CHAPTER 48
REVIEW OF THE 1986 EXTERNAL AUDIT
OF THE STATE BANK
TABLE OF CONTENTS
48.1 PURPOSE OF CHAPTER
48.2 PLAN OF CHAPTER
48.3 BUSINESS OF BANK AND BANK GROUP
48.3.1 THE BANK
48.3.2 SUBSIDIARIES
48.4 ACCOUNTS OF BANK AND BANK GROUP
48.5 INVESTIGATION OF THE AUDIT PROCESS
48.5.1 PLANNING OF THE AUDIT
48.5.1.1 Matters Noted
48.5.1.2 Conclusion
48.5.2 EXECUTION OF THE AUDIT
48.5.2.1 Preamble
48.5.2.2 Matters Noted - Corporate Lending
48.5.2.3 Matters Noted - Provision for Doubtful Debts
48.5.2.4 Matters Noted - Concessional Housing Reserve
48.5.2.5 Matters Noted - Provision for Self Insurance
48.5.2.6 Matters Noted - Contingent Liabilities
48.5.3 CONCLUDING PROCEDURES
48.5.3.1 Preamble
48.5.3.2 Matters Noted - Subsequent Event Review
48.5.3.3 Matters Noted - Management Representation Letter
48.6 CONCLUSION
48.1 PURPOSE OF CHAPTER
Chapter 46 - "The External Audits of the State Bank: Background Information" presented information regarding the statutory obligations of the Bank and the Bank's auditors respectively in relation to the preparation and audit of the accounting records and annual accounts of the Bank. The Chapter also outlined in general terms the elements of an audit process that would characterise an appropriate and adequate audit, governed principally by standards promulgated by the Professional Accounting Bodies of Australia.
This Chapter provides some introductory comments concerning important events in the business operations of the Bank during 1985-86 and significant features of the statutory accounts in respect of the 1985-86 financial year. The Chapter then reports on matters arising from the assessment of the audit process applied by the external auditors in the audit of the accounting records and accounts of the Bank for the year ended 30 June 1986. The Chapter also concludes as to the appropriateness and adequacy or otherwise of the audit process undertaken.
48.2 PLAN OF CHAPTER
The Chapter comprises the following principal segments:
(a) Business of Bank and Bank Group;
(b) Accounts of the Bank and the Bank Group;
(i) Profit and Loss Statement; and
(ii) Balance Sheet.
(c) Investigation of the Audit Process;
(i) Planning of the Audit;
(ii) Execution of the Audit; and
(iii) Concluding Procedures.
(d) Conclusion.
48.3 BUSINESS OF BANK AND BANK GROUP
48.3.1 THE BANK
The Bank commenced wholesale banking operations through its London branch in September 1984. In addition, the Bank established a number of off-balance sheet entities to purchase the land to build the State Bank Centre. The 31 storey centre was budgeted by the developers to cost $85.0M and was scheduled for completion in late 1988. The State Bank Centre development is examined in detail in Chapter 24 - "The State Bank Centre Project" of my First Report.
48.3.2 SUBSIDIARIES
During the year the Beneficial Finance Group increased its profit by $1.2M (16.7 per cent) over the previous year to $8.2M. In addition, total assets increased by $295.6M (39.6 per cent) to $1,043.0M.
48.4 ACCOUNTS OF BANK AND BANK GROUP
On 28 August 1986 an unqualified Audit Report was signed by Peat Marwick Mitchell & Co and Touche Ross & Co in respect of the accounts of the Bank for the year ended 30 June 1986. The accounts presented comprised a Profit and Loss Statement, Balance Sheet, Source and Application of Funds Statement and Notes to the Accounts, for both the Bank and the consolidated Bank Group.
The auditors are required to state in a report under section 24 (4) of the State Bank of South Australia Act, 1983 whether:
(a) the accounts are in their opinion true and fair; and
(b) the accounting records of the Bank have been properly kept in accordance with the Act.
In the 1985 audited financial statements the joint auditors specifically addressed these matters in their audit report. In all subsequent years, 1986 - 1990 the joint auditors' report does not address whether the:
"... accounting and other records and the registers required to be kept by the Bank and its Subsidiaries have been properly kept in accordance with the provisions of the relevant act or code."
There was no evidence in the audit working papers that this matter was addressed, with regard to legal reporting requirements or the impact of this obligation on the nature, timing and extent of the audit procedures.
The following Table provides key information relative to the financial results of operations and the financial position of the Bank and consolidated Bank Group.
|
Bank |
Bank Group |
|||||||||||||
|
1985 |
1986 |
1985 |
1986 |
Per Cent |
||||||||||
| Profit and Loss Statement | ||||||||||||||
|
Income |
356.0 |
547.7 |
455.4 |
690.3 |
52 |
|||||||||
|
Operating Profit |
||||||||||||||
|
Before Tax |
28.1 |
33.6 |
37.0 |
41.0 |
11 |
|||||||||
|
After Tax and Extraordinary Items |
15.2 |
23.6 |
22.4 |
27.4 |
22 |
|||||||||
| Balance Sheet | ||||||||||||||
|
Assets |
||||||||||||||
|
Loans, Advances, Receivables |
2412.6 |
3267.8 |
3112.6 |
4211.7 |
35 |
|||||||||
|
Other |
1015.3 |
2202.9 |
1017.8 |
2239.5 |
||||||||||
|
3429.9 |
5470.7 |
4130.4 |
6451.2 |
56 |
||||||||||
|
Liabilities |
||||||||||||||
|
Deposits and Borrowings |
2736.3 |
4263.0 |
3386.8 |
5158.6 |
52 |
|||||||||
|
Other |
338.6 |
815.6 |
373.4 |
882.0 |
||||||||||
|
3074.9 |
5078.5 |
3760.2 |
6040.6 |
61 |
||||||||||
|
Net Assets |
355.0 |
392.2 |
370.2 |
410.6 |
11 |
|||||||||
|
Capital, Subordinated Debt, Reserves |
355.0 |
392.2 |
390.2 |
410.6 |
11 |
|||||||||
| Doubtful Debts | ||||||||||||||
|
Expenses for the Year |
7.6 |
5.5 |
11.7 |
12.1 |
3 |
|||||||||
|
Provision at Balance Date |
9.1 |
13.0 |
17.9 |
24.2 |
35 |
|||||||||
(1) The Extraordinary Items related principally to profit of $0.47M realised by the Bank on the sale of premises and capital profit of $0.71M realised by Executor Trustee and Agency Company of South Australia Limited on the sale of a substantial amount of the company's equity portfolio.
48.5 INVESTIGATION OF THE AUDIT PROCESS
48.5.1 PLANNING OF THE AUDIT
48.5.1.1 Matters Noted
The Investigation reviewed the audit working papers to ascertain what procedures had been carried out by the joint auditors on:
(a) an overview of the Bank's systems of internal control and the approach to be taken to assess the adequacy of those systems on which reliance was placed; and
(b) an overview of the quality and reliability of the work of the Internal Audit department and the approach to be taken to assess the adequacy of that work.
Satisfactory conclusions in these areas would be vital to any decision to be made by the joint auditors to rely on the Bank's system of internal control and on the work performed by the Internal Audit department and to assess audit risk.
The audit working papers prepared by the joint auditors in respect of the year ended 30 June 1986 evidence a high degree of reliance on the Internal Audit function of the Bank for the assessment and testing of internal control. The Audit Approach Memorandum contained the following under the heading of management controls:
"Internal audit. The key factor in the Bank's internal control is the internal audit function. This department undertakes extensive audit procedures at branches and head office divisions, including the use of computer software and an integrated test facility.
The extent of our reliance on the internal audit function is expected to be considerable." ()
In their submission dated 21 December 1992 the joint auditors explained the procedures carried out by them in relation to internal controls, internal audit and computer controls:
"The overall approach to the audit of the State Bank of South Australia was primarily substantive, however, the joint auditors did rely on the work of the Bank's Internal Audit department in relation to certain areas.
In planning the audit of the Bank for the year ended 30 June 1986, the areas considered to contain the greatest audit risk were those defined as significant audit areas in the PMM Audit Approach Memorandum ...
However, no areas were considered to pose such a level of audit risk as to represent "critical audit areas", (that is no areas involved a significant risk of material mis-statement, a considerable degree of judgement or difficulty in obtaining audit evidence or in applying audit procedures ...
"At the planning stage of the 1986 audit the joint auditors identified that there were no critical audit objectives. That is, there were no areas involving:
. a significant risk of mis-statement by an amount of gauge ($4,100,000) or more;
For example, areas which have, in prior periods given rise to problems or are expected to give rise to problems in the current period.
. a considerable degree of judgement;
For example, the completeness and existence of receivables may be straight forward, but valuation may be highly judgemental. Therefore, the valuation objective is likely to be critical, although the completeness and existence of receivables may not be critical.
. difficulty in obtaining audit evidence or applying audit procedures.
For example, disclosures on related party transactions might be critical because they are difficult to audit."
"The significant audit areas identified by the joint auditors and the audit approach taken in each area follows:
1. Computer Controls Review - Preliminary reviews indicated control reliance could not be placed on computer systems. Hence, substantive approach or reliance on manual controls required.
2. Audit Software - Work of DP auditors running substantive CAAT's was relied upon to support the joint auditors work in some areas as set out below.
3. Cheque Accounts (including corporate overdrafts) - Substantive approach featuring extensive confirmation procedures and some analytical procedures. Internal audit interest simulations provided additional assurance.
4. Instalment Loans - Substantive approach.
5. Mortgage Loans - Substantive approach featuring half yearly confirmation exercises. The Internal Audit Department planned each year to run an interest simulation model which was reviewed by the joint auditors to provide related evidence.
6. Bank Premises - Substantive approach.
Although not documented in the audit workpapers in this format, the following table summarises the audit risk assessment for major financial statement captions and the level of audit evidence that the joint auditors obtained from each of the three broad classifications of audit procedures.
|
Audit Risk |
Review of |
Review of Internal |
Substantive |
|
|
Cash |
L |
M |
M |
M |
|
Investments |
L |
L |
L |
H |
|
Corporate Receivables |
M |
L |
M |
H |
|
Provisions for Doubtful Debts |
M |
L |
M |
H |
|
Instalment Loans |
M |
L |
M |
H |
|
Mortgage Loans |
M |
L |
M |
H |
|
Bank Premises |
L |
L |
L |
H |
|
Capital and Reserves |
L |
L |
L |
H |
|
Deposits |
L |
M |
M |
M |
|
Other Liabilities |
L |
L |
L |
H |
|
Profit and Loss |
L |
M |
M |
L |
|
Treasury/International |
M |
M |
M |
M |
|
(L - Low, M - Moderate, H - High) |
||||
It will be appreciated that there are areas of variable risk within each of the bank's major operations which are identified in the above table. For example, in low risk areas such as deposits it was appropriate to place some reliance on internal control/internal audit in order to reduce the level of substantive audit testing required." ()
"In order to rely on internal controls in an EDP environment, it is necessary for the auditor to satisfy himself that it is possible to rely on general controls within the EDP environment. Often, the cost/benefit of testing EDP controls is so prohibitive that it is inefficient to attempt to test those controls... In many instances, weaknesses in general EDP controls and/or in EDP application controls may preclude audit reliance on those controls. In such instances, the auditor should seek to accomplish audit objectives through either reliance on manual user controls and/or the performance of substantive procedures. The joint auditors cite as authority for this view, Statement of Auditing Practice "The Effects of an EDP Environment on the Study and Evaluation of the Accounting System and Related Internal Controls" AUP 4-1, more particularly paragraphs 17 and 18. The fact that an auditor may choose not to rely on controls does not necessarily indicate that those controls are inadequate for the business. The auditor is under no obligation to form such an opinion.
The following summarises the approach adopted regarding computer controls:
. A preliminary evaluation of EDP general controls was completed;
. It was decided that strong reliance could not be placed on EDP application controls; and
. The audit approach in high risk areas was therefore required to be either substantive or alternatively reliance could be placed on manual user controls on the basis that such manual user controls were subject to audit.
This approach is evident from the Audit Approach Memorandum." ()
The audit working papers were reviewed by the Investigation. I am satisfied that the approach set out in the submissions from the joint auditors noted above was not clearly set out in the workpapers, however, the above submissions clarify the joint auditors' planning in relation to reliance on internal controls, Internal Audit and computer controls.
48.5.1.2 Conclusion
Based on the evidence examined by the Investigation, I have formed the opinion that planning in relation to the audit was appropriate and adequate.
48.5.2 EXECUTION OF THE AUDIT
48.5.2.1 Preamble
Chapter 46 - "The External Audits of the State Bank: Background Information" sets out background information on appropriate audit procedures in this area.
48.5.2.2 Matters Noted - Corporate Lending
The work performed on corporate lending was inadequate in that the Internal Audit department appeared to have selected ninety five corporate loans for review, but the review was limited to an assessment of the security of the loans and approvals for new loans. With the exception of corporate overdrafts, none of the corporate loans were confirmed in order to verify its existence. In a memorandum from T J Whimpress/B A Fiedler to the Internal Audit department, dated 12 December 1985, the joint auditors recommended:()
"... that Internal Audit procedures include confirmation of account balances of Corporate Accounts"
A handwritten note by the audit manager next to this point reads:
"G Curyer advised this has not been proceeded with due to practical problems in confirming loans ..."
In view of the significant dollar value of the corporate loans, in my opinion they should have been confirmed by circularisation of a sample of loans.
The joint auditors have submitted that "the majority of corporate receivables balances, being corporate bank overdrafts, were subject to confirmation procedures each quarter as set out in the Audit Approach Memorandum on workpaper 1-7 (PMM file 1)". On the basis of information supplied by the joint auditors, corporate bank overdrafts represented approximately $218.0M out of a total corporate receivables balance of approximately $772.0M (). This is clearly not a "majority" and in the absence of further evidence from the joint auditors, I am not satisfied that the remaining corporate receivables balances of approximately $554.0M were subject to circularisation.
The joint auditors have further submitted that where they did not confirm specific corporate loan balances as at 30 June 1986, the existence of balances was subject to examination by verification to supporting documentation of a sample of loans by Internal Audit in their review of loan files.()
Based on the evidence examined by the Investigation, and for the reasons set out above, I am not satisfied that the joint auditors carried out appropriate and adequate audit procedures in relation to Corporate Lending balances, however, I have no reason to believe this failure to perform appropriate and adequate audit procedures resulted in a material mis-statement in the Bank's accounts.
48.5.2.3 Matters Noted - Provision for Doubtful Debts
The provision for Doubtful Debts of $12.958M appearing in the Bank's accounts at 30 June 1986 comprised the following:
(a) a specific provision of $2.458M relating to an assessment of individual loans; and
(b) a general provision of $10.5M calculated by applying risk percentages to balances outstanding and commitments for different categories of lending.()
The Lending Committee requested in their meeting on 3 April 1986 that:
"Retail Lending look critically at the underlying position or arrears control in a climate of high interest rates ... The committee was advised by Chief Manager, Retail Lending that the disturbing trend was continuing in relation to secured and unsecured debts particularly in the 3 months and over period. The Lending Examiners have addressed this problem and have reported that there is still a distinct lack of branch credit control with little follow-up on unauthorised excesses."
The Lending Committee indicated that:
"... since the implementation of more detailed instructions relating to the granting and control of temporary accommodation, an improvement has been recorded as at 31/3/86." However the committee still requested that "the Chief Manager, retail Lending submit a full report on the action being taken to reduce the level of outstandings which are totally unacceptable at the present level." ()
These comments should have alerted the auditors to spend additional time and audit effort to ensure that the provision for doubtful debts was adequate in this area.
The joint auditors have submitted that they consider:
"sufficient audit effort was focused on the Bank's provision for doubtful debts. It was not considered, at that time, that the determination of the provision represented a significant audit risk as the Bank's loss experience had been low, the Australian and world economies were performing strongly, assets typically charged as security were rapidly increasing in value and the newly de-regulated banking industry was seen as the primary reason for the growth in Bank assets." ()
In my opinion the audit work performed on the Provision for Doubtful Debts was deficient in that:
(a) The auditors relied on loan arrears reports for their assessment of doubtful debts, yet the work papers contain no evidence that the arrears reports had been tested by the auditors to determine that they were accurate or contained all loans in arrears.
The joint auditors have submitted that:
"... [the] arrears reports were subject to testing by internal and external audit [and that] given the relatively low risk that the computer generated arrears report would prove to be inaccurate (especially given that management used and relied on these reports and had not experienced any difficulties with them), it was quite appropriate to accept the level of comfort provided by internal audit testing.
In addition, in the Corporate area, the computer generated arrears reports were compared by the joint auditors to the loan officers monthly excess returns to provide additional evidence that all arrears were being reported to senior management accurately and on a timely basis."
On this basis the joint auditors submitted that:
"sufficient audit testing was conducted to minimise the risk that non-performing loans would avoid the gaze of management and the external auditors." ()
In my opinion, the joint auditors did not perform adequate procedures to provide sufficient evidence that the risk of computer generated reports providing inaccurate information was low and it was inappropriate for the joint auditors to rely on management's use of the reports as providing assurance that the information contained in it would be reliable for audit purposes.
(b) The audit files contain inadequate evidence of any examination of security for amounts outstanding or in arrears.
The joint auditors have submitted that:
"... given the economic environment of the times and the firm real estate market the risk of security problems was assessed as low and it was considered appropriate to take comfort from internal audits review of securities which was examined in detail by the joint auditors ..." ()
(c) The provision for doubtful debts was based largely on a risk weighting to be applied to various categories of lending. Accordingly, one of the key audit steps should be to assess those weightings for reasonableness compared to other banks or past experience. No evidence that the auditors had addressed the issue of whether the risk factors applied were appropriate, or that the provision had been compared to other banks or financial institutions, was found on file.
The joint auditors have submitted that there is no generally accepted requirement for calculating the general provision for doubtful debts and that the nature of such a provision is often questioned. ()
Further, the joint auditors have submitted that there is no objectively verifiable rate by which it could be determined whether the percentages used were correct. () I note the following comments made in the joint auditors' submission:
"In practice, banks use a variety of methods to estimate general provisions for doubtful debts. It is a fact that no single method is considered preferable or ideal. The method used must be logical, fit the bank's circumstances and the basis for calculating the allowance must be comprehensive and take into consideration the range of risks and the range of the various types of lending. The objective of all methods should be to estimate the amount of uncollectable loans based on conditions at the balance sheet date." ()
In my opinion, failure by the joint auditors to assess the actual percentages used, as stated in the above extract, represented an inadequacy in their audit procedures.
(d) The London branch had corporate exposures totalling GBP 44,000,000, the collectability of which was not assessed by the London auditors. The review of these exposures by head office auditors (ie in Adelaide) was limited to the following comment by the audit manager:
"Discussed listing in Corporate and International (loans) with senior staff and satisfied no accounts irregular requiring provisioning by Adelaide"
In my view, given the size of the exposures involved, the joint auditors should have at least reviewed the loan file documentation and other correspondence concerning selected large exposures.
The joint auditors have submitted that the level of audit testing, comprising detailed discussion with and enquiry of senior bank lending officers, was wholly appropriate in the circumstances given the following matters:
". The total exposures are comprised of over forty individual accounts, most of which are in the range of $US2.0M to $US5.0M. None of the individual exposures were therefore highly material.
. Most of the exposures are to well-known Australian and international corporates (eg Comalco, News Corp. etc) Banks, or Financial institutions.
. Many of the exposures are off-balance sheet exposures (mainly swaps). The credit risk on these transactions is clearly much less than the total face value fo the swap contracts." ()
The joint auditors have not submitted any evidence to confirm that the above reasoning was applied at the time of performing the audit. In my opinion failure to document such matters represented an inadequacy of the audit.
Based on the evidence examined by the Investigation, and for the reasons set out above, I am not satisfied that the joint auditors performed appropriate and adequate audit procedures when auditing the provision for doubtful debts, however, I have no reason to believe any such failure to perform appropriate and adequate audit procedures resulted in a material mis-statement in the Bank's accounts.
48.5.2.4 Matters Noted - Concessional Housing Reserve
Chapter 46 - "The External Audits of the State Bank: Background Information" provides a discussion of this matter and a consideration of the joint auditors' submissions on the subject. The conclusion which follows draws on that discussion.
Note 6 to the 30 June 1986 accounts of the Bank discloses an "Equalisation of Interest - Housing Advances Reserve" (known in other years as the Concessional Housing Reserve) with a balance at 30 June 1986 of $42.5M. The balance of this reserve increased by $11.9M during the financial year ended 30 June 1986.
The work papers contain no evidence that the joint auditors considered the propriety of the treatment of this item as a reserve rather than a liability to the government. Concessional housing income of $17.2M was generated during the year, of which $5.3M was recorded as income to the bank and $11.9M was transferred directly to the "Equalisation of Interest- Housing Advances Reserve" in the equity section of the balance sheet.
The work papers do not record adequate evidence to support recognising only a portion of the surplus as profit, and why the balance was transferred to a reserve rather than a liability account.
Total Capital and Reserves at 30 June 1986 were $392.3M for the Bank and $404.7M for the Bank Group.
Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that the joint auditors did not carry out appropriate and adequate audit procedures concerning the "Equalisation of Interest - Housing Advances Reserve" and its presentation in the Bank's accounts and it was inappropriate for the joint auditors to accept management's treating this balance as a reserve forming part of the Bank's capital and reserves. The question of whether the accounts of the Bank at 30 June 1986 were as a result materially mis-stated is considered in the section headed "Conclusion" at the end of this Chapter.
48.5.2.5 Matters Noted - Provision for Self Insurance
Chapter 46 - "The External Audits of the State Bank: Background Information" provides a discussion of this matter and a consideration of the joint auditors' submissions on the subject. The conclusion which follows draws on that discussion.
As occurred during the 1985 audit the provision for self insurance of $4.6M was not supported by any evidence given by the Bank's officials. The nature and substance of the account was not tested by the auditors. Since the balance remained unchanged from the prior period the profit for the year was not affected by this account, however, because no work was performed by the auditors on the account they could not have determined whether the amount was under- or over-stated. Any such under or over-statement would have affected the profit and net assets for the 30 June 1986 year. This matter was raised by the joint auditors in their letter to management dated 17 December 1985 and again by the joint auditors in their letter to management dated 9 December 1986.
In my opinion, the amount was material, and it was inappropriate to simply raise the matter with management and not pursue the matter further as any mis-statement may have affected the truth and fairness of the 30 June 1986 accounts of the Bank.
Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that:
(a) the joint auditors did not obtain appropriate and adequate audit evidence to justify accepting management's assertion that the provision was not materially mis-stated; and
(b) the balance was materially mis-stated.
The question of whether the accounts of the Bank at 30 June 1986 were as a result materially mis-stated is considered in the section headed "Conclusion"at the end of this Chapter.
48.5.2.6 Matters Noted - Contingent Liabilities
Note 1 to the 30 June 1986 accounts of the Bank states that the accounts comply with Schedule 7 of the Companies (South Australia) Code, where practicable and appropriate. Clauses 5(2) and (3) of Schedule 7 (as applicable at 30 June 1986) required certain disclosures in relation to commitments and contingencies.
The 30 June 1986 accounts of the Bank (notes 17 and 18) complied with the disclosure requirements of Schedule 7 noted above. This was the first year that the Bank so complied.
Note 17 disclosed contingent liabilities totalling more than $1,900.0M. No evidence was found on file of any substantive audit work performed on contingent liabilities.
No evidence was found on file that commitments such as loans approved but not advanced and undrawn credit facilities available to borrowers were considered for inclusion in the disclosures made. These would be important disclosures in the accounts of a bank.
In their submission the joint auditors describe their audit procedures with respect to contingent liabilities. These include:
"... testing of supporting documentation;
. inspection of Board minutes; and
. due consideration to audit results and knowledge of the business." ()
The Investigation could find little evidence in the audit file of the detailed audit testing mentioned or of the discussions with management documented by a formal management representative letter. The joint auditors have, () however, pointed out that their file contains a Board docket which recommended that the directors approve the accounts of the Bank and that:
"... this docket includes statements made by the Managing Directors and the Chief Accountant that all known contingent liabilities and commitments of the Bank up to 28 August 1986 had been disclosed in the accounts ..."
The joint auditors consider that these representations provided related evidence as to the completeness and accuracy of contingent liabilities and commitments.
The joint auditors have referred to a workpaper on their file prepared by the Bank's staff showing the compilation of the contingent liabilities. () They claim this workpaper was checked with the Bank staff responsible for its preparation and that this represented a test of the accuracy of the contingent liability details. There is no evidence on the workpaper of this, or more importantly, of any checking by the joint auditor with the underlying records.
Based on the evidence examined by the Investigation, and for the reasons set out above, I am not satisfied that the joint auditors performed appropriate and adequate audit procedures to gain reasonable assurance of the accuracy and completeness of the disclosure made in the accounts in respect of contingent liabilities, however, I have no reason to believe any such failure to perform appropriate and adequate audit procedures resulted in a material mis-statement in the Bank's accounts.
48.5.3 CONCLUDING PROCEDURES
48.5.3.1 Preamble
Chapter 46 - "The External Audits of the State Bank: Background Information" sets out background information on appropriate audit procedures in this area.
48.5.3.2 Matters Noted - Subsequent Event Review
There is no evidence in the audit working papers that the joint auditors performed a review of events occurring subsequent to balance date and up to 28 August 1986 (the date of signing their report on the Bank's accounts) for the year ended 30 June 1986, with the exception of reviewing minutes of Board meetings up to 24 July 1986.()
In their submission, () the joint auditors claim that the review of subsequent events was an ongoing matter, and a record was only made when a matter arose which required consideration. In my opinion, the procedure of reviewing subsequent events is sufficiently important for the enquiries made to be documented as part of the audit evidence.
Based on the evidence examined by the Investigation, and for the reasons set out above, I am not satisfied that the audit procedures adopted with respect to the review of events subsequent to balance date were appropriate and adequate, however, I have no reason to believe any such failure to obtain appropriate and adequate audit evidence resulted in a material mis-statement in the Bank's accounts.
48.5.3.3 Matters Noted - Management Representation Letter
The only evidence found on file that the joint auditors had considered representations from management was a letter from the Managing Director and the Chief Accountant of the Bank to the Board of Directors.() The letter indicated that certain matters relating to liquid assets, investments, loans and advances, bad debts and fixed assets had been considered and recommended that the Board of Directors authorise the Chairman and Managing Director to sign the accounts.
There was no letter of representation from management to the joint auditors. Obtaining such a letter of representation is not considered mandatory by the Professional Accounting Bodies. However, Peat Marwick policies noted below required that a management representation letter be obtained.
An "Accounting and Audit Bulletin" issued by Peat Marwick on 12 June 1987 refers to existing requirements of Paragraph 1301 of the PMI Audit Manual to obtain a management representation letter. Although the bulletin is dated 12 June 1987, the reference is to an existing policy requirement.
In their submission () the joint auditors state that, although their internal audit guides support the obtaining of written management representation, this is not a mandatory requirement and that the requirements of their internal audit guides were met by the review of Board papers in conjunction with the final Bank Accounts.
In their submission the joint auditors note that AUP25 states:
"The auditor should obtain evidence that management acknowledges its responsibility for the appropriate presentation of the financial statements ... The auditor can obtain evidence of management's acknowledgment of such responsibility and approval ... by obtaining a written representation." ()
In my opinion the review of Board papers is an inadequate substitute for written representations from management and/or the Board addressed to the joint auditors. There is no assurance that the Board papers cover all matters of concern to the joint auditors. They are prepared for a different purpose and addressed to persons whose existing knowledge of matters may be quite different from that of the joint auditors.
Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that the audit procedures with regard to obtaining management representation on significant matters were inappropriate and inadequate, however, I have no reason to believe this failure to perform appropriate and adequate audit procedures resulted in a material mis-statement in the Bank's accounts.
48.6 CONCLUSION
In my opinion, the audit opinion expressed by the joint auditors on the accounts for the year ended 30 June 1986 was inappropriate, and the carrying out of the audit process leading to that opinion was inadequate, in the following respects:
(a) the joint auditors failed to deal adequately with the significant matters noted in the section on "Concluding Procedures" above;
(b) the joint auditors did not carry out appropriate and adequate audit procedures to gain reasonable assurance that certain amounts shown as assets and liabilities as noted in the section on "Execution" above were not materially mis-stated;
(c) the Provision for Self-Insurance of $4.6M was materially mis-stated; and
(d) the joint auditors wrongly accepted management treating the balance of the "Equalisation of Interest - Housing Advances Reserve", of $42.5M, as forming part of the Bank's capital and reserves.
By reason of the foregoing, the joint auditors' opinion that the accounts and group accounts for the year ended 30 June 1986 complied with Section 269 of the Companies Code, Australian Accounting Standards and applicable approved accounting standards, and gave a true and fair view, was inappropriate, in that there was not a proper basis for that opinion.
In my opinion, for the following reasons, the accounts failed to give a true and fair view, by virtue of items (c) and (d). First, item (c) was, in my opinion, material in relation to the reported profit of the Bank for the year of $33.6M before tax. Second, item (d) was, in my opinion, material by its nature, and in relation to the Bank's reported capital and reserves of $392.3M.