CHAPTER 46
THE EXTERNAL AUDITS OF THE STATE BANK:
BACKGROUND INFORMATION
TABLE OF CONTENTS
46.1 PURPOSE OF CHAPTER
46.2 PLAN OF CHAPTER
46.3 STATUTORY REQUIREMENTS FOR PREPARATION OF ACCOUNTS AND AUDITS
46.3.1 PREPARATION OF ACCOUNTS
46.3.2 AUDIT OF ACCOUNTS
46.4 APPOINTMENT OF AUDITORS
46.5 EXTERNAL AUDITORS' RESPONSIBILITIES AND EXTERNAL AUDIT PROCESS
46.5.1 AUDITORS' RESPONSIBILITIES
46.5.2 PHASES OF THE AUDIT PROCESS
46.5.2.1 Planning the Audit
46.5.2.2 Execution of the Audit
46.5.2.3 Conclusion of the Audit
46.5.3 THE IMPORTANCE OF AUDIT WORKING PAPERS
46.5.4 RELIANCE ON MANAGEMENT
46.5.5 RELIANCE ON THE WORK OF OTHER AUDITORS
46.5.6 MATERIALITY
46.6 AUDIT OF FINANCIAL INSTITUTIONS
46.7 INVESTIGATION OF THE EXTERNAL AUDITS OF THE ACCOUNTS 1985-1990
46.8 RECURRING TRANSACTIONS AND AUDIT PROCEDURES 1985-1990
46.8.1 INVESTMENT PURCHASES AND DISPOSALS
46.8.2 PROVISION FOR DOUBTFUL DEBTS
46.8.3 CONTINGENT LIABILITIES
46.8.4 SUPERANNUATION PROVISION
46.8.5 PROVISION FOR TAXATION
46.8.6 CONCESSIONAL HOUSING RESERVE
46.8.7 BANK ACCEPTANCES OF CUSTOMERS
46.8.8 PROVISION FOR SELF INSURANCE
46.8.9 CONCLUDING PROCEDURES
46.8.10 EVALUATION OF AUDIT DIFFERENCES
46.8.11 SUBSEQUENT EVENTS REVIEW
46.8.12 MANAGEMENT REPRESENTATION LETTERS
46.8.13 CUMULATIVE NATURE OF ADJUSTMENTS
46.1 PURPOSE OF CHAPTER
The purpose of this Chapter is to provide salient background information to convey some understanding of:
(a) The statutory responsibilities enunciated in the State Bank of South Australia Act, 1983 ("the Act"), in relation to the preparation, and the external audit, of the accounts of the Bank.
(b) The nature of the external audit process, and the responsibilities of the external auditors engaged to undertake that process.
(c) Particular transactions and audit procedures which will be noted in each of the Chapters dealing with the external audits in particular financial years.
The background information will also facilitate understanding of the issues and conclusions which have emanated from the investigation of the external audits of the accounts of the Bank, 1985 to 1990, and which are discussed in detail in Chapter 47 - "Review of the 1985 External Audit of the State Bank" to Chapter 52 - "Review of the 1990 External Audit of the State Bank".
46.2 PLAN OF CHAPTER
The Chapter comprises the following principal segments:
(a) Statutory requirements for preparation of Accounts and Audits;
(b) Appointment of External Auditors;
(c) External Audit Process and External Auditors' Responsibilities;
(d) Audit of Financial Institutions; and
(e) Nature of the Investigation of the External Audits of the Accounts 1985 to 1990.
46.3 STATUTORY REQUIREMENTS FOR PREPARATION OF ACCOUNTS AND AUDITS
46.3.1 PREPARATION OF ACCOUNTS
Section 23 of the Act imposes certain obligations on the Bank Board in respect of the preparation of the accounts of the Bank. Section 23 states:
"23. (1) The Board shall cause accounting records to be kept in such a manner as to -
(a) record correctly and explain the transactions and financial position of the Bank;
(b) enable true and fair accounts of the Bank to be prepared from time to time;
and
(c) enable the accounts of the Bank to be conveniently and properly audited.
(2) Within three months after the end of a financial year, the Board shall cause the following accounts to be prepared:
(a) an account giving a true and fair view of the income and expenditure of the Bank for the financial year and of any surplus or deficit relating to the financial year;
and
(b) a balance sheet giving a true and fair view of the state of affairs of the Bank as at the end of the financial year.
(3) The Board shall, as soon as practicable after the accounts prepared under (2) have been audited, forward to the Governor a report on the operations of the Bank during the financial year to which the accounts relate together with a copy of the audited accounts.
(4) Copies of the report and the audited accounts shall be laid before each House of Parliament."
The following statement has appeared in Note 1 to the accounts for each of the financial years under review:-
"Preparation of the accounts in compliance with [the State Bank of South Australia Act, 1983] is deemed to be in compliance with the provisions of the Companies (South Australia) Code."
This statement appears to be incorrect, for the reasons set out below. Questions therefore arise whether the Bank or the auditors properly considered whether the statement was correct or not.
The Bank is not a company registered under the Companies (South Australia) Code. Accordingly, the provisions of Section 288 of the Companies (South Australia) Code, which relax certain reporting requirements which would otherwise apply to banking corporations, could have no practical application to the Bank.
In particular, the provisions of Section 288(3) could not apply to the Bank. That sub-section provides:
"Where, under a law of the Commonwealth relating to banking, a prescribed corporation is required to prepare accounts annually, accounts for the corporation that comply with the provisions of that law shall be deemed to comply with the provisions of this Code relating to accounts."
Further, the Bank is not governed by a law of the Commonwealth relating to banking, ie the Banking Act, because this act does not apply to a State Bank, so it would seem that Section 288(3) could not apply even if Section 288 itself applied to the Bank.
It would, therefore, seem that the statement in Note 1 to the accounts, referred to above, is incorrect.
The following further statement has appeared in Note 1 to the accounts for each of the financial years under review:
"Where practicable, accounts have been drawn up generally in accordance with the requirements of the [Companies (South Australia)] Code and Schedule 7 of the Companies (South Australia) Regulations and with Accounting Standards so far as they are considered appropriate to the Bank."
In my opinion, this statement must be taken to mean, that there is no significant departure from the specified requirements unless otherwise stated in the accounts or notes, because readers of the accounts would have no way of knowing which of the specified accounting requirements the Board of Directors might consider appropriate or not.
It is not necessary for present purposes to set out all of the requirements of the Companies (South Australia) Code concerning accounts. It is noted, however, that Section 269(7) requires that:
"The directors shall, before the profit and loss account and balance-sheet ... are made out, take reasonable steps -
(a) to ascertain what action has been taken in relation to the writing off of bad debts and the making of provisions for doubtful debts and to cause all known bad debts to be written off and adequate provision to be made for doubtful debts;
(b) to ascertain whether any current assets, other than current assets to which paragraph (a) applies, are unlikely to realise whether directly or indirectly in the ordinary course of business their value as shown in the accounting records of the company and, if so, to cause -
(i) those assets to be written down to an amount that they might be expected so to realise; or
(ii) adequate provision to be made for the difference between the amount of the value as so shown and the amount that they might be expected so to realise; and
(c) to ascertain whether any non-current asset is shown in the books of the company at an amount that, having regard to its value to the company as a going concern, exceeds the amount that it would have been reasonable for the company to expend to acquire that asset as at the end of the financial year and, unless adequate provision for writing down that asset is made, to cause to be included in the accounts such information and explanations as will prevent the accounts from being misleading by reason of the overstatement of the amount of that asset."
46.3.2 AUDIT OF ACCOUNTS
Section 24 of the Act, prescribes certain requirements in relation to the external audit of the accounts of the Bank. Notably, Section 24 states:
"24. (1) Within the first three months of each financial year, the Board shall appoint two or more auditors of the Bank for that financial year.
(2) Any auditor appointed under subsection (1) must be a registered company auditor or a firm of registered company auditors.
(3) It is the duty of the auditors to report on the Bank's accounting records and on the accounts to be laid before Parliament in respect of the financial year for which they are appointed as auditors of the Bank.
(4) The auditors shall, in a report under this section, state-
(a) whether the accounts are, in their opinion, properly drawn up in accordance with this Act and so as to give a true and fair view of the matters to which they relate;
and
(b) whether the accounting records of the Bank have been, in their opinion, properly kept in accordance with the provisions of this Act."
In each of the years under review, the auditors reported to the Bank and to Parliament that in their opinion:
(a) The accounts of the Bank and of the Bank Group were properly drawn up in accordance with the provisions of the Act.
(b) The accounts of the Bank and of the Bank Group were properly drawn up in accordance with the provisions of the Companies (South Australia) Code as appropriate to a banking organisation.
(c) The accounts of the Bank and of the Bank Group so drawn up give a true and fair view of the state of the affairs of the Bank and of the Bank Group as at the balance date and of the results of the Bank and of the Bank Group for the year then ended.
(d) The accounts so drawn up give a true and fair view of the other matters required by Section 269 of that Code to be dealt with in the accounts and the group accounts.
(e) The accounts so drawn up are in accordance with Australian Accounting Standards and applicable Approved Accounting Standards as applicable to a banking organisation.
The auditors' report also noted that they had not acted as auditors of Beneficial Finance and its subsidiary companies.
In my opinion, for the reasons stated above, the statements referred to in (b) and (e) above must be taken to mean, that unless otherwise stated in the accounts or notes forming part of the accounts, the provisions of the Companies (South Australia) Code, Australian Accounting Standards, and applicable Approved Accounting Standards regarding company accounts, are all appropriate to a banking organisation.
46.4 APPOINTMENT OF AUDITORS
The following chart identifies the auditors appointed pursuant to Section 24(1) of the Act for each of the years ended 30 June 1985 to 30 June 1990 and dates of appointment.
|
FINANCIAL |
|
|
DATE OF |
|
1985 |
Peat, Marwick, Mitchell & Co |
T J Whimpress, Partner |
28/06/84 |
|
1986 |
Peat, Marwick, Mitchell & Co |
T J Whimpress, Partner |
26/09/85 |
|
1987 |
Peat, Marwick, Mitchell & Co |
T J Whimpress, Partner |
24/09/86 |
|
1988 |
Peat, Marwick, Mitchell & Co |
T J Whimpress, Partner |
24/09/87 |
|
1989 |
Peat, Marwick, Mitchell & Co |
T J Whimpress, Partner |
29/08/88 |
|
1990 |
Peat, Marwick, Hungerfords |
T J Whimpress, Partner |
28/09/89 |
46.5 EXTERNAL AUDITORS' RESPONSIBILITIES AND EXTERNAL AUDIT PROCESS
46.5.1 AUDITORS' RESPONSIBILITIES
External auditors' responsibilities concerning the audit process are set out in the applicable pronouncements of the Professional Accounting Bodies in this country(), and in the common law. The following is a summary of the salient points:
(a) In forming the audit opinion, the auditors must perform sufficient tests to obtain reasonable assurance that the financial information is properly stated in all material respects, that is, that transactions have been properly recorded in the accounting records and that transactions have not been omitted.()
(b) Internal controls may contribute to the reasonable assurance the auditor seeks, and audit procedures must include an evaluation of the accounting systems and internal controls upon which the auditor chooses to place reliance in determining the nature, timing and extent of substantive audit procedures.()
(c) While it is not the purpose of the audit to determine the adequacy of internal controls for management purposes, the auditors must inform Management, or in certain cases the Board of Directors, concerning any material weaknesses in internal control and accounting procedures of which the auditors become aware during the course of the audit.()
(d) The auditors must obtain appropriate and sufficient audit evidence through the performance of compliance and substantive procedures from which they could reasonably draw conclusions and base their opinion concerning the accounts and financial position of the reporting entity.()
(e) The auditors must bring to bear on the work they have to perform that skill, care and caution, which a reasonably competent, careful and cautious auditor would use. What is reasonable skill, care and caution will be determined by the circumstances of the time.()
The above is no more than a summary of auditors' responsibilities, which are more fully set out in the applicable pronouncements.
I have assessed the appropriateness and adequacy of the external audit by reference to what I consider to be the ordinary standard of skill, care and caution which a reasonably competent auditor would bring to bear. In forming my views, I have had regard to applicable professional standards and practices.
The joint auditors have submitted to me that I have in the Investigation implicitly applied a standard of care and assurance far in excess of the normal standard of professional care, skill and competence required by professional standards.() In particular, the joint auditors submit that I should have regard to the requirements in the applicable professional standard that an audit must be conducted in an efficient and effective manner. This requirement arises from AUS1, paragraph 20, which provides:
"Auditors shall plan their work to enable them to conduct an effective audit in an efficient and timely manner".
The joint auditors also submit that I should have regard to the risk which is inherent in the concept of "reasonable assurance".() This risk is noted in AUS1:
"Because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any system of internal control, there is an unavoidable risk that even some material misstatement may remain undiscovered. However, any indication that some fraud or error may have occurred which could result in material misstatement would cause auditors to extend their procedures to confirm or dispel their suspicions." ()
From these pronouncements of the Professional Accounting Bodies the joint auditors derive the proposition that the auditor should limit his work to the minimum necessary to support his opinion or in other words to the extent which is sufficient to limit audit risk to an appropriate level.() The joint auditors submit that it is necessary to have regard to this proposition in determining the applicable standard of care and assurance.()
The joint auditors submitted that I must make allowance for the practical aspects of conducting an audit in relation to a complex organisation such as the Bank, and that the audit opinion was, of necessity, expressed approximately 8 weeks subsequent to the relevant balance date.() Mr B Lander QC on behalf of the joint auditors clarified this by saying the joint auditors do not submit that the standard of care would be affected by the complexity of an audit or the length of time allowed for it.() Mr Lander, however, repeated on 18 May 1993 the submission that I must make allowance for the practical aspects of the auditors completing the audit in the time required by the Bank.() Mr Lander acknowledged that section 23(2) of the State Bank Act requires that the Board prepare the accounts within 3 months after the balance date, and sub-section (3) requires that as soon as practicable after the accounts have been audited they must be forwarded to the Governor.
The joint auditors also refer me to paragraph 11 of AUS1, which provides:
"Judgement permeates the auditor's work; for example, in deciding the nature, timing and extent of audit procedures, and in assessing the reasonableness of the judgements and estimates made by management in preparing the financial information. Furthermore, much of the evidence available to the auditor is persuasive rather than conclusive in nature. Because of the above factors, absolute certainty in auditing is rarely attainable."
Mr Lander QC submitted on behalf of the joint auditors that the applicable standard of care should make allowance for the fact that the bank was and is wholly owned by the State Government.() It presumably follows from this that the Government could have obtained any further information or explanations it wished in relation to the financial accounts of the Bank. In the course, however, of the evidence and submissions on behalf of the joint auditors, Mr J H Richardson of KPMG Peat Marwick expressed the view that the accounts of the Bank should stand on their own, regardless of the position of the State Government as sole "shareholder".()
I consider it is relevant to note the context in which the audits in the years under review were conducted. In the year ended 30 June 1985 the Bank adopted a strategic plan, the prime objective of which was to increase the assets of Bank Group to over $8.0B by 1990 from a base at 1 July 1984 of $3.1B.() It was recognised by the Bank that, to achieve its objective of growth, the Bank would be required to compete vigorously with foreign banks entering the deregulated Australian financial market, and the Bank's policy was that it was ready to do so.() The Bank is a statutory instrumentality of the State of South Australia, whose debts are guaranteed by the State of South Australia. Section 21(1) of the Act, provides:
"The liabilities of Bank are guaranteed by the Treasurer."
In other words, any loss incurred by the Bank, or any subsidiary, which for commercial reasons the Bank must support, is a loss which would be borne effectively by the "shareholders", the people of South Australia. This is quite different from the situation with large public companies, where persons may choose to become shareholders, generally with the benefit of limited liability.
In my opinion, paragraph B of my Terms of Appointment requires me to investigate the appropriateness and adequacy of all aspects of the external audits, including the exercise by the joint auditors of their professional judgment. In reaching my findings and conclusions concerning the external audits I have had regard to applicable professional standards and practices, including those referred to above in the joint auditors' submission.
46.5.2 PHASES OF THE AUDIT PROCESS
The phases of the audit process, and the responsibilities of the external auditor in relation to each, are as follows:
46.5.2.1 Planning the Audit
The auditor should plan the audit to enable it to be conducted in an efficient and effective manner. Planning should cover the acquisition of knowledge of the client's business and systems, establishing the degree of reliance that the auditor can place on internal controls built into the financial accounting systems, and determining the nature, timing and extent of the audit procedures to be performed. An important part of the process is a review and evaluation of the role and function of any internal audit activity, and how this can be usefully utilised by the external auditor.
The external auditor acquires an understanding of the business and the environment (and the nature of any changes occurring in that business and environment) in which the client entity operates, in order to make an assessment of the inherent risk to which the client is exposed, and to isolate areas which are of special audit significance by virtue of their magnitude or inherent risk or through past experience.
The external auditor also gains an understanding of the financial accounting systems, including internal control procedures, used for processing and recording significant transactions to assess the control risk of the client. The extent of internal controls in systems is important to the auditor. The accounts will be based on information flowing from the systems, and by assessing the effectiveness of the controls the auditor can form a view as to the reliability of the information generated by those systems on which he intends to rely.
During this planning phase the external auditor decides on the nature and extent of audit evidence to be obtained. The auditor also sets levels of materiality by which he will assess the significance of any errors in the accounts.
Through this work the auditor develops the audit approach and documents the overall audit plan for the expected scope and conduct of the audit.
Where there is a joint audit, as in the case of the State Bank, the planning process will include discussion on how the resources of the individual auditors will be most effectively utilised. In most cases this will involve some division of responsibility between the joint auditors for different aspects of planning and execution of the audit.
When certain subsidiaries are audited by different auditors, the planning must take this into account, and appropriate arrangements made for reporting by those auditors and assessment, including possible review, of their work.
The final part of this planning phase is the preparation of a written audit programme showing the nature, timing and extent of audit procedures necessary to implement the overall audit plan.
It may be that in the planning process the auditor identifies requirements for special skills to enable performance of the programmed tasks. In a banking environment, these typically are in the areas of computer systems, treasury operations, and taxation.
46.5.2.2 Execution of the Audit
Actual performance of the tests of internal controls, financial transactions, and account balances, occurs during the execution phase.
Tests are of two types. Compliance tests are designed to obtain reasonable assurance that those internal controls in systems on which audit reliance is to be placed are operating satisfactorily. Substantive procedures are designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the systems. They may be used to supplement the assurance gained from compliance testing of controls, or to gain assurance in areas where controls are inadequate or where it is more appropriate to rely on other evidence. Substantive tests take the form of tests of transactions and balances, use of evidence from third parties, and analyses of ratios and trends, including the investigation of unusual fluctuations and items.
Methods of testing include observation, inquiry, inspection, and confirmation of third parties, computation and analytical review of significant ratios and trends, and includes the investigation of unusual fluctuations and items. Analytical procedures may include the comparison of financial information with comparable information from prior periods, budgets, forecasts and similar industry information. The selection and timing of the tests for particular items will have been decided upon at the planning phase.
The amount of substantive testing to be undertaken of transactions and items appearing in the accounts is based on the external auditor's assessment of the risk of errors, the extent and results of the tests of controls (ie compliance testing), and the materiality of the transactions or account balances.
There is a close relationship between the results of the evaluation and compliance tests of the client's internal controls, and the level of substantive testing. If the external auditor has obtained a reasonable level of confidence in the financial accounting systems' ability to produce reliable information, through the general review of internal controls and compliance tests of their effectiveness, the substantive tests can be significantly decreased. There is, however, always a need for a certain level of substantive testing, the level varying according to the nature and circumstances of the entity under audit.
46.5.2.3 Conclusion of the Audit
After the external auditor has completed the audit programme, it is necessary to draw together and evaluate the evidence obtained during the execution phase of the audit. The external auditor has to form an opinion whether the accounts have been prepared in accordance with the applicable statutes and regulations and accounting standards, and whether the accounts give a true and fair view, and that there is adequate disclosure of all matters necessary to give a true and fair view. Adequate disclosure would necessarily include reporting by way of notes to the accounts, on the existence of `contingent' liabilities, and `events' that may have occurred subsequent to balance date but which have an effect on the information provided in the accounts.
The audit process concludes with the external auditor issuing an audit report to accompany the reporting entity's accounts.
In addition to his audit report on the accounts, the external auditor may issue what is commonly called a management letter to the Board of Directors or Executive Management. This letter is designed to bring to the client's attention, at the appropriate level of management or the Board of Directors, significant matters which have come to the attention of the auditor in the course of the audit. Commonly they relate to deficiencies in internal accounting controls or areas where the auditor believes greater efficiencies can be achieved. These letters may include recommendations to improve the procedures used in compiling the annual accounts, or to strengthen control procedures for the prevention of error or loss. A management letter can never be regarded as a substitute for the issuing of a qualified audit report on the annual accounts.
Management letters are commonly issued at the completion of the audit, although, depending on circumstances, they may be issued more frequently. If a serious matter comes to light in the course of the audit, it is normal procedure for the auditor to report the matter promptly to the appropriate level of management or the Board of Directors.
46.5.3 THE IMPORTANCE OF AUDIT WORKING PAPERS
Audit working papers are the principal evidence of the audit work performed by the external auditor to support his opinion.()
The auditor should, in his working papers, document matters which are important in providing evidence that the audit was carried out in accordance with the auditing standards and practice statements of the Professional Accounting Bodies.()
The auditor should document his overall audit plan at the conclusion of the planning process.()
Statement of Auditing Practice - Documentation, AUP 15, operative from January 1983 provides:
"...
4. Working papers should record the auditor's planning, the nature, timing and extent of the auditing procedures performed, and the conclusions drawn from the evidence obtained.
5. Working papers should be sufficiently complete and detailed for an experienced auditor to obtain an overall understanding of the audit. The extent of documentation is a matter of professional judgment since it is neither necessary nor practical for the auditor to document in his working papers every observation, consideration or conclusion made.
6. All significant matters which require the exercise of judgement, together with the auditor's conclusion thereon, should be included in the working papers."
The failure of audit working papers to document significant matters including those requiring the exercise of the external auditor's judgement would, in my opinion, be a significant omission which would call into question the adequacy of an audit.
46.5.4 RELIANCE ON MANAGEMENT
Auditing standards require an auditor to obtain sufficient appropriate audit evidence to enable him to draw reasonable conclusions on which to base his opinion on the accounts.() Auditing practice statements recognise that the reliability of evidence is influenced by its source, external evidence being generally more reliable than internal evidence obtained from the entity, and that there should be a rational relationship between the cost of obtaining evidence and the usefulness of the information obtained.()
The following pronouncements were made by the Court in the Pacific Acceptance case:
"If a matter calling for an explanation concerns the authority of an employee or otherwise may reflect on the performance of his duty, prima facie he is not the person from whom an explanation should be sought, or if sought, from whom it should be accepted without verification ... In such a circumstance the inquirer would need to realise that the information was being given by an interested party and weigh it accordingly, and, if the matter was possibly material, look for other confirmation of the explanation and be prepared if the matter was sufficiently material, to go to the board in the case of a general manager, or to Head Office in the case of a branch manager ..." ()
"[The auditor] does not undertake the 'audit' on the basis that because the borrower is reputably wealthy, and the manager believes he is wealthy, or because head office has confidence in and trusts the branch manager, that no question and no occasion could arise to make any check against any possibility of error ... in any transaction or against any possibility of negligence or unreliability of the manager ... If the auditor did so conduct the 'audit' he would not do his duty, which is not to be satisfied by reliance on reputations and rumours or beliefs of other persons, but to satisfy himself by proper recognised auditing checks ... If procedures are to be framed and carried out which bear in mind the possibility of error ... so that they may be reasonably expected to reveal most material errors ... if they exist, they must involve some techniques of the auditors' seeing for himself and guarding against undue reliance on those who may err wittingly or unwittingly. Prima facie the duty of the auditor is to satisfy himself on the material matters by such checks and procedures as are commonly understood to comprise an 'audit'. He does not satisfy himself merely by being content that management is responsible and is satisfied about the matter. Of course, the fact that management is satisfied may be relevant in aiding to produce an apparent state of regularity which may justify some reduction in the auditor's checks. Prima facie the auditor's job is to check material matters for himself from available documents and he does not ordinarily do his job or 'audit' if he merely seeks the assurance of another as to the check that other has made or as to his views as to the effect of documents." ()
Mr Lander QC on behalf of the joint auditors submitted on the authority of the Guardian Insurance case that auditors are entitled, in the absence of anything calculated to arouse suspicion, to presume the honesty of the company employees and the efficacy of its internal control.() I accept the submission that auditors do not have to approach the audit with a suspicion of dishonesty on the part of the company and its employees. It is, however, in my opinion, clear that the auditor must approach the audit with an inquiring mind, ready to check against possible error or unreliability.()
Mr Lander submitted that an auditor is always entitled to rely upon assertions made by management which appear to the auditors to be reasonable, and he is entitled to continue to rely upon those assertions unless he has reasonable grounds to suspect that the assertions that are being made to him are wrong.() Mr Lander also submitted that, not only is the auditor entitled to rely upon the assertions of fact made by management, but he is also entitled to rely upon the evidence that is produced by management as being reliable unless he has a reasonable ground to suspect that the evidence of itself is unreliable.() I do not accept these submissions. In my opinion, however, the extent of permissible reliance must depend upon the particular circumstances.
46.5.5 RELIANCE ON THE WORK OF OTHER AUDITORS
As noted above, the external auditors of the Bank have reported, in each of the years under review, their unqualified opinion on the accounts of the Bank Group, while noting that they had not acted as auditors of Beneficial Finance and its subsidiary companies. It is clear from the statements of auditing standards and practice of the Professional Accounting Bodies that the opinion expressed by a holding company auditor on the consolidated accounts are his alone, notwithstanding that he may not have audited all of the subsidiaries.() Consequently, the principal auditor must obtain reasonable assurance that the work performed by another independent auditor with respect to the accounts of one or more subsidiaries is adequate for the purpose of forming an audit opinion on the consolidated accounts.()
Paragraphs 6 and 8 of Statement of Auditing Practice AUP 11 provide, in part:
"...
6. The principal auditor should also perform procedures to obtain reasonable assurance that the work performed by the other auditor is adequate for the principal auditor's purpose. For example, the principal auditor might discuss with the other auditor the audit procedures applied or review a written summary of the other auditor's procedures and findings (which may be in the form of a completed questionnaire or checklist), or review sufficient working papers of the other auditor. The principal auditor may wish to perform these procedures during a visit to the other auditor ...
8. The principal auditor may consider it appropriate to discuss with the other auditor and the management of the [subsidiary] the audit findings or other matters affecting the financial statements of the [subsidiary]. He may also decide that supplemental tests of the records or the financial statements of the [subsidiary] are necessary. He may request the other auditor to perform such tests or, alternatively he may perform them himself."
As noted above in relation to working papers, the principal auditor should document in his own working papers the procedures he has performed, and the conclusions he has reached regarding the above matters and he should record the results of discussions with the other auditor.()
46.5.6 MATERIALITY
The concept of materiality is an overriding concept which governs the preparation and presentation of accounts and also the application of Australian Accounting Standards and applicable Approved Accounting Standards.
When performing the audit of an entity's accounts the auditor needs to establish an appropriate level of materiality to allow the consideration of matters arising in proper perspective. If, for instance, a detected error is less than the level of materiality appropriate for its consideration the auditor may choose not to insist upon its correction. If the error is above that level, and thus deemed to be material, the auditor will take steps to have the matter suitably resolved.
The concept also has applicability when deciding upon the extent of audit testing to be performed, as the auditor is concerned to detect errors or mis-statements which are material in effect.
The general test of materiality, which must be applied subject to the circumstances, is that:
"... [an item of information is] material if its omission, non-disclosure or mis-statement would cause the financial statements to mislead users when making evaluations or decisions". ()
In deciding whether an item is material, its nature and its amount should both be taken into account, although in particular circumstances either alone may have to be recognised as the decisive factor.() Guidelines for quantitative assessment of materiality are set out in Australian Accounting Standard AAS5.()
In my opinion, a relevant circumstance affecting decisions as to materiality is the underlying financial condition and stability of the reporting entity. As the entity "gets into difficulty", materiality will have finer limits because with increasing financial distress, users of accounts will want to know more and there is less room for error.()
There are clearly some matters the omission of which, by their nature, can render accounts false or misleading regardless of the amount involved. For example, Section 269 of the Companies (South Australia) Code sets out certain requirements which apply without any qualification as to materiality. The accounts of a company and its subsidiaries must be consolidated, or presented as group accounts, and the identity of the subsidiaries and their contribution to consolidated profit stated by way of note, regardless of the materiality of the amounts involved.() Similarly, the accounts of a company must comply with the prescribed requirements in Schedule 7 which apply regardless of materiality unless otherwise stated.
As noted above, the requirements of the Companies (South Australia) Code apply to the Bank only by reason of the Bank having so elected and by reason of the terms of the Directors' Statement and Report of Auditors stating their opinion as to compliance.
Both the Companies Code and the Australian Accounting Standard on materiality contemplate that circumstances can arise when disclosures of material matters over and above strict compliance with statutory requirements and accounting standards may be necessary in order to ensure that the accounts give a true and fair view.()
46.6 AUDIT OF FINANCIAL INSTITUTIONS
Banks and other financial Institutions have the following characteristics which distinguish them from other business entities:
(a) They have custody of large volumes of cash and negotiable securities whose physical security has to be assured. This applies both to storage and transfer of such items and makes financial institutions especially vulnerable to misappropriation and fraud. Such institutions therefore establish formal operating and accounting procedures, well-defined limits for individual discretion, and rigorous systems of internal control.
(b) Financial Institutions engage in a large volume and variety of transactions, many having high value. This necessitates complex accounting systems, sound internal control procedures, and widespread use of computers.
(c) Financial Institutions generally need and have well developed internal audit functions to monitor their internal control systems.
(d) Financial Institutions often assume significant contingent commitments without any transfer of funds. These transactions may not involve accounting entries to the primary records and consequently the failure to record such items may be difficult to detect. Information on these transactions is generally presented in the notes to the accounts rather than in the balance sheet.
(e) Financial Institutions continue to develop new products and practices that may not be matched by a concurrent development of Statements of Accounting Standards and/or Auditing Practices. The absence of specific Statements may mean that the financial accounting and reporting treatment of some items will need to be determined from basic principles to ensure adequacy of disclosure of the items in the accounts of the client.
Accordingly, the external audit of a Financial Institution can be expected to involve a degree of reliance upon:
(a) The system of internal control, involving a high level of understanding of the systems in use, and a high level of testing of the integrity of those systems.
(b) The effectiveness of the internal audit function to the greatest extent possible but with a corresponding level of inquiry into and assessment of the effectiveness of the internal audit operations.
The joint auditors have submitted that it is not necessary for an auditor of a Financial Institution such as the Bank to place reliance on internal controls.() The joint auditors submit that:
"Where audit reliance [on internal controls] ... is planned, the auditor needs to test the effectiveness of those controls. In many instances it is more efficient and cost effective for the auditor not to place audit reliance on the controls and to adopt alternative audit procedures which place no reliance on those controls." ()
The joint auditors support that proposition by reference to paragraph 21 of AUP 12, which provides:
"The auditor may decide not to rely on particular internal control because, for example,
(a) they are defective in design and therefore their operation would provide insufficient assurance as to the accuracy and completeness or information produced by the accounting system, or
(b) the audit effort required to test to compliance with those internal controls would exceed the reduction in effort that could be achieved by reliance on them."
I do not consider that there is any conflict between that pronouncement of the Professional Accounting Bodies and the above general propositions concerning audit methodology. In my opinion, the ultimate question is whether the auditors have obtained appropriate and sufficient audit evidence through the performance of the particular combination of compliance and substantive procedures actually chosen by the auditors in particular instances.()
Additionally, the following features could be expected to be covered by the external audit of a Financial Institution:
(a) A considerable understanding and evaluation of the various risks and exposures involved in the activities of the Financial Institution, both for the purpose of designing an appropriate audit approach and for the purpose of determining the appropriate disclosures of exposures in the accounts. In a financial institution these risks can be broadly grouped into `product and service' risks and `operating' risks.
(i) Product and Service Risks
The most significant product and service risk in a bank is usually credit risk, which is the risk that a customer or counterparty will not discharge its obligations. Associated with the credit risk is the risk that securities may diminish in value due to factors affecting the value of the underlying assets. Other product and service risks include:
. Liquidity Risk: the risk of loss arising from the possibility of the financial institution not having sufficient funds to meet its obligations;
. Interest Rate risk: the risk of loss arising from the sensitivity of earnings to future movements in interest rates;
. Currency Risk: the risk of loss arising from movements in the exchange rates applicable to foreign currency assets, liabilities, rights and obligations;
. Market Risk: the risk that the value of assets, obligations and exposures may change due to market factors affecting interest rates, exchange rates, security prices, property values, etc; and
. Fiduciary Risk: the risk of loss arising from factors such as failure to maintain safe custody or negligence in the management of assets on behalf of other parties.
Product and service risks increase with the degree of concentration of a financial institution's exposure to any one customer, industry, geographic area or country.
(ii) Operating Risks
Operating risks arise out of the need to process high volumes of transactions accurately within short timeframes. This need is almost always addressed through the use of large scale computer systems with the resultant risks of failure to process executed transactions in a timely manner, loss of data arising from system failure, and wide-scale error arising from a breakdown in internal controls.
(b) A sensitivity to external factors such as the state of the economy, the competitive position, and the regulatory framework due to the extent that these factors affect the volatility of the various risks.
46.7 INVESTIGATION OF THE EXTERNAL AUDITS OF THE ACCOUNTS 1985-1990
The Investigation assessed the appropriateness and adequacy of the external audits of the accounts of the Bank and its subsidiaries for the years ended 30 June 1985 to 30 June 1990.
It is important to emphasise that the year by year assessment did not take the form of a re-performance of the audit of the accounts. The Investigation entailed the review and evaluation of the audit process applied by the external auditor in each year in relation to the accounting records and the accounts of the Bank, including the procedures adopted by the auditors with regard to planning of the audit, execution of the audit, and concluding and reporting on the audit.
It must also be borne in mind that the investigation of the external audit process is not the same as an assessment of the accuracy of the accounts of the Bank. For example, if the external auditor's conduct of the audit had been inadequate, the only conclusion that could be drawn with confidence would be that there was not a proper basis for the audit opinion expressed by the auditor. Whether the accounts comply with the statutory requirements, and give a true and fair presentation of the entity's results of operations and financial position would depend upon other matters. Conversely, it is conceivable that the conduct of the audit might have been adequate without the auditor detecting an error or irregularity in the accounts.
The Investigation was undertaken with expert assistance from three of the major Australian firms of Chartered Accountants, being Coopers & Lybrand, Deloitte Touche Tohmatsu, and Ernst & Young.
The review and evaluation of the annual audit process included an analysis of the external auditor's audit methodology, review of external audit evidence obtained and documented in the external auditor's working papers, and direct inquiry of external auditors engaged on the audits of the Bank. Conclusions drawn in relation to the appropriateness and adequacy of the external audits were made in consideration of the Professional Accounting Bodies' Accounting and Auditing Standards and the statutory requirements applying at the relevant times.
The issues and conclusions which have arisen from the Investigation of the external audits of the accounts of the Bank are presented in the following Chapters; Chapter 45 - "The External Audits of State Bank: Introduction" to Chapter 53 - "The External Audits of the State Bank: Findings and Conclusions".
46.8 RECURRING TRANSACTIONS AND AUDIT PROCEDURES 1985-1990
46.8.1 INVESTMENT PURCHASES AND DISPOSALS
The objectives of an auditor in performing tests on investment purchases include:
(a) to verify the cost of the investments and hence, subject to any write-downs, the carrying amount of investments at year end; and
(b) to ensure that any interest accrued on fixed interest securities to the date of purchase is correctly treated. Accrued interest should be recorded so that any subsequent receipt of interest in cash is treated as a reduction of the receivable rather than as income.
The objectives of an auditor performing tests on investment disposals include:
(a) to ensure that the correct amount is taken from the book value of investments in relation to the investments sold; and
(b) to ensure that the profit or loss on disposal is correctly calculated and recorded.
46.8.2 PROVISION FOR DOUBTFUL DEBTS
Financial institutions make provisions in their accounts for losses incurred in respect of loans and advances. These provisions are commonly divided into two types, "specific" and "general".
Specific provisions relate to identified loans where there is a recognition that a loss has probably been incurred. Where it is anticipated the amount which is reasonably likely to be recovered would be less than the carrying value in the accounts, then a specific provision should be raised for the shortfall.()
The determination of specific provisions is generally a matter of judgement and estimation. Having regard to applicable professional standards and practices, in my opinion, the objectives of auditors with regard to the audit of estimates is to obtain sufficient appropriate audit evidence to be able to conclude whether the estimates are reasonable in the circumstances.() This would involve the auditor obtaining reasonable assurance that the data on which an estimate is based are accurate, complete, and relevant, and that the assumptions on which an estimate is based are reasonable.()
General provisions are established to provide for losses already incurred within the existing loan portfolio but which have not yet been specifically identified.()
The provision for doubtful debts appearing in the Bank's accounts, comprised the following:
(a) Specific provision relating to an assessment of recoverability of individual loans.
(b) General provision relating to the perceived credit risk inherent in the Bank's corporate, treasury and retail operations, and calculated by applying risk percentages to outstanding balances and commitments for different categories of exposure.
The joint auditors submitted,() and I accept, that a general provision can also reflect risks on identified loans where there is some concern but where it is not possible to determine the extent of any specific provision required. The joint auditors cite the following extract from a publication of the Institute of Chartered Accountants in England and Wales:
"Most banks make both specific and general provisions against bad and doubtful loans. However, although these provisions may be computed separately, they are no more than elements of the same provision. In total the specific and general elements of a bank's provision for bad and doubtful loans should represent the aggregate amount by which management considers it necessary to write down its loan portfolio in order to state it at its estimated net realisable value in the ordinary course of business.
The specific element relates to particular loans identified as bad or doubtful and its aim is to write down the value of those loans to their estimated realisable value at the balance sheet date. The general element relates primarily to those risks associated with loans that may prove to be wholly or partly irrecoverable which have not been separately identified but which can reasonably be expected to exist. The general element may also reflect the risk associated with identified loans about which the bank has some concern but where it is not clear, from evidence available, that a specific provision is needed, or where it is not possible, in the circumstances, reasonably to determine the extent of any specific provision required".
In the course of the joint auditors' evidence and submissions, it was put to Mr M Colman, a partner in KPMG Peat Marwick that the above situation should be distinguished from one in which the auditor considered that a specific provision should be made but the management of the client entity refused to accept it. Mr Colman was asked whether the auditor could accept the failure to make a specific provision on the basis that the entity had a general provision. Mr Colman's view was that it would depend upon the size of the difference between the auditor and management and if, for example, it was a very significant difference which used up all of the general provision, then the auditor "would probably not feel comfortable with that"().
The joint auditors submitted,() and I accept, that when assessing the preferred level of general provisions it is appropriate to consider the level of conservatism employed in the client entity's provisioning exercise, that is, it may be appropriate to increase the general provision to cover a less conservative approach which may have been adopted in identifying specific provisions.
In auditing the specific provision for doubtful debts, an auditor would typically evaluate and test the systems of internal control governing the monitoring, risk management, and provisioning of credit exposures. In performing his work he would focus particularly on those categories of credit exposure which had been assessed as high risk at the planning stage of the audit. He would then normally perform a detailed credit review of selected individual exposures which were material and/or of high risk or doubtful quality, in order to assess the appropriateness of the specific provisions raised by the management of the bank against those exposures.
In auditing the general provision, an auditor would assess the implications of the Bank's policy on lending, the appropriateness of Board policy, and the basis of the calculation, having regard to the adequacy of the risk percentages for each category of credit exposure. Additionally, he may consider the bank's history of bad debts, levels of general provisions carried by other banks, deterioration in the economy or corporate environment and concentrations of industry and geographical risks when assessing the overall adequacy of the provision.
46.8.3 CONTINGENT LIABILITIES
The disclosure of commitments and contingent liabilities in its accounts is particularly relevant to a Bank. It provides important information on its future funding obligations and its risk exposure to a range of contingent liabilities which are often large in relation to the bank's resources. Contingent liabilities also include those which may arise in relation to pending law suits and other legal actions.
From the audit point of view, the main risk is one of omission. As the contingencies are often not included in the bank's double entry accounting system, the auditor needs to pay attention to the systems for recording such matters, and to carry out substantive procedures such as a review of major customers' files and an examination of related fee income. The auditor will normally obtain representations from management that all contingent liabilities have been recorded, and from the entity's solicitors with respect to possible liabilities from legal actions.
46.8.4 SUPERANNUATION PROVISION
The 1987 accounts of the Bank at note 7 record that the Provision for Superannuation of $57.7M and the Provision for Retiring Allowances of $16.7M were transferred to State Bank of South Australia (Provisions) Trust as at 1 July 1987. Such a transfer never took place.
In March 1987, the Bank's Board had agreed to transfer the Bank's superannuation provisions off-balance sheet by transferring corresponding assets into a separate superannuation trust fund, and a draft trust deed to give effect to this was approved.
The accounting procedures to transfer the assets off-balance sheet were implemented on 1 July 1987, however, the trust deed which had been prepared was not executed at that time. The joint auditors have submitted as follows:
"The matter was the subject of discussions between the joint auditors and Bank management in July 1988. It was put to the joint auditors that it was still intended to give practical effect to the original proposal but that changes in tax ... legislation together with stamp duty complications could preclude the legal documentation proceeding. The joint auditors accepted that provided the Bank's intention remained certain and there was clear commitment of the designated assets to the Fund that the Fund could be accounted for as if it were a separate entity within the body of the Bank's financial statements."()
The Board then decided late in July 1988 to rescind their earlier decision to approve a trust deed and instead to operate the Fund as if it were a separate entity within the Bank's financial statements. The joint auditors have submitted that assets comprising land and buildings, investments in debentures and deposits were identified as being superannuation fund assets which were sufficient to cover the superannuation liabilities as determined by the public actuary.() The joint auditors have submitted that the income from these assets has since 1988 always been credited to the Provision for Superannuation, and comprises rent from the Bank, external tenants and staff for bank housing loans plus interest on investments, and the Provision for Superannuation has also borne the expenses of the property assets including repairs, rates and taxes, cleaning etc. () The joint auditors have submitted that:
"In the joint auditors' opinion all actions taken by the Board since 1988 have clearly demonstrated that the original intentions of the proposal have been put into effect. All rights and interests in the assets designated to meet the superannuation liabilities have been reserved and all income and other benefits arising from those assets has been credited to the Fund. The details of the assets held to meet the superannuation liability are set out in the notes to the accounts. In summary, the Superannuation (Provisions) Trust Fund has operated and been accounted for as if it had been separately established outside the Bank and the intention of the original proposal has been preserved".()
The joint auditors submitted that a trust had been created, which was effective to transfer beneficial title in the assets from the Bank for the benefit of employees entitled to superannuation benefits, such that the relevant assets would not have been available to creditors of the Bank, but that it was, nevertheless, appropriate for the Bank to include such assets in its own balance sheet.()
Having reviewed the submissions of the joint auditors, I am not satisfied that it was appropriate for the joint auditors to accept that the Provision for Superannuation, and corresponding assets in the books of the Bank, constituted a separate fund. In my opinion, it was inappropriate for the joint auditors to accept the Bank's treatment of income derived from relevant assets and revaluation increments as an accretion to the Provision for Superannuation.
The Professional Accounting Bodies' Statement of Accounting Standard AAS10 "Accounting for the revaluation of Non-Current Assets" and the Approved Accounting Standard ASRB1010 of the same name require that, where a class of non-current assets is revalued, the revaluation increment should be accounted for by crediting the increment directly to an asset revaluation reserve.
During the years ended 30 June 1988 to 1990 inclusive, the revaluation increment in respect of the revaluation of certain "earmarked" assets was credited to the Provision for Superannuation, rather than being credited to an asset revaluation reserve. This treatment in my opinion constituted a contravention of Approved Accounting Standard ASRB1010.
In my opinion, it was inappropriate for the joint auditors to accept the Provision for Superannuation as representing anything other than a liability of the Bank to pay superannuation benefits to employees. It follows, in my opinion, that the joint auditors should have carried out appropriate procedures to ensure that the liability was not materially misstated in the accounts.
To the extent that the Provision for Superannuation may have been under-stated, it would have been appropriate to make an additional charge against profits for the year, and a failure to do so would mean that profits for the year would be over-stated.
46.8.5 PROVISION FOR TAXATION
The Bank is required to pay out of its profits an amount to the State Government in lieu of Federal income tax. This is a statutory obligation and is not a matter over which the Bank has a power to make recommendations as is the case with other payments to the State Government representing returns on investment.
The authority for this payment in lieu of tax is provided by section 22(1)(a) of the State Bank of South Australia Act 1983 (as amended) which requires the Bank to pay to the Treasurer, for the credit of the General Revenue of the State, in respect of each financial year:
"... a sum equal to the income tax for which the Bank would have been liable under the law of the Commonwealth assuming that it were a public company liable to income tax under that law."
It is a generally accepted accounting principle that an entity's net profit for a reporting period should be presented after deduction of all expenses including taxation.
The Profit and Loss Statement of the Bank for the years ended 30 June 1985 and 1986 disclosed the amount payable under Section 22(1)(a), which was described as "State Government Tax", as a deduction from operating profit before tax in arriving at the operating profit after tax. The Bank calculated the future income tax benefit and the deferred tax liability appearing in the accounts for those years in accordance with Australian Accounting Standard "Accounting for Income Tax (Tax-effect Accounting)" (issued in July 1976 and amended to September 1978)("AAS3").
For the 1987, 1988 and 1989 years the Bank changed the presentation of State Government tax in its accounts. Although the amount was calculated in the same manner as in 1985 and 1986 and the notes to the accounts stated that the Bank adopted tax effect accounting principles, the State Government tax for those years was not shown as a deduction from the operating profit before tax but rather included in the amount disclosed as a distribution to the State Government. As there was no State Government tax payable for 1990 there was no effect of this presentation on the 1990 accounts. The effect of this presentation for years 1987, 1988 and 1989 is to charge the tax relating to those years' profit against accumulated profits rather than being taken into account when calculating the annual profit. This presentation is contrary to generally accepted accounting principles and to the requirements of Australian Accounting Standard AAS1.
For the year ended 30 June 1991 the Bank reverted to its practice in 1985 and 1986 and disclosed the State Government tax as a deduction from the operating profit before tax, separately from the distribution to the State Government of South Australia.
In their evidence and submissions () the joint auditors have presented the view that, although they acknowledge "the payment has the substance of income tax from the Bank's perspective, it nevertheless, irrespective of its method of calculation, represented a return by the Bank to its owner." The joint auditors went on to describe the Bank's treatment as being the same as three other South Australian Government instrumentalities.
The joint auditors also state () that income tax for accounting standards' purposes is effectively defined in AASB1020 as tax payable under Australian income tax legislation and any applicable foreign tax legislation.
As acknowledged by the joint auditors, the amount payable by the Bank under Section 22(1) of its Act has the substance of income tax. It is calculated in exactly the same manner as Federal income tax payable by a public company, and the Bank has no discretion over its calculation. A distribution of income, on the other hand, is commonly understood to be a discretionary payment, an amount decided by the Board.
In my view, the substance of the payment under Section 22(1) is that of a charge in the nature of income tax and thus an expense, and it is, therefore, appropriate that its treatment in the Bank's accounts should reflect that nature in the manner adopted by the Bank in its 1985, 1986 and 1991 accounts. In 1992 the Bank incurred a loss, but the accounting policies noted in the 1992 accounts show the Bank to be following the same policy as in 1991 as regards the State charge in lieu of income tax.
As regards to the other South Australian entities mentioned above, an examination of the relevant parts of their enabling statutes shows them to be quite different from those applying under the Bank's legislation. They provide no real assistance in deciding upon the appropriate presentation of the Bank's obligations to make a payment to the State Government in lieu of income tax.
AAS3 "Accounting for Income Tax/Tax Effect Accounting" does not define the term "income tax". The commentary accompanying the standard notes that some government business undertakings are subject to income tax under their own enabling legislation. The inference is that the standard should apply to charges which will not be levied under the Federal income tax laws. Similarly, AASB1020, in providing for any applicable foreign tax to be defined as income tax, also indicates that the term should not be limited to that applying under Federal income tax laws.
Accordingly, I have concluded that the Bank's obligations under Section 22(1) should be presented in its accounts as income tax in terms of the applicable accounting standards. I believe that the Bank's accounts for 1985, 1986 and 1991 were in accordance with the applicable accounting standards, while those of 1987, 1989 and 1990 did not follow the applicable standard.
The effect of treating payments due under Section 22(1) as distributions of income is to overstate the operating profit after tax by the amount of the obligations so treated.
46.8.6 CONCESSIONAL HOUSING RESERVE
This reserve was raised in connection with the concessional housing scheme, a service provided by the Bank as part of the State Government's "House Ownership made Easy Program". The scheme provided low interest mortgage loans to assist low income earners to buy a home. Annual movements in the "Equalisation of Interest - Housing Advances Reserve" (also called the "Concessional Housing Reserve" in some years) were meant to reflect the difference between the interest received by the Bank from loans under the scheme and the interest paid on funds provided by the State Government, less administration and commission taken by the Bank.
The joint auditors submitted that:()
"1. Under the terms of the arrangements confirmed with the Treasurer of South Australia on 9 February 1978 (workpaper 10-206/2) the operational surplus of the Concessional Housing Scheme (i.e. the excess after the administration and commission fees of the Bank) "would not be taken into the bank's revenues but be set aside as a special surplus in trust for housing purposes". This "special surplus" was to be used for subsidies, remissions and further lending at concessional rates as directed. Accordingly, the surpluses in the years 1985 to 1988 were not considered to be income of the Bank, viz;
|
$ |
|
|
1985 |
11.018m |
|
1986 |
11.879m |
|
1987 |
8.169m |
|
1988 |
6.960m |
|
1989 |
6.217m |
The only surplus to which the Bank was entitled to under the 1978 agreement was a commission of 0.875% on the average advances over the year, which commission represented an allowance to the Bank as recompense for administering the scheme ...
2. Any surpluses under the scheme were quite properly treated as not being Bank revenue in the terms of this arrangement ...
3. The funds were not returnable to Treasury under the terms of the 1978 arrangements, and therefore were not a liability of the Bank as at 30 June 1985 to 1988.
4. In 1987 as noted in Note 10 of the Bank's 1987 financial statements there was a restructuring of the Bank's capital. Included in this restructuring on the direction of the SA Treasurer, an amount of $150m was transferred from the concessional Housing Scheme Reserve to the Bank's Capital. This direction once again reinforced the view that the Housing Scheme Reserve was more of an affair of capital than a liability on revenue account.
5. As noted in Note 15 of the Bank's 1989 financial statement, the Concessional Housing portfolio was sold during that financial year at book value to the South Australian Department of Housing and Construction Board Minute 88/453. The 1989 arrangements included the transfer of the Concessional Housing Reserve to the Capital of the Bank of $63.868m. The joint auditors submit that this 1989 arrangement confirms the capital nature of the reserve applicable to the South Australian State Government, and does not represent profits of the Bank."
In my opinion, it was inappropriate that the joint auditors treated the surplus as forming part of the capital and reserves of the Bank when it appeared that the surplus should be set aside in trust to be applied for housing purposes as directed by the State Government.
The joint auditors submitted,() and I accept, that a trustee need not keep trust funds separate from its own assets if permitted by the terms of the trust. Nevertheless, in my opinion, it is not appropriate for the trustee to account for such funds as if the trustee were entitled to the whole of the benefit of the funds. In the case of the Concessional Housing Reserve it appears that the Bank was obliged to apply the surplus for subsidies, remissions and further lending at concessional rates under the concessional housing scheme as directed by the State Government. That is, on the evidence available to the auditors, the surplus should have been recorded as a liability of the Bank.
In my opinion, the subsequent application of the "reserve", by way of transfer to the Bank's capital at the direction of the State Government, supports the view that the Bank was not otherwise entitled to the funds.
46.8.7 BANK ACCEPTANCES OF CUSTOMERS
Where a bank has accepted liability on a bill, the amount payable to the holder of the bill is shown as a liability by the bank and the amount receivable from the customer is shown as an asset. Where a customer is unable to meet its obligations, the bank may suffer a loss. Hence it is important to disclose in the accounts the bank's exposure under bill acceptances.
46.8.8 PROVISION FOR SELF INSURANCE
In each of the years 1985 to 1990 inclusive the Bank maintained in its accounts a provision for self insurance.
The provision was supposed to represent the difference between the premiums that might have been paid by the Bank if the risks involved were insured with third parties and losses actually suffered by the Bank. Although the matter is addressed in more detail in the Chapters dealing with the individual years' audits, in general, little audit work appears to have been carried out to establish the basis and quantum of the provision.
In his oral evidence and its accompanying exhibit() Mr Richardson of KPMG Peat Marwick said it was reasonable to conclude that the provision was substantially an over-provision and that the joint auditors could take some comfort from its existence when considering possible over-statement of assets. They regarded it as a "free reserve". In my opinion, no significant provision was required.
46.8.9 CONCLUDING PROCEDURES
Concluding procedures are those procedures adopted by an auditor of an entity to identify, resolve and document his conclusions concerning significant aspects of the audit including how exceptions and contentious or unusual matters, if any, are to be dealt with.
It is vital that:
(a) The procedures ensure that all significant matters are identified and brought to the attention of the person responsible for signing the auditor's report.
(b) The resolution of each significant matter is given the necessary degree of attention to ensure the accounts of the entity show a true and fair view in accordance with applicable law and to ensure that other significant matters that do not affect the truth and fairness of the accounts are brought to the attention of the proper level of authority within the entity. In the case of some matters this may involve the person responsible for signing the auditor's report consulting with some of his partners or peers.
46.8.10 EVALUATION OF AUDIT DIFFERENCES
Part of the conclusion phase of an audit is the evaluation of audit differences noted during the course of the assignment. This process will evaluate the differences in terms of materiality to particular balance sheet and profit and loss categories and/or the accounts taken as a whole. Audit "differences" include both errors of fact and differences of opinion. Both forms of errors should be evaluated.
Where there are errors identified during the course of the audit which are not corrected by the client a worksheet would normally be prepared which accumulates such items so that the auditor can consider their aggregate effect on the accounts.
46.8.11 SUBSEQUENT EVENTS REVIEW
The dating of the auditor's report allows the reader to infer that the auditor has considered the effect on the accounts and on the auditor's report of events and transactions about which the auditor became aware that occurred up to that date.
An auditor should design his audit procedures to include a review of events and transactions occurring subsequent to the year end up to the date of his audit report.
The purpose of such a review is to identify any events which:
(a) Provide further information to substantiate relevant amounts shown in the Balance Sheet and Profit and Loss Account for the year under examination. If such an event occurs which indicates that an amount may be materially inaccurate, an adjustment should be made to the Accounts.
(b) Although they relate solely to the year subsequent to the year under examination, are sufficiently material to warrant disclosure in the notes to the accounts of the earlier year.
46.8.12 MANAGEMENT REPRESENTATION LETTERS
During the course of an audit the auditor will obtain evidence through enquiries of management, and in some cases, such as future plans and intentions, management representations may be the only audit evidence which might reasonably be expected to exist. The auditor should ensure that the representations made by management are substantiated, and where possible, through corroborative audit procedures by obtaining written representations.
A review of Board papers, while covering matters of importance to the Bank, is an inadequate substitute for written representations from management and/or the Board of Directors, addressed to the auditor. There is no assurance that Board Papers cover all matters of concern for the auditor, as they are prepared for a different purpose, and for the use of persons whose existing knowledge of matters may be quite different from that of the auditors.
46.8.13 CUMULATIVE NATURE OF ADJUSTMENTS
In the following Chapters where matters are noted which in my opinion should have led to the accounts for the year being adjusted, no attempt has been made to restate opening balances on the hypothetical assumption that adjustments noted in my Report in respect to prior years had been made.
For example, as I have noted above, the Self Insurance Provision, in my opinion, represented a "free reserve" which should have been substantially written back to profit. If this adjustment had been made at 30 June 1985, it is likely that the subsequent increments in the provision would not have been material in relation to any year.
In actual fact, however, none of the required adjustments noted in the Chapters were ever made, and in my opinion, having recorded the preceding observations, it is appropriate to consider each year in isolation and to take into consideration the cumulative effect of previous unadjusted items.