias, which is a tendency to use an initial piece of information as an anchor against which subsequent information is inadequately assessed.

  • Automation bias, which is a tendency to favour output generated from automated systems, even when human reasoning or contradictory information raises questions as to whether such output is reliable or fit for purpose.

  • Availability bias, which is a tendency to place more weight on events or experiences that immediately come to mind or are readily available than on those that are not.

  • Confirmation bias, which is a tendency to place more weight on information that corroborates an existing belief than information that contradicts or casts doubt on that belief.

  • Groupthink, which is a tendency for a group of individuals to discourage individual creativity and responsibility and as a result reach a decision without critical reasoning or consideration of alternatives.

  • Overconfidence bias, which is a tendency to overestimate one’s own ability to make accurate assessments of risk or other judgements or decisions.

  • Representation bias, which is a tendency to base an understanding on a pattern of experiences, events or beliefs that is assumed to be representative.

  • Selective perception, which is a tendency for a person’s expectations to influence how the person views a particular matter or person.

Practical Implications

The revisions to APES 110, potentially expose Professional Accountants and auditors to greater scrutiny and litigation than they have been subject to historically.

The amendments make it very difficult for Professional Accountants to produce reports or advice framed around assumptions they have been provided which are clearly incorrect, misleading or otherwise deficient.

ASRS 4400 (revised) Agreed-Upon Procedures Engagements

ASRS 4400 (revised) Agreed-Upon Procedures Engagements, has been revised to respond to the growing demand for these engagements, particularly in relation to the need for increased accountability around funding and grants.

The revised requirements and application material promote consistency in the performance of agreed-upon procedures engagements, and include enhancement relating to, among other matters:

  • the exercise of professional judgement

  • compliance with independence requirements

  • engagement acceptance and continuance considerations

  • using the work of a practitioner’s expert

  • greater clarity and transparency in the agreed-upon procedures report.

ISRS 4400 (revised) will be effective for agreed upon procedure (AUP) engagements for which the terms of engagement are agreed on or after 1 January 2022.

In addressing public interest issues relevant to AUP engagements, the revised standard intends to:

  • Respond to the needs of stakeholders―the scope of the revised standard has been broadened to meet the demand for AUP engagements on both financial and non-financial subject matters

  • Provide clarity in the AUP report

  • Enhance consistency in the performance of AUP engagements.

Key amendments to agreed upon procedures engagements

Key amendments include:

  • The scope now covers AUP engagements on both financial and non-financial subject matters

  • The term ‘factual findings’ has been replaced by the term ‘findings,’ which is defined as the factual results of agreed-upon procedures performed

  • Setting out that ‘findings’ exclude opinions or conclusions in any form as well as any recommendations

  • Setting out that findings are capable of being objectively verified

  • Requirement for the AUP report to include a statement on independence

  • Requirement for the practitioner to exercise professional judgment throughout the engagement, including in accepting, conducting and reporting on the AUP engagement, taking into account the circumstances of the engagement.

New requirements in relation to engagement acceptance and continuance considerations

The revised standard introduces new requirements in relation to engagement acceptance and continuance considerations, including:

  • The requirement to understand the purpose of the engagement, and the requirement to decline the engagement if the practitioner becomes aware of any facts or circumstances indicating that the procedures are inappropriate for the purpose of the engagement

  • Only accepting or continuing the engagement when certain conditions are met

  • Communicating with the firm if information is obtained that would have caused the firm to decline the engagement had that information been available earlier, so that necessary action can be taken.

Indications that the procedures the practitioner is asked to perform are inappropriate for the purpose of the agreed-upon procedures engagement

ASRS 4400 sets out the circumstances where it is inappropriate to accept or perform of the agreed-upon procedures engagement, these being:

  • The procedures are selected in a manner intended to bias the intended users’ decision-making

  • The subject matter on which the agreed-upon procedures are performed is unreliable

  • An assurance engagement or advisory service may better serve the needs of the engaging party or other intended users.

Considering the needs of the intended user

ASRS 4400 sets out that in certain circumstances it may only be appropriate to accept or continue the agreed upon procedure engagement if the practitioner requests the engaging party to:

  • Distribute a copy of the anticipated procedures and the form and content of the agreed-upon procedures report as set out in the terms of engagement to the intended user

  • Obtain acknowledgement from the intended user of the procedures to be performed

  • Discuss the procedures to be performed with appropriate representatives of the intended user.

In some circumstances it may only be appropriate to accept or continue the agreed upon procedure engagement if the practitioner reads correspondence between the engaging party and other intended user if the engaging party is not the only intended user.

Practical implications of ASRS 440 (revised)

The nature of an agreed upon procedure has historically meant this type of engagement as being viewed as the least risky type of engagement performed by an auditor, largely because as by definition the auditor provides no assurance and is not governed by the auditing standards.

ASRS 4400 (revised) together with the amendments to APES 110 will mean that auditors now need to consider the needs of users and ensure that their reported findings are not influenced by bias or self-interest.

2023 Another challenging year for auditor

2023 will see the audit firm:

  • test its quality management system for compliance with ISQM1

  • implement the revised ASA 220 Quality Control for an Audit of a Financial Report and Other Historical Financial Information and the new standard ISQM2 Engagement Quality Reviews

  • Apply ASA315 to the audit of 30 June 2023 year ends

2024 Adjusting to the new norm

At present no new or revised auditing standards are applicable for 2024, this year will represent a period of audit firms being inspected against the new and revised suit of auditing standards and the revised quality standards.

New quality management standards

As part of the IAASB’s drive to improve audit quality, the IAASB introduced two revised quality management standards.

The challenge of implementing these new standards should not be underestimated, with the full impact being felt in 2023.

2023 will be the first full year audit firms apply ISQM1, which require audit firms to:

  • Continually monitor the appropriateness of the firm’s quality risk management for changing risks and conditions

  • Evaluate the performance of the audit firm’s leadership

  • Evaluate and conclude whether the system of quality management is achieving its objectives (to be performed annually)

  • Take further action if the conclusion on whether the system of quality management is achieving its objectives is unsatisfactory.

Practical implications

The ongoing compliance with ISQM1 should not be underestimated, audit firms are required to test their quality management system at least annually.

The audit firm will have clearly failed to comply with the requirements of ISQM1 if:

  • An annual review of the effectiveness of the audit firm’s quality management system is not performed

  • Appropriate actions are not taken for weaknesses identified in the annual review.

ISQM2 Engagement Quality Reviews

ISQM2 is effective for audit and review engagements of financial statements for periods beginning on or after 15 December 2022, applying to half year reviews for 30 June 2023 and full year audits 31 December 2023.

ISQM 2 Engagement Quality Reviews, addresses:

  • The appointment and eligibility of the engagement quality (EQ) reviewer

  • The EQ reviewer’s responsibilities relating to the performance and documentation of an EQ review.

The changes introduced in ISQM 2 are intended to:

  • Extend the scope of engagements subject to an EQ review (in addition to audits of financial statements of listed entities)

  • Strengthen the eligibility criteria for an individual to be appointed as an EQ reviewer

  • Enhance the EQ reviewer’s responsibilities relating to the performance (including the nature, timing and extent of procedures) and documentation of the EQ review.

ISQM2 requires an EQ review for:

  • Audits of financial statements of listed entities

  • Audits or other engagements for which an EQ review is required by law or regulation

  • Audits or other engagements for which the firm determines that an EQ review is an appropriate response to address one or more quality risk(s).

The EQ reviewer must have:

  • An understanding of professional standards, applicable legal and regulatory requirements and of the firm’s policies or procedures relevant to the engagement;

  • Knowledge of the entity’s industry

  • An understanding of, and experience relevant to, engagements of a similar nature and complexity

  • An understanding of the responsibilities of the engagement quality reviewer in performing and documenting the engagement quality review

  • Sufficient time

  • Appropriate authority

  • Comply with relevant ethical requirements, including threats to objectivity and independence

  • Comply with provisions of relevant laws and regulations.

Practical implications

The introduction goes hand in hand with application of ISQM1 and ASA220 revised. Audit firms will need to carefully determine whether their EQ reviewers:

  • Have the appropriate skills and experience for each engagement to which they are assigned

  • Have the appropriate authority

  • Are given sufficient time.

An interesting inclusion is that ISQM2 permits the use of suitably qualified external EQ reviewers and the use of assistants.

Revised Auditing Standards

The period 2022 to 2024 sees the introduction of two revised auditing standards, namely:

These revised auditing standards are part of the IAASB’s and AuASB’s continued drive to improve audit quality.

ASA 220 (revised) Quality Management for an Audit of Financial Statements

ASA 220 (revised) is effective for audit and review engagements of financial statements for periods beginning on or after 15 December 2022, applying to half year reviews for 30 June 2023 and full year audits 31 December 2023.

The revisions to ASA 220 continue the drive for quality set out in ASA 540 (revised) and ASA 315 (revised), emphasizing the importance of professional scepticism, and requiring enhanced documentation of the auditor’s judgments. It also is fully in line with ISQM1 and ISQM2.

ASA 220 (revised) makes it clear that it is the engagement partner’s overall responsibility to manage and achieve quality on the engagement and this is achieved through the engagement partner having sufficient and appropriate involvement throughout the audit engagement.

ASA 220 (revised)) sets out that the Engagement partner is responsible for:

  • managing and achieving quality at the engagement level

  • determining the nature, timing and extent of direction, supervision, and review.

The engagement partner is required to be satisfied that their involvement has been sufficient and appropriate to provide the basis for taking overall responsibility.

Practical implications

The revisions to ASA 220, require the audit partner to be appropriately involved in all phases of the audit and for there to be evidence of this. For those audit partner that typically have a “hands off” approach or are simply too stretched, delegating significant work to their senior managers, this revised standard together with ISQM1 requires a change to their business model.

ASA 315 (revised) Identifying and Assessing the Risks of Material Misstatement

2023 is the year to apply ASA 315 (revised)

ASA 315 (revised) is operative for financial reporting periods commencing on or after 15 December 2021, applicable to audits of 31 December 2022 and 30 June 2023 year ends.

The standard has been revised to respond to challenges and issues with the current ASA 315. The revised requirements focus on ‘what’ needs to be done, and the application material enhanced, modernized, and reorganized to describe ‘why’ and ‘how’ procedures are to be undertaken.

ASA 315 (revised) is very much aligned to the changes contained within ASA 540 (revised) and includes similar new concepts and definitions. ASA 315 (revised) sets out:

  • There is a spectrum of inherent risk

  • Inherent risk factors that must be considered by auditors

  • The requirement to perform separate assessments of inherent risk and control risk

  • Consideration of ‘significant classes of transactions, account balances and disclosures’ and ‘relevant assertions’

  • Introduces a new definition of ‘significant risk’ being those risks close to the upper end of the spectrum of risk

  • Requires the auditor to ‘stand-back’ to evaluate the completeness of significant classes of transactions, account balances and disclosures at the end of the risk assessment process

  • Where the auditor does not contemplate testing the operating effectiveness of controls, the risk of material misstatement is the same as the assessment of inherent risk.

Practical implications

Revisions to ASA 315 are in response to dissatisfaction by audit regulators as to how auditors identify and respond to risk. Whilst the basic objective of the audit has not changed, ASA 315 (revised) is very prescriptive as to how risk identification should take place, emphasizing the requirement to link risk to assertions and the need to apply an appropriate level of professional scepticism.

ASA 315 (revised) is very much in line with ASA 540 (revised) that came into force in 2021, so the key changes in respects of the risk of material misstatements arising from management’s accounting estimates should not come as a surprise to auditors in 2023.

IAASB work plan

Auditing standards applicable in Australia are driven by the activities of the IAASB. The activity of the IAASB has been impacted by the ongoing effects of the pandemic. In November 2021 the IAASB released its detailed Quarterly Work Plan Table for 2022‒2023.

As can be seen below this work plan does not envisage any new standards being issued till 2023.

Planned date for an exposure draft Planned date for final approval of a new or revised auditing standard
Audit Evidence September 2022 March 2024
Fraud June 2023 Not stipulated
Going Concern December 2022 December 2023
Audits of Less Complex Entities – Development of a Separate Standard July 2021 March 2023

Some good news for auditors

For auditors, although 2022 continues the new era of complexity and a drive for quality, the good news is that the accounting changes in 2022 are minimal which we will discuss in our article “2022 the horizon for Accountants”.

3.2 - 2021 The Auditor's year in review

The theme of 2021 for the Audit profession in Australia was, audit quality, audit quality and the consequences of not achieving the required level of audit quality!

Major changes that occurred to auditing standards in 2021

2021 saw two significantly revised auditing standards come into effect, namely:

These revised standards are directed to:

  • improve audit quality

  • places significant emphasis on applying professional scepticism

The standards should have seen Australian auditors make significant changes to their audit approach in respect of audit estimates, including:

  • Goodwill impairment

  • Impairment of non financial assets

  • Impairment of financial assets

  • Impairment of inventory

  • Impairment of deferred tax assets

  • Fair value estimates of non financial assets

  • Fair value of financial assets

  • Valuation of provisions

Accounting estimates are one of the key areas challenging auditors and have become even more problematic in recent years with the introduction of AASB 9 Financial Instruments, AASB 15 Revenue from Contracts with Customers and AASB 16 Leases. Accounting estimates in respect of goodwill impairment, net realizable value of inventory, bad debt provisions and revenue recognition are major areas of ASIC surveillance and restatement. Errors in accounting estimates commonly form the subject of litigation against directors and auditors.

The amendments centre on:

  • Identifying risk of material misstatement arising from accounting estimates

  • Distinguishes inherent risk from control risk in respect of accounting estimates

  • Sets out that inherent risk is impacted by complexity, subjectivity and estimation risk

  • Requires consideration as to how management have considered estimation risk

  • Requires auditor to “stand back” and to consider and evaluate evidence that both supports and contradicts management’s estimate

  • Emphasizes professional scepticism as a response to management bias

  • Emphasizes work required around disclosure of accounting estimates

  • Sets out that when testing how management has arrived at an accounting estimate an auditor needs to consider the method, assumptions, and data upon which the estimate is based.

Practical implications

Correct application of ASA 540 (revised) requires:

  • a change in the auditor’s mindset

  • a change in how the auditor performs and documents their risk analysis in respect of management estimates

  • a reconsideration as to what audit evidence they should obtain and how they interpret that evidence.

If the auditor determines risk arising from management estimates can be reduced by the controls that are in place to manage that risk, then auditors will have to identify those controls and perform work to obtain sufficient appropriate audit evidence that those controls are adequate to address the risk.

The standard is explicit in its requirement for the auditor to consider whether management have appropriately considered estimation risk, and if not, to request that management adjust their estimate. This will expose the auditor to greater scrutiny if it is determined by the regulator or litigator that the estimates in the financial statements did not reflect estimation risk.

ASA 540 (revised) explicitly requires the auditor to stand back and consider all audit evidence in respect of an accounting estimate, including evidence that contradicts management’s estimate. This may prove problematic for some auditors, who may have in the past focused their attention on obtaining audit evidence that corroborated managements estimate.

ASA 500 (revised) Audit Evidence

ASA 500 was revised as a result ASA 540 (revised) and introduces the definition of External Information Sources. An auditor is required to distinguish information from an External Information Source from that of a management expert and to evaluate whether External Information Sources is relevant and reliable for the purposes of audit evidence.

The revised standard explicitly requires consideration of whether the information was prepared for a wide range of users or for the client, and whether the client was in a position to influence the information provided from the external source.

Practical implications

Careful consideration will be required as to whether information from a third party to support a management estimate represents relevant and reliable audit evidence, and whether it can be concluded it is free from potential bias

A critical ASIC audit inspection report

In November 2021 ASIC released the results of the ASIC audit inspections, key findings being:

  • negative findings in 23% of areas inspected in the largest 6 Audit firms (BDO, Deloitte, EY, GT, KPMG, and PwC);

  • negative findings in 32 % of areas inspected across 16 Audit firms inspected (including the largest six firms);

  • negative findings in 59% of the key audit areas inspected for firms outside the largest six firms.

  • 9% of the audited entity’s Financial Reports subject to the ASIC inspection were materially misstated

ASIC set out:

The increased overall level of negative findings is of concern and warrants deliberate and concerted efforts by all firms to improve audit quality and reduce the overall level of findings.

Firms should carefully evaluate the effectiveness of their existing initiatives to improve audit quality and implement improvements and further initiatives. This includes:

  • promoting a strong culture focused on audit quality,

  • attracting and retaining the right talent for complex audits,

  • thorough supervision and review of audits; and

  • holding partners, managers and staff accountable for audit quality

AUASB’s Bulletin ‘Supporting Auditors in Enhancing Audit Quality’

In response to the ASIC Audit Inspection Report the Australian Auditing and Assurance Standards Board (AuASB) issued a bulletin titled ‘Supporting Auditors in Enhancing Audit Quality’

The AuASB set out that in recent years the largest number of ASIC’s inspection findings relate to audit work on asset values and impairment of non-financial assets. The AuASB set out that The following pronouncements and publications have been issued by the AUASB to assist auditors in the area of the audit of asset values and impairment of non-financial assets:

  • ASA 540 Auditing Accounting Estimates and Related Disclosures has been reissued with significantly enhanced requirements and application material.

  • Guidance Statement GS 005 Evaluating the Appropriateness of a Management’s Expert Work has been reissued to provide detailed guidance on practical implementation of ASA 500.

Auditing revenue and receivables

The AuASB acknowledge that the audit of revenue and receivables is the area with the second highest number of negative findings from ASIC inspections in recent years.

The AuASB set out that the following has been issued to enhance audit quality:

  • The revised ASA 540 which assists auditors in performing appropriate procedures in relation to the estimation of performance obligations, unearned revenue and expected credit losses under the accounting standards for Contract Revenue and Financial Instruments that have come into effect in recent years.

  • The IAASB illustrative examples of how to apply ISA 540 when auditing expected credit loss accounting estimates.

  • The IASB / AASB’s guidance on AASB 9 Financial Instruments, Application of IFRS 9 in the light of the Coronavirus uncertainty, and AASB 15 Revenue from Contracts with Customers (December 2018), which will assist both preparers and auditors.

  • The revised ASA 315 Identifying and Assessing the Risks of Material Misstatement, which has been enhanced to drive auditors to perform a more appropriate and robust risk assessment, and thereby a more focused response to those identified risks.

The AuASB also set out the following that should improve audit quality:

  • ASQM 1 which requires firms to design, implement and operate a system of quality management to manage the quality of engagements performed by the firm. ASQM 1 applies to all firms that perform audits or reviews of financial reports, or other assurance or related services engagements.

  • ASQM 210, which covers the appointment, eligibility, and responsibilities of the Engagement Quality Reviewer.

  • Revisions to ASA 220 which includes specific responsibilities of the auditor regarding quality management at the engagement level for an audit of a financial report, and the related responsibilities of the engagement partner.

Clearly there is a need for improve audit quality and the AuASB believe that the enhanced auditing standards, together with the improved Quality management standards should address the issues raised by ASIC.

In future inspections and litigation, clearly the auditor will be judged against complying with the revised auditing and quality management standards, auditors must realise that the bar has been significantly raised and that going forwards the lack of audit quality should be much easier to prove.

The conviction of the auditor of Halifax

2021 saw the first conviction of an auditor for failing to conduct audits in accordance with auditing standards.

In the case former auditors of Halifax Investment Services Pty Ltd (Halifax), Mr Robert James Evett and EC Audit Pty Ltd (formerly Bentleys NSW Audit Pty Ltd) were convicted and sentenced to pay a fine of $10,000 and $40,000 respectively for failing to conduct audits in accordance with auditing standards.

The breaches of the auditing standards included that:

  • EC Audit failed to understand Halifax’s business and failed to design appropriate tests to identify material misstatements in the accounts, and

  • Mr Evett failed to take responsibility for the overall conduct of the audits and failed to ensure that staff with appropriate skills were conducting the audits.

Mr Evett and EC Audit are the first auditors in Australia to face criminal charges and to be sentenced under section 989CA of the Corporations Act.

Current litigation against Australian auditors

Australian auditors should be aware of the significant number of legal cases currently in progress against the audit firms. These include:

Firm Company Accounting/ Audit Issue
Deloitte Hastie Asset impairments
Deloitte Freedom Foods Capitalisation of expenses Impairment of inventory
Ernst and Young Blue Sky Alternative Investments Limited Revenue recognition and valuation of assets
Ernst and Young LM First Mortgage Income Fund Impairment of financial assets
Ernst and Young Quintis Valuation of biological assets and revenue recognition
Ernst and Young Penrice Soda Holdings Valuation of inventory
KPMG Arrium Impairment
Pitcher Partners Slater and Gordon Impairment of goodwill
PricewaterhouseCoopers Axcesstoday Classification of liabilities and going concern
PricewaterhouseCoopers Cornerstone Revenue recognition

3.3 - Relevance of ASIC’s 2021 Audit Inspection Report

In November 2021 ASIC published the results of its 2021 audit inspections, in REP 709 ‘Audit inspection report: 1 July 2020 to 30 June 2021’. The report showed:

  • negative findings in 23% of areas inspected in the largest 6 Audit firms (BDO, Deloitte, EY, GT, KPMG, and PwC);

  • negative findings in 32 % of areas inspected across 16 Audit firms inspected (including the largest six firms);

  • negative findings in 59% of the key audit areas inspected for firms outside the largest six firms; and

  • 9% of the audited entity’s Financial Reports subject to the ASIC inspection were materially misstated.

The Inspection report should be considered by:

  • Audit Committee members when choosing their auditor;

  • Audit Committee and Board members when reviewing and approving their entity’s financial report;

  • Lawyers and litigators when considering the general competency and quality of Australian audit firms; and

  • Auditors in Australia.

ASIC Inspection Report 1 July 2020 to 30 June 2021

In its 2021 Audit Inspections, ASIC identified negative findings in 23% of the 115 key audit areas reviewed on a risk basis at the largest six audit firms (where most of ASIC’s inspection effort was directed). This compares to 24% of the 156 key audit areas reviewed at the largest six firms for the 12 months to 30 June 2020The equivalent findings for 149 key audit areas reviewed across 16 firms was 32% this year and 27% for the 179 key audit areas reviewed across 13 firms in 2020.

The largest number of negative findings continued to relate to the audit of:

  • asset values;
  • impairment of non-financial assets; and
  • revenue.

Other areas of ASIC findings included the audit of:

  • inventories;
  • investments;
  • financial instruments;
  • expenses and payables; and
  • provisions.

Improving audit quality

ASIC noted that the increased overall level of negative findings was of concern and warrants deliberate and concerted efforts by all firms to improve audit quality and reduce the overall level of findings. ASIC recommend that firms should carefully evaluate the effectiveness of their existing initiatives to improve audit quality and implement improvements and further initiatives. This includes:

  • promoting a strong culture focused on audit quality;

  • attracting and retaining the right talent for complex audits;

  • thorough supervision and review of audits; and

  • holding partners, managers, and staff accountable for audit quality.

Overview of ASIC 2021 Inspection Findings

Overall Results

There were negative findings in 32% of the 149 key audit areas we reviewed on a risk basis across 45 audit files at 16 firms (including the largest six firms) this year. This compares to 27% for the 179 key audit areas reviewed across 53 audit files at 13 firms in the 2020 inspection.

Results of the largest six firms

For the largest six firms (where ASIC directed most of their inspections) there were negative findings in 23% of the 115 key audit areas reviewed across 35 audit files this year. This compares to 24% of the 156 key audit areas across 46 audit files reviewed in the 2020 inspection.

Ranking of the largest six firms

The performance of the largest six firms was as follows:

Firm Rank 2021 Rank 2020 Negative Findings 2021 Negative Findings 2020
Ernst & Young 1 1 7% 14%
BDO 2 2 20% 20%
PricewaterhouseCoopers 3 3 25% 23%
Deloitte Touche Tohmatsu 4 6 29% 35%
KPMG 5 4 30% 26%
Grant Thornton 6 5 45% 27%

Results of Firms outside of the largest six firms

The level of negative findings based on the key audit areas reviewed in 2021 for firms outside the largest six firms was 59% compared to 48% for those reviewedin 2020. However, the findings percentages for firms outside the largest six firms are not directly comparable between periods as six of the 10 firms inspected this year were not inspected in 2020.

Audits reviewed where the financial report was materially misstated

ASIC identified a number of instances where negative findings were made during the audit inspection where the audited entities made material changes to net assets and profits in the relevant financial report or in a subsequent financial report, which ASIC believe related to concerns identified by ASIC in their audit inspection.

In total 9% of the audited entity’s Financial Reports subject to the ASIC inspection were materially misstated:

Percentage of Financial statements materially misstated
18 months to 30 June 2018 9%
12 months to 30 June 2019 2%
12 months to 30 June 2020 3%
12 months to 30 June 2021 9%

Adjustments to financial reports following ASIC Audit inspection

ASIC reported the following in respect of material adjustments made to to previously reported net assets and profits for listed entities as identified from:

  • notices lodged by auditors under section 311 of the Corporations Act 2001; and

  • material changes to net assets and profits resulting from ASIC financial reporting surveillances.

Section 311 notices ASIC surveillances
18 months to 30 June 2018 21 17
12 months to 30 June 2019 33 8
12 months to 30 June 2020 29 18
12 months to 30 June 2021 26 9
Total 109 52

These adjustments concern matters not identified or addressed during a previous audit. The matters may have been subsequently identified by the company or ASIC rather than the auditor.

Media Releases setting out restatements following the ASIC inspection

As part of the inspection report for the largest six firms inspected ASIC set out companies that had subsequently corrected their Financial Reports (albeit prospectively) following the ASIC inspection. These being:

Audit Firm Entity Year end Findings
BDO Mosaic Brands Limited 28 June 2020 The company increased its make good provision from $5.6 million to $8.3 million in its financial report for the year ended 27 June 2021 See Media Release (21-255MR) Mosaic Brands increases lease make good provision (22 September 2021).
Deloitte Elixinol Global Limited 31 December 2019 The company wrote down goodwill, inventories, and other assets by $60 million in its financial report for the half-year ended 30 June 2020 see Media Release (20-214MR).
KPMG Ainsworth Game Technology 30 June 2020 The company wrote down the non-financial assets of its Latin American business by $23.1 million and inventory by $3.4 million and increased its estimated expected credit losses on trade receivables by $6 million See Media Release (21-068MR) Ainsworth writes down assets (12 April 2021).
PwC Nitro Software Limited 30 June 2019 The company reduced both its contract assets and deferred revenue by $14.7 million in its financial report for the half-year ended 30 June 2020 See Media Release (20-214MR)ASIC notes reporting changes (17 September 2020).

Deficiencies identified by ASIC

Summary of negative Findings by Transaction Type

ASIC presented their findings by key audit areas. These findings set out by key audit areas were as follows:

Transaction / Balance sheet item Rank 2021 Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/receivables 1 17 15 40% 29%
Impairment/ asset valuation 2 10 14 29% 26%
Inventories/ cost of sales 3 5 5 38% 28%
Expenses/payables 4 3 1 43% 43%
Investments/ financial instruments 5 2 7 20% 64%
Provisions 6 2 3 33% 43%
Taxation 6 2 1 40% 10%
Leases 8 1 3 13% 0%
Loans/borrowings 8 1 1 14% 20%
Acquisition accounting 8 1 1 33% 8%
Other 3 1 43% 0%

Deficiencies auditing revenue and receivables

ASIC identified a number of matters contributing to negative findings in relation to revenue and receivables. ASIC reviewed revenue and receivables in 43 key audit areas in the 2021 inspection and in 51 key audit areas in the 2020 inspection.

The matters contributing to the negative findings being:

  • Test of details;

  • Accounting estimates;

  • Substantive analytical procedures;

  • Internal controls;

  • Risk assessment; and

  • Accounting policies.

Tests of details, audit procedures on accounting estimates, and substantive analytical procedures contribute to about 70% of ASIC’s findings for revenue and receivables.

ASIC provided a detailed breakdown of the key factors contributing to revenue and receivables their negative findings in the 12 months to 30 June 2021 and the 12 months to 30 June 2020:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
Tests of details:
procedures performed did not address the level of risk assessed 13 8
obtaining insufficient independent evidence for items selected 2 3
sample sizes and sampling techniques were inadequate 2 1
errors were not investigated or evaluated 1 2
source data used was not tested for completeness or accuracy 1 5
Accounting estimates:
not testing and/or challenging the relevance and reliability of data and assumptions used in expected credit loss models 13 5
insufficient testing of trade receivables 4 5
insufficient testing of significant assumptions to estimate unearned/deferred income 2 -
Substantive analytical procedures:
thresholds for investigating differences were too high and/or population not disaggregated 3 2
the relationship used was not plausible or did not consider key factors affecting the expectation 2 4
data used to develop the auditor’s expectation was not reliable or tested 2 3
differences between recorded amounts and the auditor’s expectation of those amounts that exceed the tolerable threshold were not identified or adequately investigated 2 1
Inappropriate reliance on internal controls 8 4
Risk assessment not performed appropriately, or no procedures performed for risks/assertions 5 9
Accounting policies:
inappropriate accounting policy for revenue recognition, or not checking for consistency with key contract terms 3 2
not obtaining an understanding of systems and controls relating to recognition of revenue 1 -
Other:
deficiencies in instructions to or communication with component auditors, insufficient involvement in the work of component auditors or evaluation and review of work performed 2 5
insufficient consideration of whether service providers met the definition of service organisations 1 -
relied on assessments and testing performed in previous years audit without explaining the basis of the continued reliance - 1

Deficiencies auditing impairment of non-financial assets

ASIC reviewed work on impairment and asset values in 40 key audit areas in their 2021 inspection and in 54 key audit areas in their 2020 Inspection.

Audit procedures over forecast cash flows, other key assumptions and expert or specialist work contribute to about 75% of ASIC’s findings for impairment of non-financial assets.

The matters contributing to the negative findings being audit failures with respect to:

  • Forecast cash flows;

  • Other key assumptions;

  • Expert or specialist work;

  • Sensitivity testing;

  • Impairment model testing;

  • Impairment indicators;

  • Fair value methodology; and

  • Valuation cross-checks.

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
Forecast cash flows:
cash flows, including capital expenditure, or terminal value not reasonable or were not adequately tested 10 8
not challenging forecasts where the entity has not met forecasts historically 1 5
Other key assumptions:
discount rate, exchange rate, commodity price or other key assumptions not appropriate or reasonable 6 13
insufficient testing of recoverability of resources or mining approvals 3 -
Issues with work performed by audit firm’s expert or specialist 3 3
Issues with sensitivity testing or no sensitivity testing performed 3 3
Impairment model not adequately tested, including:
mathematical accuracy 1 3
impact of the new lease standard 1 -
determination or calculation of cash-generating units - 2
Impairment indicators:
did not ask management to perform impairment testing where there were indicators of impairment or there was goodwill or other indefinite life intangible assets 1 2
impairment indicators were not assessed - 4
Other:
deficiencies in disclosures not identified or corrected 1 3
deficiencies in instructions to or communication with component auditors, insufficient involvement in the work of component auditors or evaluation and review of work performed 2 1
risks not appropriately assessed - 1
insufficient skills and expertise to adequately assess and conclude on impairment calculations - 1

Deficiencies auditing inventory

ASIC identified a number of negative findings in respect of the audit of inventory:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For inventory and cost of sales, ASIC found instances where auditors did not:
adequately test the accuracy and value of inventories, including provisions for stock obsolescence 8 -
evaluate the design and implementation of systems, processes and controls or test key controls 5 1
adequately test the existence and cut-off of inventories, including stocktake attendance by component auditors 3 6
appropriately scope and evaluate the work of the component auditor or management expert 1 6

Deficiencies auditing taxation

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For taxation balances, ASIC found instances where auditors did not:
include all tax workpapers on file, adequately test the accuracy of tax workings, assess the tax treatment of material items, or review relevant transfer pricing documents 6 1
sufficiently test the entity’s compliance with relevant tax legislation 3 -
appropriately evaluate the work of management’s expert, or use their own expert 3 1
evaluate the design and implementation of systems, processes and controls or test key controls 1 -

Deficiencies auditing expenses and payables

ASIC identified a number of negative findings in respect of the audit of expenses and payables:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For expenses and payables, ASIC found instances where auditors did not:
test the relevance and reliability of data and assumptions used 5 -
adequately test the completeness and accuracy of expenses 2 1
test key controls or perform tests of detail using a representative sample 1 1
evaluate the design and implementation of systems, processes and controls - 1
sufficiently evidence work performed by the component auditor - 1

Deficiencies auditing financial instruments and investments

ASIC identified a number of negative findings in respect of the audit of financial instruments and investments:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For financial instruments and investments, ASIC found instances where auditors did not:
perform sufficient or appropriate tests of details over underlying assets, or use an adequate sample size for the assessed risk 3 6
consider whether an investment should have been equity accounted 1 1
test the relevance and reliability of data and assumptions used for valuations, including comparisons to market data - 8
appropriately evaluate the work and reports of their own or management’s expert, including resolving issues raised by the expert - 4
evaluate the design and implementation of systems, processes and controls or test key controls - 1
consider the requirements for a service organisation and whether reporting was appropriate in the circumstances - 1
consider whether a loan to a joint venture was part of the net investment and should have been written down for significant losses of the joint venture - 1

Deficiencies auditing provisions

ASIC identified a number of negative findings in respect of the audit of provisions:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For provisions, ASIC found instances where auditors did not:
adequately test the completeness and accuracy of provisions, or identify and investigate variances 2 6
assess the relevance, completeness and accuracy of the methods and source data used by experts 1 2
test the relevance and reliability of data and assumptions used - 1
use their own expert where the audit team did not have sufficient knowledge, experience or expertise - 1
evaluate whether the recognition criteria for a provision had been met under the accounting standard - 1

Deficiencies auditing loans and borrowings

ASIC identified a number of negative findings in respect of the audit of loans and borrowings:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For loans and borrowings, ASIC found instances where auditors did not:
obtain sufficient evidence over completeness of borrowings, including compliance with covenants 1 -
perform adequate procedures over management’s assessment of going concern and consider whether a material uncertainty existed - 1

Deficiencies auditing acquisitions

ASIC identified a number of negative findings in respect of the audit of acquisitions:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For acquisitions, ASIC found instances where auditors did not:
identify whether the acquisition treatment was incorrect 1 -
consider whether contingent consideration in a business combination should have been accounted for as remuneration rather than goodwill - 1

Deficiencies auditing leases

ASIC identified a number of negative findings in respect of the audit of leases:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For leases, ASIC found instances where auditors did not:
sufficiently assess whether make good provisions should have been recognised for leased premises 1 -

Deficiencies auditing cash

ASIC identified a number of negative findings in respect of the audit of cash:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For cash, ASIC found instances where auditors did not:
confirm cash held or bonds issued by foreign financial institutions 2 -

Deficiencies auditing disposal of operations

ASIC identified a number of negative findings in respect of the audit of disposal of operations:

Contributing factors 12 months to 30 June 2021 12 months to 30 June 2020
For disposal of operations, ASIC found instances where auditors did not:
obtain sufficient evidence that the disposal was highly probable at balance date 2 -

Issues identified in respect of experts and other auditors

ASIC identified negative findings when using experts and component auditors to review and audit:

  • impairment of non-financial assets;

  • values of investment properties and other assets;

  • revenues and receivables;

  • provisions; and

  • tax balances.

ASIC found cases where the auditor did not:

  • use their own expert where the audit team did not have sufficient knowledge and experience or relied on an expert’s review performed a number of years earlier without demonstrating or testing the continued relevance and reliability;

  • sufficiently use their own expert (e.g., to review all relevant aspects of the determination of the discount rate used in an impairment assessment);

  • appropriately scope, review and evaluate the work and reports of their own expert, consider the appropriateness of the work and/or resolve issues raised by the expert;

  • test the work of management’s expert such as obtaining evidence supporting and challenging assumptions and forecasts, re-performing calculations and reviewing any model used;

  • assess the relevance, completeness and accuracy of source data used by experts or assess the competence, capabilities, and objectivity of experts;

  • have sufficient group audit strategies and instructions to, or communication with, component auditors; and

  • sufficiently review and evaluate the work of component auditors.

Issues identified in respect of journal entries

ASIC identified deficiencies in journal entry testing in 7% of audit files reviewed in the 2021 inspection, compared to 4% of files reviewed in the 2020 inspection. Findings included instances where the auditor did not test journal entries and adjustments made at year end or did not evaluate whether journal entries and adjustments needed to be tested throughout the year.

ASIC inspection results by audit firm

BDO 2021 inspection report findings

ASIC concluded that BDO did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in two of the 10 key audit areas (20%) reviewed across three audits by the firm in the 2021 inspection. This compares to two of the 10 key audit areas reviewed (20%) for the 12 months ending 30 June 2020.

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/ receivables - - 0% 0%
Impairment/ asset valuation 1 - 50% 0%
Inventories/ cost of sales - - 0% 0%
Expenses/ payables - - 0% 0%
Investments/ financial instruments - 2 0% 100%
Taxation - - - 0%
Leases 1 - 50% 0%
Loans/ borrowings - - 0% 0%

ASIC presented the following in respect of the negative findings identified in respect of BDO in the 2021 inspection that could give rise to a risk of material misstatement:

Entity Areas with findings Findings
Entity A 1 of 4 key audit areas reviewed Impairment testing — the auditor inappropriately concluded that there were no impairment indicators, and that impairment testing was not necessary
Entity B 1 of 3 key audit areas reviewed Lease make good provision — the auditor did not assess whether make good provisions should have been recognised for leased stores

ASIC’s 2021 inspection report for BDO is set out in REP 710 BDO firms in Australia: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of BDO

ASIC completed risk-based reviews of aspects of 8 financial reports of listed and other public interest entities audited by BDO in its 2021 inspection. Following ASIC’s inquiries, one entity, being Mosaic Brands Limited made material changes to net assets or profits:

Entity Year end Findings
Mosaic Brands Limited 28 June 2020 The company increased its make good provision from $5.6 million to $8.3 million in its financial report for the year ended 27 June 2021 See [Media Release (21-255MR)] (https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-releases/21-255mr-mosaic-brands-increases-lease-make-good-provision/) Mosaic Brands increases lease make good provision (22 September 2021)

Improving audit quality at BDO

ASIC set out the following in respect of Improving audit quality at BDO:

The continuing level of negative findings from our limited reviews warrants deliberate and concerted action by BDO. The firm needs to focus on identifying and addressing the root causes for the matters reported from our audit file reviews, financial reporting surveillances, and for findings from internal and global firm reviews. The firm should continue to evaluate the effectiveness of its current initiatives to improve audit quality and revise them or implement new and improved actions if they are not achieving appropriate outcomes.

Deloitte 2021 inspection report findings

ASIC concluded that Deloitte did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in five of the 17 key audit areas reviewed (29%) across five audits by the firm in the 2021 inspection. This compares to nine of the 26 key audit areas reviewed (35%) for the 12 months ending 30 June 2020.

ASIC’s negative findings relate to

  • impairment testing;

  • the audit of revenue and receivables;

  • inventories and cost of sales;

  • expenses and payables; and

  • loans and borrowings.

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/receivables 5 12 29% 35%
Impairment/ asset valuation 1 2 20% 25%
Inventories/ cost of sales 1 2 50% 100%
Expenses/payables 1 - 100% 0%
Investments/ financial instruments 1 - 33% 0%
Taxation - - 0% 0%
Leases - - 0% 0%
Loans/borrowings 1 1 100% 0%
Acquisition accounting 1 - 33% 0%

ASIC presented the following in respect of the negative findings identified in respect of Deloitte in the 2021 inspection that could give rise to a risk of material misstatement:

Entity Areas with findings Findings
Entity A 1 of 4 key audit areas reviewed Royalty liability — the auditor did not evaluate the reasonableness of the discount rate and forecast commodity prices used in the calculation of the liability estimate or carry forward a prior year independent expert’s report to support management’s forecast production and sales volumes.
Entity B 2 of 5 key audit areas reviewed Loans and borrowings/ going concern — the auditor did not detect a material misstatement in loans and borrowings and in finance costs due to a deficiency in review of loan agreements. The auditor did not gather sufficient appropriate audit evidence to assess whether material uncertainty existed over the company’s ability to repay or reschedule loans and borrowings on their maturity in two to three years after year end or to find other sources to replace them. Inventories — the auditor did not test the cost of inventories for a major part of the business and did not test the elimination of profits in inventory relating to intragroup sales.
Entity C 1 of 3 key audit areas reviewed Revenue — the auditor did not set expectations that were sufficiently precise in a substantive analytical procedure (SAP) or demonstrate that prior year average revenue per customer was a sufficiently plausible relationship to predict current year revenue and did not perform specific substantive tests over revenue cut-off.
Entity D 1 of 2 key audit areas reviewed Processing plant impairment testing — the auditor did not obtain sufficient appropriate evidence and exercise an appropriate level of professional scepticism to evaluate a number of key assumptions, judgements and estimates used in the entity’s DCF model.

ASIC’s 2021 inspection report for Deloitte is set out in REP 711 Deloitte Touche Tohmatsu Australia: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of Deloitte

ASIC completed risk-based reviews of aspects of 43 financial reports of listed and other public interest entities audited by Deloitte in its 2021 inspection. Following ASIC’s inquiries, one entity, being Elixinol Global Limited made material changes to net assets or profits:

Entity Year end Findings
Elixinol Global Limited 31 December 2019 The company wrote down goodwill, inventories, and other assets by $60 million in its financial report for the half-year ended 30 June 2020 see MR20-214

Improving audit quality at Deloitte

ASIC set out the following in respect of Improving audit quality at Deloitte:

The level of negative findings from our limited reviews is of concern and warrants continued deliberate and concerted action by Deloitte. The firm needs to focus on identifying and addressing the root causes for the matters reported from our audit file reviews, financial reporting surveillances, and for findings from internal and global firm reviews. The firm should continue to evaluate the effectiveness of its current initiatives to improve audit quality and revise them or implement new and improved actions if they are not achieving appropriate outcomes.

Ernst and Young 2021 Inspection Report Findings

ASIC concluded that EY did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in two of the 30 key audit areas reviewed (7%) across eight audits in the 2021 inspection This compares to five of the 35 key audit areas reviewed (14%) for the 12 months ending 30 June 2020.

ASIC’s negative findings relate to:

  • impairment testing; and

  • the audit of revenue and receivables.

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/receivables 1 1 10% 10%
Impairment/ asset valuation 1 2 13% 18%
Inventories/ cost of sales - - 0% 0%
Expenses/payables - - 0% 0%
Investments/ financial instruments - 1 0% 100%
Provisions - 1 0% 50%
Taxation - - 0% 0%
Leases - - 0% 0%
Loans/borrowings - - 0% 0%

ASIC presented the following in respect of the negative findings identified in respect of EY in the 2021 inspection that could give rise to a risk of material misstatement:

Entity Areas with findings Findings
Entity A 1 of 4 key audit areas reviewed Impairment testing — the auditor did not obtain sufficient evidence over the reasonableness of the quantum of resources included in the impairment testing model for a significant asset class.
Entity B 1 of 3 key audit areas reviewed Rental revenue — the auditor did not obtain sufficient evidence over the occurrence and accuracy of rental revenue, such as not testing key automated controls relied on by the auditor, not testing the accuracy of revenue and deferred revenue calculations against contracts and not testing contract terminations.

ASIC’s 2021 inspection report for EY is set out in REP 712 Ernst & Young Australia: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of Ernst and Young

ASIC completed risk-based reviews of aspects of 57 financial reports of listed and other public interest entities audited by the firm during the 2021 inspection. No material changes were made to net assets or profits.

Improving audit quality at Ernst and Young

ASIC set out the following in respect of Improving audit quality at EY:

The level of negative findings from our limited reviews has declined in recent years. However, the firm should continue to identify and address the root causes for the matters reported from our audit file reviews and for findings from internal and global firm reviews. The firm should also continue with its current initiatives to implement enhanced actions to maintain and sustain improved audit quality.

Grant Thornton 2021 Inspection Report Findings

ASIC concluded that GT did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in five of the 11 key audit areas reviewed (45%) across three audits in the 2021 inspection This compares to three of the 11 key audit areas reviewed (27%) for the 12 months ending 30 June 2020.

ASIC’s negative findings relate to:

  • Revenue/receivables

  • impairment testing; and

  • Investments/ financial instruments

  • Taxation

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/receivables 2 1 67% 33%
Impairment/ asset valuation 1 2 25% 50%
Investments/ financial instruments 1 - 100% 0%
Taxation 1 - 100% 0%
Loans/borrowings - - 0% 0%
Acquisition accounting - - 0% 0%
Expenses payables - - 0% 0%

ASIC presented the following in respect of the negative findings identified in respect of Grant Thornton in the 2021 inspection that could give rise to a risk of material misstatement:

Entity Areas with findings Findings
Entity A 1 of 3 key audit areas reviewed Taxation — the auditor did not perform audit procedures over the group tax balances, failed to engage a specialist or expert in the audit of US tax balances and did not obtain sufficient evidence over transfer pricing.
Entity B 1 of 4 key audit areas reviewed Revenue from professional services and sales of hardware and software — the auditor did not obtain sufficient evidence over revenue recognition for professional services and sale of hardware and software.
Entity C 3 of 4 key audit areas reviewed Goodwill — the auditor did not adequately evaluate the nature and extent of audit procedures performed by the component auditor.
Revenue — the auditor did not adequately evaluate the nature and extent of audit procedures performed by the component auditor.
Investment in listed entity — the auditor did not consider the facts and circumstances of the entity’s relationship with the investee to conclude that the accounting treatment was appropriate.

ASIC also identified the following findings which did not involve a risk of material misstatement:

Entity Findings
Entity A Impairment testing of goodwill and other intangibles assets—the auditor should have included management’s impairment models on file and clearly evidenced the work done on forecast budgets to support the work done
Revenue—the auditor should have more clearly documented the audit procedures performed in testing revenue stream
Entity B Impairment testing of goodwill—despite the apparent headroom, the auditor should have considered the impairment assessment of goodwill for each CGU in more detail and documented all relevant supporting information on the engagement file

ASIC’s 2021 inspection report for GT is set out in REP 713 Grant Thornton Australia Limited: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of Grant Thornton

ASIC completed risk-based reviews of aspects of seven financial reports of listed and other public interest entities audited by the firm during the 2021 inspection. No material changes were made to net assets or profits.

Improving audit quality at Grant Thornton

ASIC set out the following in respect of Improving audit quality at Grant Thornton:

The level of negative findings from our limited reviews is of concern and warrants continued deliberate and concerted action by Grant Thornton. The firm needs to focus on identifying and addressing the root causes for the matters reported from our audit file reviews and for findings from internal and global firm reviews. The firm should continue to evaluate the effectiveness of its current initiatives to improve audit quality and revise them or implement new and improved actions if they are not achieving appropriate outcomes.

KPMG 2021 Inspection Report Findings

ASIC concluded that KPMG did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in eight of the 27 key audit areas reviewed (30%) across eight audits by the firm in the 2021 inspection. This compares to 10 of the 39 key audit areas reviewed (26%) for the 12 months ending 30 June 2020.

ASIC’s negative findings relate to:

  • the audit of revenue and receivables; and

  • impairment testing.

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/ receivables 4 4 44% 36%
Impairment/ asset valuation 2 3 18% 27%
Inventories/ cost of sales 1 1 50% 25%
Expenses/payables - - 0% 0%
Investments/ financial instruments - - 0% 0%
Provisions - 2 0% 33%
Taxation - - 0% 0%
Leases - - 0% 0%
Loans/ borrowings 1 - 100% 0%
Acquisition accounting - - 0% 0%

ASIC presented the following in respect of the negative findings identified in respect of KPMG in the 2021 inspection that could give rise to a risk of material misstatement:

Entity Areas with findings Findings
Entity A 1 of 3 key audit areas reviewed Revenue—the auditor performed controls and substantive procedures. This included a substantive analytical procedure that was not sufficiently precise to detect a material misstatement and contained a calculation error not identified by the auditor resulting in a variance which was greater than the acceptable difference and performance materiality.
Entity C 2 of 4 key audit areas reviewed Asset impairment—the auditor did not adequately evaluate some key assumptions in the entity’s value in use model and the auditor’s sensitivity analysis did not sufficiently address changes to key assumptions › Assets held for sale—the auditor did not obtain sufficient evidence to support the key factors that indicate that the planned disposal of assets held for sale was highly probable.
Entity D 3 of 3 key audit areas reviewed Valuation of inventories—the auditor did not sufficiently test standard costs and variance adjustments used in the valuation of inventories at year end. Trade receivables — the auditor did not obtain sufficient evidence over impairment losses on receivables due to insufficient evaluation of impairment loss allowances including the COVID-19 impact on the expected credit loss allowance. Impairment — the auditor did not obtain sufficient evidence over revenue forecasts and the appropriateness of the WACC rate used in the assessment of the valuation of non-financial assets.
Entity E 1 of 3 key audit areas reviewed Revenue — the auditor did not obtain sufficient evidence over the accuracy of specific types of revenue as the auditor did not agree a sample of those revenue transactions to appropriate source documents.
Entity E 1 of 3 key audit areas reviewed Finance lease receivables — the auditor did not perform sufficient substantive procedures over the accuracy of finance lease receivables and the sample selected for controls testing was not a finance lease.

ASIC’s 2021 inspection report for KPMG is set out in REP 714 KPMG Australia: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of KPMG

ASIC completed risk-based reviews of aspects of 51 financial reports of listed and other public interest entities audited by KPMG in its 2021 inspection. Following ASIC’s inquiries, one entity, being Ainsworth Game Technology Limited made material changes to net assets or profits:

Entity Year end Findings
Ainsworth Game Technology 30 June 2020 The company wrote down the non-financial assets of its Latin American business by $23.1 million and inventory by $3.4 million and increased its estimated expected credit losses on trade receivables by $6 million See Media Release (21-068MR) [21-068MR Ainsworth writes down assets | ASIC - Australian Securities and Investments Commission Ainsworth writes down assets (12 April 2021

Improving audit quality at KPMG

ASIC set out the following in respect of Improving audit quality at KPMG:

The level of negative findings from our limited reviews is of concern and warrants continued deliberate and concerted action by KPMG. The firm needs to focus on identifying and addressing the root causes for the matters reported from our audit file reviews, financial reporting surveillances, and for findings from internal and global firm reviews. The firm should continue to evaluate the effectiveness of its current initiatives to improve audit quality and revise them or implement new and improved actions if they are not achieving appropriate outcomes.

PricewaterhouseCoopers 2021 Inspection Report Findings

ASIC concluded that PwC did not obtain reasonable assurance that the financial report was free of material misstatement (negative findings) in five of the 20 key audit areas reviewed (25%) across eight audits by the firm in the 2021 inspection. This compares to eight of the 35 key audit areas reviewed (23%) for the 12 months ending 30 June 2020.

The largest number of negative findings relate to the audit of revenue and receivables including expected credit loss models.

Transaction / Balance sheet item Number of errors identified in 2021 Inspection Number of errors identified in 2020 Inspection % errors in 2021 Inspection % errors in 2020 Inspection
Revenue/ receivables 4 2 44% 20%
Impairment/ asset valuation - 1 0% 13%
Inventories/ cost of sales - - 0% 0%
Expenses/ payables - - 0% 0%
Investments/ financial instruments - 2 0% 67%
Provisions - 1 0% 50%
Taxation - 1 0% 25%
Leases - - 0% 0%
Loans/ borrowings - - 0% 0%
Acquisition accounting - - 0% 0%

ASIC’s 2021 inspection report for PwC is set out in REP 715 PricewaterhouseCoopers Australia: Audit inspection report—1 July 2020 to 30 June 2021

Financial report findings in respect of PricewaterhouseCoopers

ASIC completed risk-based reviews of aspects of 61 financial reports of listed and other public interest entities audited by PwC in its 2021 inspection. Following ASIC’s inquiries, one entity, being Nitro Software Limited made material changes to net assets or profits:

Entity Year end Findings
Nitro Software Limited 30 June 2019 The company reduced both its contract assets and deferred revenue by $14.7 million in its financial report for the half-year ended 30 June 2020 See Media Release (20-214MR) https://asic.gov.au/about-asic/news-centre/find-a-media-release/2020-releases/20-214mr-asic-notes-reporting-changes/ ASIC notes reporting changes (17 September 2020)

Improving audit quality at PricewaterhouseCoopers

ASIC set out the following in respect of Improving audit quality at PricewaterhouseCoopers:

The level of negative findings from our limited reviews is of concern and warrants continued deliberate and concerted action by PwC. The firm needs to focus on identifying and addressing the root causes for the matters reported from our audit file reviews, financial reporting surveillances, and for findings from internal and global firm reviews. The firm should continue to evaluate the effectiveness of its current initiatives to improve audit quality and revise them or implement new and improved actions if they are not achieving appropriate outcomes.

Audit quality culture

ASIC set out that firm leadership, partners, managers, and staff all have important roles in contributing to a culture focused on audit quality. ASIC set out the following examples of considerations in respect of audit quality culture:

Who Examples of considerations
Firm leadership Giving strong, genuine, consistent, and frequent messages to partners and staff that audit quality is not negotiable
Firm leadership Providing genuine support for partners and staff in challenging accounting policies, estimates and disclosures in individual audits, and making necessary calls to issue a modified audit report
Firm leadership Ensuring that the firm and assurance division have a prominent focus on audit quality, in comparison to other objectives such as selling other services to audited entities
Firm leadership Monitoring and assessing culture through means such as people surveys, 360-degree reviews of partners, interviews with the boards and audit committees of audited entities and interviews with staff
Firm leadership Ensuring that whistle blowers are protected and the matters they raise are appropriately actioned
Partners and staff Embracing the need to improve audit quality and the consistency of audit execution
Partners and staff Understanding and being accountable for their roles in conducting quality audits
Partners and staff Focusing on the information needs of, and potential harm to, investors and creditors

The role of directors, audit committees and management

ASIC set out that company directors, audit committees and management have roles in supporting quality audits. Among other matters, directors and audit committees should consider:

  • non-executive directors recommending audit firm appointments and setting audit fees;

  • assessing the commitment of the auditors to audit quality;

  • reviewing the resources devoted to the audit, including the amount of partner time, the need for the auditor to use experts and the appropriate use of other auditors;

  • accountability of the lead audit partner, the review partner, specialists and audit team members for audit quality;

  • facilitating the audit process, including support by entity management for the audit process;

  • two-way communication with the auditor on concerns and risk areas; and

  • assessing the auditor’s professional scepticism in challenging accounting treatments and estimates.

  • ensuring independence of the auditor; and

  • asking for the results of any ASIC review of the audit files and asking the auditor how they have responded to any ASIC findings.

ASIC set out that directors and audit committees should ensure the company’s internal governance and risk frameworks are robust and support the preparation of financial statements free of material misstatements.

3.4 - 2021 the Horizon for Auditors

Over the next four years significant changes are being made to Australian Auditing Standards.

The key amendments to Auditing and Ethical Standards applicable to Australian auditors are:

2021 2022 2023
First year application of ASA540 (revised) ISQM1 to be in place system by 15 December 2022 First year of implementing and quality under ISQM1
First year application of ASA 500 (revised) Readiness for ASA 315 (revised) First year of ISQM2
ASRE 2410 (revised) First year of ASA 200 (revised)
APES 305 (revised) First year of ASA 315 (revised)

A challenging horizon ahead for auditors

The audit profession has come under significant pressure in recent years, having to audit new and complex accounting standards against a background of increasing criticism from regulators globally and an increasingly litigious environment.

The IAASB have released a series of revised auditing standards (ASA 540, ASA 500 and ASA 315) to improve audit quality, emphasizing the need for auditors to apply professional skepticism. Concurrently, the IAASB has introduced a new standard in respect of quality management for audit firms (ISQM1).

The fundamental requirements of an audit, being to obtain sufficient appropriate audit evidence to opine whether the financial report is free of material misstatement, has not been changed or been enhanced. Nor has the requirement to understand the entity and the environment it operates in, so as to identify the risk of material misstatement through error or fraud. The revised auditing standards will however make it clearer for reviewers, regulators, and litigators to identify when the auditor has failed to properly identify risk and failed to obtain sufficient audit evidence.

Auditing and ethical standard changes applicable for 2021

The following new and revised pronouncements have application to annual financial reporters with a year-ending on or after 31 December 2020:

The IAASB and AUASB have issued a revised version of ASA 540.

Accounting estimates are one of the key areas challenging auditors and have become even more problematic in recent years with the introduction of AASB 9, 15 and 16. Accounting estimates in respect of goodwill impairment, net realizable value of inventory, bad debt provisions and revenue recognition are major areas of ASIC surveillance and restatement. Errors in accounting estimates commonly form the subject of litigation against directors and auditors.

The amendments center on:

  • Identifying risk of material misstatement arising from accounting estimates
  • Distinguishes inherent risk from control risk in respect of accounting estimates
  • Sets out that inherent risk is impacted by complexity, subjectivity and estimation risk
  • Requires consideration as to how management have considered estimation risk
  • Requires auditor to “stand back” and to consider and evaluate evidence that both supports and contradicts management’s estimate
  • Emphasizes professional skepticism as a response to management bias
  • Emphasizes work required around disclosure of accounting estimates
  • Sets out that when testing how management has arrived at an accounting estimate an auditor needs to consider the method, assumptions, and data upon which the estimate is based.

Practical implications

Correctly applying ASA 540 (revised) requires a change in the auditor’s mindset, how they perform and document their risk analysis in respect of management estimates, what audit evidence they obtain and how they interpret that evidence.

If the auditor determines risk arising from management estimates can be reduced by the controls that are in place to manage that risk, then auditors will have to identify those controls and perform work to obtain sufficient appropriate audit evidence that those controls are adequate to address the risk.

The standard is explicit in its requirement for the auditor to consider whether management have appropriately considered estimation risk, and if not, to request that management adjust their estimate. This will in turn, expose the auditor to greater scrutiny if it is determined by the regulator or litigator that the estimates in the financial statements did not reflect estimation risk.

ASA 540 (revised) explicitly requires the auditor to stand back and consider all audit evidence in respect of an accounting estimate, including evidence that contradicts management’s estimate. This may prove problematic for some auditors, who may have in the past focused their attention on obtaining audit evidence that corroborated managements estimate.

ASA 500 (revised) Audit Evidence

ASA 500 was revised as a result ASA 540 (revised) and Introduces the definition of External Information Sources. An auditor is required to distinguish information from an External Information Source from that of a management expert and to evaluate whether External Information Sources is relevant and reliable for the purposes of audit evidence.

The revised standard explicitly requires consideration of whether the information was prepared for a wide range of users or for the client, and whether the client was in a position to influence the information provided from the external source.

Practical implications

Careful consideration will be required as to whether information from a third party to support a management estimate represents relevant and reliable audit evidence, and whether it can be concluded it is free from potential bias.

ASRE 2410 (revised) Review of a Financial Report Performed by the Independent Auditor of the Entity

The auditor’s review report has been reordered so that the conclusion comes first, followed by a basis for conclusion. The auditor is required to report a material uncertainty related to going concern under the heading “Material Uncertainty Related to Going Concern” instead of an “Emphasis of Matter”.

Practical implications

The review conclusion has changed! Auditors that issue a review opinion in the old format will be clearly signaling that they are not up to date with current auditing standards.

APES 305 (revised) Terms of Engagement

The. revised standard is effective for engagements commencing on or after 1 July 2021 with early adoption permitted. The revisions require specific considerations and communications where the auditor will outsource elements of the audit.

Practical implications

It is becoming increasingly common for audit firms to outsource elements of their audit, including set up of audit files, completion of disclosure checklists etc. These arrangements will have to be fully disclosed to the client. Such disclosure may raise questions from the client around data and cyber security arrangements with the outsource provider.

ISQM1 was issued by the IAASB in December 2020 and requires that auditors implement a quality management system by 15 December 2022.

The objective of ISQM1 is for the audit firm to have reasonable assurance that:

  • The firm and its staff have fulfilled their responsibilities in accordance auditing and ethical standards and in accordance with other professional and legal requirements; and
  • Reports issued by the firm are appropriate.

The audit firm is required to design and implement a risk assessment process to establish quality objectives, identify and assess quality risks and to design and implement responses to address identified risks.

ISQM1 sets out that an audit firm’s system of quality management must address the following eight components:

  1. The firm’s risk assessment process;
  2. Governance and leadership;
  3. Relevant ethical requirements;
  4. Acceptance and continuance of client relationships and specific engagements;
  5. Engagement performance;
  6. Resources;
  7. Information and communication; and
  8. The monitoring and remediation process.

Practical implications

Auditors need to start the design of their quality management system as early as possible, it is not something that should be left to the second half of 2022!

ISQM1 if implemented properly, will in many cases highlight deficiencies in an audit firm’s quality management, including failures to:

  • Demonstrate how the firm is committed to quality in respect of its partners and staff;
  • Demonstrate how the firm ensures its partners and staff possess the appropriate technical knowledge to perform an audit of the required quality;
  • Demonstrate how partners and staff have access to appropriate accounting and auditing technical resources; and
  • Demonstrate how the firm has effectively handled breaches in audit quality.

2022 Another challenging year on the horizon

2022 will involve an audit firm implementing ISQM1 by 15 December 2022 and preparing to implement ASA 315 (revised).

ISQM1 will need to be implemented by 15 December 2022.

Practical implications

Audit firms need to determine as soon as possible, their plan and timeline for implementing ISQM1.

This plan must include:

  • The individual and team who are responsible for implementation;
  • A realistic time frame for implementation, considering peak audit workloads, staff turnover, training requirements and the need to rectify deficiencies.

The firm’s quality management plan will form the basis for future inspections by regulators and professional bodies. Therefore, a robust and well considered plan is crucial.

2023 The year you test your quality management system

2023 will see the audit firm test its quality management system for compliance with ISQM1 and implement the revised ASA 220 Quality Control for an Audit of a Financial Report and Other Historical Financial Information and the new standard ISQM2 Engagement Quality Reviews.

2023 will be the first full year audit firms apply ISQM1, which require audit firms to:

  • Continually monitor the appropriateness of the firm’s quality risk management for changing risks and conditions;
  • Evaluate the performance of the audit firm’s leadership;
  • Evaluate and conclude whether the system of quality management is achieving its objectives (to be performed annually); and
  • Take further action if the conclusion on whether the system of quality management is achieving its objectives is unsatisfactory.

Practical implications

The ongoing compliance with ISQM1 should not be underestimated, audit firm’s are required to test their quality management system at least annually.

The audit firm will have clearly failed to comply with the requirements of ISQM1 if:

  • An annual review of the effectiveness of the audit firm’s quality management system is not performed; and
  • Appropriate actions are not taken for weaknesses identified in the annual review.

ISQM2 Engagement Quality Reviews

ISQM2 is effective for audit and review engagements of financial statements for periods beginning on or after 15 December 2022, applying to half year reviews for 30 June 2023 and full year audits 31 December 2023.

ISQM 2, Engagement Quality Reviews, addresses:

  • The appointment and eligibility of the EQ reviewer; and
  • The EQ reviewer’s responsibilities relating to the performance and documentation of an EQ review.

The changes introduced in ISQM 2 are intended to:

  • Extend the scope of engagements subject to an engagement quality (EQ) review (in addition to audits of financial statements of listed entities);
  • Strengthen the eligibility criteria for an individual to be appointed as an EQ reviewer; and
  • Enhance the EQ reviewer’s responsibilities relating to the performance (including the nature, timing and extent of procedures) and documentation of the EQ review.

ISQM2 requires an EQ review for:

  • Audits of financial statements of listed entities;
  • Audits or other engagements for which an EQ review is required by law or regulation; and
  • Audits or other engagements for which the firm determines that an EQ review is an appropriate response to address one or more quality risk(s).

The EQ reviewer must have:

  • An understanding of professional standards, applicable legal and regulatory requirements and of the firm’s policies or procedures relevant to the engagement;
  • Knowledge of the entity’s industry;
  • An understanding of, and experience relevant to, engagements of a similar nature and complexity;
  • An understanding of the responsibilities of the engagement quality reviewer in performing and documenting the engagement quality review;
  • Sufficient time;
  • Appropriate authority;
  • Comply with relevant ethical requirements, including threats to objectivity and independence; and
  • Comply with provisions of relevant laws and regulations.

Practical Implications

The introduction goes hand in hand with application of ISQM1 and ASA220 revised. Audit firms will need to carefully determine whether their EQ reviewers:

  • Have the appropriate skills and experience for each engagement to which they are assigned;
  • Have the appropriate authority; and
  • Are given sufficient time.

An interesting inclusion is that ISQM2 permits the use of suitably qualified external EQ reviewers and the use of assistants.

ASA 220 (revised) Quality Management for an Audit of Financial Statements

ASA 220 (revised) is effective for audit and review engagements of financial statements for periods beginning on or after 15 December 2022, applying to half year reviews for 30 June 2023 and full year audits 31 December 2023.

The revisions to ASA 220 continue the drive for quality set out in ASA 540 (revised) and ASA 315 (revised), emphasizing the importance of professional skepticism, and requiring enhanced documentation of the auditor’s judgments. It also is fully in line with ISQM1 and ISQM2.

ASA 220 (revised) makes it clear that it is the engagement partner’s overall responsibility to manage and achieve quality on the engagement and this is achieved through the engagement partner having sufficient and appropriate involvement throughout the audit engagement.

ASA 220 (revised)) sets out that the Engagement partner is responsible for:

  • managing and achieving quality at the engagement level; and
  • determining the nature, timing and extent of direction, supervision, and review.

The engagement partner is required to be satisfied that their involvement has been sufficient and appropriate to provide the basis for taking overall responsibility.

Practical implications

The revisions to ASA 220, require the audit partner to be appropriately involved in all phases of the audit and for there to be evidence of this. For those audit partner that typically have a “hands off” approach or are simply too stretched, delegating significant work to their senior managers, this revised standard together with ISQM1 requires a change to their business model.

2023 The Year to apply ASA 315 (revised) Identifying and Assessing the Risks of Material Misstatement

ASA 315 (revised) is operative for financial reporting periods commencing on or after 15 December 2021, applicable to audits of 31 December 2022 and 30 June 2023 year ends.

The standard has been revised to respond to challenges and issues with the current ASA 315. The revised requirements focus on ‘what’ needs to be done, and the application material enhanced, modernized, and reorganized to describe ‘why’ and ‘how’ procedures are to be undertaken.

ASA 315 (revised) is very much aligned to the changes contained within ASA 540 (revised) and includes similar new concepts and definitions. ASA 315 (revised) sets out:

  • There is a spectrum of inherent risk;
  • Inherent risk factors that must be considered by auditors;
  • The requirement to perform separate assessments of inherent risk and control risk;
  • Consideration of ‘significant classes of transactions, account balances and disclosures’ and ‘relevant assertions’;
  • Introduces a new definition of ‘significant risk’ being those risks close to the upper end of the spectrum of risk;
  • Requires the auditor to ‘stand-back’ to evaluate the completeness of significant classes of transactions, account balances and disclosures at the end of the risk assessment process; and
  • Where the auditor does not contemplate testing the operating effectiveness of controls, the risk of material misstatement is the same as the assessment of inherent risk.

Practical implications

Revisions to ASA 315 are in response to dissatisfaction by audit regulators as to how auditors identify and address risk. Whilst the basic objective of the audit has not changed, ASA 315 (revised) is very prescriptive as to how risk identification should take place, emphasizing the requirement to link risk to assertions and the need to apply an appropriate level of professional skepticism.

ASA 315 (revised) is very much in line with ASA 540 (revised) that came into force in 2021, so the key changes in respects of the risk of material arising from management’s accounting estimates should not come as a surprise to auditors in 2023.

Some good news for Auditors

For Auditors, although 2021 heralds a new era of complexity and a drive for quality, the good news is that the accounting changes in 2021 are minimal which we discuss in our article “2021 the horizon for Accountants”.

4 - Audit Committees

Resources for audit committees.

4.1 - The role of directors, audit committees and management in improving audit quality

In its 2021 audit inspection report ASIC set out that company directors, audit committees and management have roles in supporting quality audits. Among other matters ASIC suggested that, directors and audit committees should consider:

  • non-executive directors recommending audit firm appointments and setting audit fees;

  • assessing the commitment of the auditors to audit quality;

  • reviewing the resources devoted to the audit, including the amount of partner time, the need for the auditor to use experts and the appropriate use of other auditors;

  • accountability of the lead audit partner, the review partner, specialists and audit team members for audit quality;

  • facilitating the audit process, including support by entity management for the audit process;

  • two-way communication with the auditor on concerns and risk areas;

  • assessing the auditor’s professional scepticism in challenging accounting treatments and estimates;

  • ensuring independence of the auditor; and

  • asking for the results of any ASIC review of the audit files and asking the auditor how they have responded to any ASIC findings.

ASIC set out that directors and audit committees should ensure the company’s internal governance and risk frameworks are robust and support the preparation of financial statements free of material misstatements.

Following on from each of these points, Audit Committees should consider

Who recommends the audit firm appointment and the setting of fees?

In many cases it is executive management that both recommend the appointment and retention of the auditor, particular the CFO, with justification of selection including low fees or value for money.

Clearly such an arrangement can reduce audit quality and increase the risk that the audit is not performed in accordance with Australian Auditing standards:

  • Would the CFO choose the auditor most likely to question particular accounting treatment? or instead recommend an auditor that takes a more “pragmatic: “commercial” stance?

  • Would the CFO choose to pay an auditor high fee so the auditor can perform a thorough job and identify misstatements? or would the CFO prefer the audit to be performed “efficiently” so as to reduce the risk of the auditor detecting material misstatements?

  • If the auditor is dependent upon keeping the CFO happy, so as to retain the audit and negotiate audit fees, is the auditor motivated to keep the CFO happy and to avoid challenging the CFO’s judgement?

For audit quality to be maintained, the appointment of auditors and the determination of audit fees, should be determined by the audit committee, not the CFO.

How does the audit committee assess the commitment of the auditors to audit quality?

When engaging any supplier or service provider the purchaser of those goods and services should take steps to ensure that service provided is fit for purpose and of the appropriate quality, this basic requirement also applies to the purchase of audit services.

  • What steps does the audit committee take to ensure the quality of the audit services they are being provided with?

  • How well does the audit firm perform in audit inspections?

  • Is it appropriate for the CFO to be the sole judge of the quality of the audit being provided?

Does the audit committee consider whether appropriate resources are devoted to the audit?

Again when purchasing a service the purchaser should evaluate whether the service provided was appropriately resourced, this should apply to the assessment of the audit service received:

  • How involved was the audit partner?

  • How many hours did the audit partner spend on the audit?

  • What was the experience and qualifications of the audit team?

  • Did the auditor use experts in the audit (IFRS experts, valuers etc)?

  • Did the auditor appropriately supervise component auditors?

Were the lead audit partner, the review partner, specialists and audit team members accountable for audit quality?

It is important for the audit committee to understand how audit quality was applied to their audit considering:

  • How did the audit partner ensure appropriate quality was applied?

  • Does the auditor believe they delivered a quality audit?

  • Were adequate resources given to the audit?

  • Was the time allowed conducive to performing a quality audit?

Did the Directors and the Company facilitate a quality audit?

If an audit committee wants a quality audit, then they need to determine if the company and its management facilitated the audit process:

  • Was the fee realistic?

  • Was the audit timeframe realistic?

  • Were deadlines realistic?

  • Was the auditor supplied with the appropriate information in a timely manner?

  • Does the CFO have adequate resources to produce a financial report free of material misstatement?

  • Does the CFO and the finance team have sufficient resource to spend sufficient time with the auditors?

Was there two-way communication with the auditor on concerns and risk areas?

Many auditors promise a ‘no surprises’ audit, but fail to properly communicate the audit process and the audit risks with the audit committee.

  • Was there an audit planning meeting?

  • Was the audit committee involved or consulted in the development of the audit plan?

  • Was an audit plan presented to the audit committee?

  • Did the audit committee have concerns as to the application of financial reporting, that required to be discussed with the auditor?

  • Does the audit involve auditing key judgements and estimates?

  • Is there a communications process between the auditor and the audit committee?

Did the audit committee assess the auditor’s professional scepticism in challenging accounting treatments and estimates?

Many accounting failures arise from management being too aggressive and optimistic in making estimate, that are neither realistic or supportable, such judgements leading to material misstatements of:

  • Impairment of goodwill;

  • Impairment of non-current assets;

  • Inadequate bad debt provisions;

  • Overvalued inventory;

  • Overvalued property;

  • Overvalued financial assets; and

  • Too early recognition of revenue.

It is imperative that an audit committee:

  • Understand the key judgements used in preparing the financial report;

  • Are satisfied that the estimates are based on reasonable and supportable assumptions;

  • Understand how the auditor planned to obtain sufficient and appropriate audit evidence to determine if the key assumptions in the estimates were on reasonable and supportable;

  • Understand what evidence the auditor obtained to determine whether or not the key assumptions in the estimates were on reasonable and supportable; and

  • Understand whether the auditor challenged the assumptions in the estimates.

Did the audit committee ensure the independence of the auditor?

Auditors are obliged under law, ethical standards and auditing standards to be independent and will provide confirmation to the board to that effect prior to issuing their audit opinion.

However independence is a subjective area requiring both actual threats to independence and perceived threats to independence.

Audit committees need to consider actual or perceived:

  • Self interest threats to their independence; and

  • Self review threats threats to their independence.

Self-interest threats may include:

  • Consideration whether the audit partner is overly financially exposed should the audit be lost;

  • Whether the audit firm has been involved in the due diligence of assets acquired that may be impaired;

  • Whether the firm has given tax advice that may prove to be incorrect;

  • Whether the firm has given accounting advice that may be incorrect; and

  • Whether the firm has failed to identify material errors in past financial reports and is incentivised to overlook them in the current year audit fearing litigation.

Self-review threats may include:

  • Tax advice;

  • Accounting advice;

  • Performing due diligence; and

  • Performing valuation services.

Has the audit committee asked for the results of any ASIC review of the audit files and asked the auditor how they have responded to any ASIC findings?

Perhaps the easiest way for an audit committee to gauge the quality of their audit is to request the auditor to provide them with the results of any ASIC review of the audit files.