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