October 2013 marked the first anniversary of Westworth Kemp Pty Ltd. It has been a year in which we set up our own office in York Street, Sydney and ventured offshore, with an assignment in New Zealand, where, on our last visit, Auckland really looked its best.
Lessons for auditors
Failed second tier finance houses and investment companies were definitely the flavour of 2013, still the fallout from the Global Financial Crisis (GFC) of 2007/2008 and the boom years beforehand. From rural Victoria to New Zealand and to Queensland, the story is the same, second tier lenders receiving deposits from unsuspecting mums and dads and lending them to real estate developers just prior to the 2007 crash. These organisations appeared to be lending on mortgage security, but wise after the event, all was not as it appeared.
At risk of sounding suspiciously like the report from an ASIC surveillance programme, some of the audits we have seen were distinctly lacking in scepticism and good audit evidence, particularly as regards asset values. The auditor is there as part of a safety net to protect the stakeholders in an organisation who are not involved in its management, including shareholders and investors in the entity’s debentures or units, who have relied on assertions in a disclosure document as to the quality of the underlying assets.
We have seen auditors accepting the assurances of management that a debtor will pay and that there is adequate security, without fully analysing the audit evidence and assessing the security risk. We have also seen auditors chatting through systems with client staff to gain an understanding of how the business operates, but then not going back to test the output from the system they have learned about. It is not enough to learn how the system operates that produces that key printout that the auditor is relying on – the auditor needs to test it to make sure the information in it is reliable. Similarly, it is important to check the work of experts such as valuers against other available evidence to ensure that their report rests on valid assumptions that reflect the circumstances of the asset concerned.
A rigorous audit is an important part of the governance safety net and auditors need to be brave and bare their teeth. On a number of assignments we have seen the auditor submitting management letter points to the Board where an emphasis of matter in the audit report would have been more appropriate. Management letter points are important, but setting in place structures to monitor difficult loans should be an accepted element in internal control, rather than something that is put in place late in the day when the lender is teetering on the brink of bankruptcy.
A new and interesting development in the post GFC wash up from the failure of these second tier finance houses is the commencement of class actions against the auditor who audited the compliance plan as well as the auditor of the financial statements. Again, the compliance plan is part of the investor protection safety net, but rather than questions of material misstatement, the compliance plan audit focuses on whether the organisation operated in accordance with its constitution for the benefit of its members. It remains to be seen what 2014 will bring.
The long form audit report proposals
Would the proposals coming out of the International Auditing and Assurance Standards Board in the form of Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing have had any effect on helping to prevent the collapse of these second tier lenders? Sadly, we think that in most cases, they would not. The proposals include a new ISA 701 entitled Communicating Key Audit Matters in the Independent Auditor’s Report, which would require the auditor to communicate those matters that, in the auditor’s professional judgement, were of most significance to the audit of the financial statements. One danger however is that such disclosures become boiler plate like the statement of risks in a prospectus and become meaningless. Another is that the auditor sees the disclosures as a means of avoiding having to qualify the audit report, in the same way that some auditors are using reporting to management.
From our work on failed audits, a long form report would not have avoided the collapse of the company. The matters that the proposals suggest should appear in a long form report should have been included in reports to management or those charged with governance well before the eventual collapse. We have observed either a failure to make such comments at an early enough stage or a failure to make such comments with sufficient emphasis for the real issues to be understood.
A long form report in our view is a panacea that will achieve nothing that cannot already be achieved by effective corporate reporting, challenged by robust audit reporting within the existing framework. However greater involvement of the audit committee, including their making a public report as advocated by the UK FRC, might result in that committee challenging the cautious comments being made to them by external auditors.
There are good auditors out there …
An article has recently come to our attention describing the fate of a diligent auditor who discovered a sticky situation at a Canadian maple syrup depot – by losing his balance on a syrup barrel at the stock take while he was climbing a pile of barrels. The wobbly barrel turned out to be empty and alerted the auditors to a large fraud. The full story can be read in Bloomberg Businessweek on this link: http://www.businessweek.com/articles/2013-01-02/the-great-canadian-maple-syrup-heist.
Mentioned in Despatches
The big thrill for 2013 was when one of our cases proceeded to a hearing in the Supreme Court of Victoria and Chris had to give evidence. His evidence as the preferred accounting expert was mentioned in glowing terms in the judgement – further details can be found at http://www.westworthkemp.com.au/_blog/News/post/praise-for-chris-from-vic-supreme-court/.
The judgement also provides a good summary of the case law relating to the payment of dividends out of profits. While the case was under the old dividend rules (S 245T of the Corporations Act 2001 as it stood in 2005), notwithstanding the subsequent change in the law to prefer a solvency over a profits test for dividends, his conclusions on directors’
obligations to consider financial information before paying a dividend are still relevant (see http://www.westworthkemp.com.au/Blog/ICM_Investments_Pty_Ltd_v_San_Miguel_Corporation_and_another.pdf for more details).
A Blast from the Past
This year saw the 15th birthday of the Institute’s ANT newsletter, conceived as a quick weekly update on accounting and auditing issues for members. No one expected that 15 years on it would still be going. In September 1998, we still had our own Aussie GAAP accounting standards and AUS auditing standards that were not yet legally binding. We had our own UIG making interpretations. Now we take for granted globalised standard setting.
While some things change, some remain the same – the Auditing and Assurance Standards Board was discussing audit reporting and AUS 708 on Going Concern – sounds familiar? Plus ca change …
WK would like to congratulate the Institute’s ANT writers on doing a great job keeping the profession up to date over the last 15 years and wishes them all the best for the next 15.
And lastly our awards for 2013
Award for the coolest crockery goes to Allens Melbourne for their teapots and best biscuits to HSF Melbourne, where it is almost impossible to attend a meeting without snacking. Simpson Grierson in Auckland deserves an honourable mention for introducing us to a New Zealand delicacy, ginger slice, and serving very cute mini mince pies in December.
And our restaurant tips (with thanks to instructing solicitors on secondment from Sydney at Ashursts and HSF in Melbourne, who are exploring the Melbourne eating scene and appreciate that an expert needs to be fed and the PWC insolvency team who pointed us in the right direction in Auckland!)
We discovered that Flinders Lane is the home of interesting restaurants, with its attractively reused industrial spaces and eclectic décor. Try Coda and Chin Chin. We also discovered share plates thanks to Movida and in Melbourne and The Depot in Auckland, a wonderful way of sampling a variety of courses without eating too much.
We wish our clients and contacts all the best for the festive season and look forward to more adventures in accounting and auditing in 2014!
Chris and Stephanie act as consultants and experts (“clean” and “dirty” experts) in the context of dispute resolution on a variety of financial reporting and audit issues.
Westworth Kemp Consultants can provide support to businesses, professional practices and regulators seeking to implement systems designed to foster compliance
Independent advice on the interpretation of auditing (or assurance) and accounting (or financial reporting) standards can be hard to find.