VOLUME SEVENTEEN
THE EXTERNAL AUDITS OF THE STATE BANK OF SOUTH AUSTRALIA

 

 

CHAPTER 45
THE EXTERNAL AUDITS OF THE STATE BANK: INTRODUCTION

 

 

TABLE OF CONTENTS

45.1 TERM OF APPOINTMENT B

45.2 NATURAL JUSTICE PROCESS

45.3 SCOPE OF INVESTIGATION

45.4 INFORMATION SOURCES

 

 

 

45.1 TERM OF APPOINTMENT B

 

The Terms of Appointment of the Investigation require me to inquire into, and report on the `External' and `Internal' audits of the State Bank of South Australia. Chapter 23 - "Internal Audit of the State Bank" addresses the Internal Audit activity of the Bank, relevant to Term of Appointment A(g). This Volume of the Report, comprising Chapters 45 - "The External Audits of the State Bank: Introduction" to Chapter 53 - "The External Audits of the State Bank: Findings and Conclusions, focuses on the investigation into the External audits of the Bank, relevant to Term of Appointment B. Specifically, Term of Appointment B (as amended, 23 December 1992), requires:

"The Auditor-General is to investigate and inquire into and report on whether the external audits of the accounts of the Bank and Beneficial Finance Corporation Ltd ... were appropriate and adequate."

In Chapter 23 - "Internal Audit of the State Bank", I have commented on the distinction between the objectives of Internal Audit and External Audit. To restate, the primary obligation of External Audit is to provide an opinion on the entity's financial statements based on evidence obtained from examination of the entity's records and from third parties as appropriate, and includes the evaluation of the entity's internal controls to the extent that the auditor chooses to rely on selected controls. The principal responsibility of Internal Audit is not to attest to the entity's financial statements but to monitor the systems of internal control introduced by the Board to safeguard the entity's assets and promote operational efficiency. To this extent Internal Audit is not part of the internal control system, which should be able to operate effectively without Internal Audit, but a monitoring function. In reaching its objective External Audit may, where the auditor considers it appropriate and after proper review, rely on the work of Internal Audit.

In considering Term of Appointment B, I am of the opinion that I am required to investigate the procedures carried out by the auditors and to determine whether those procedures were proper, and whether the information elicited by the auditors provided a proper basis for the opinion which they expressed in each of the years under review. That is, I am required to determine by this inquiry whether the opinion of the auditor was proper in the circumstances. This requires me to inquire into the exercise of the auditors' judgement in the circumstances as to proper procedures, and as to proper conclusions, which could be drawn from the information before the auditors.

In my view I am not limited to determining, as the joint auditors have submitted I should, whether the particular judgment or opinion formed by the auditor was one within a range which might be reasonably open to him. I consider that Term of Appointment B requires me to have regard to the view which would be likely to prevail in the profession.

"Audit" in my view is used in my Terms of Appointment to mean an "official examination and verification of accounts and records". That is, it is the process of examination and verification which is the essential element rather than simply the outcome of the process, ie the opinion expressed by auditor.

The terms "appropriate" and "adequate" potentially overlap. In the context in which they are used, however, "appropriate" in my view is used in my Terms of Appointment to mean "proper" or "fit for a particular purpose", and "adequate" in my view is used to mean "sufficient".

The purpose of an audit is clearly to enable the auditor to express an opinion on the accounts, and, in my opinion, the appropriateness and adequacy of the audit is to be determined having regard to this purpose.

The joint auditors submitted that, unless I am in a position to conclude that there has been a material mis-statement in the accounts, ie that the accounts did not give a true and fair view, no criticism could be made of the external audit under my Terms of Appointment.() I reject that submission for the following reasons.

I consider that Term of Appointment B requires me to investigate the audit processes and procedures carried out by the auditors to support the opinion they expressed on the accounts. It does not, however, require me to conduct a fresh audit of the accounts of the Bank and the Bank Group. The Investigation has therefore been conducted by way of detailed review of the working papers of the joint auditors, with the co-operation and assistance of the joint auditors. It may be, however, that as a result of matters arising out of the Investigation, I would be able to make a finding that the accounts did not give a true and fair view by reason of exceptions specifically noted, and where, in my opinion, this is the case, I have done so.

The expression of an opinion by a professional person impliedly represents that there are reasonable grounds for the holding of such an opinion.() If an auditor did not have reasonable grounds for expressing the opinion he expressed, it could not in my view be said that his audit was "appropriate" or "adequate" within the ordinary meaning of those words.

It was submitted to me that I must not have regard to applicable professional standards in interpreting Term of Appointment B.() As it happens I do not consider this to be necessary, but I note the pronouncement of the Professional Accounting Bodies in Statement of Auditing Standards AUS1, which provides in part:

"3. This Statement of Auditing Standards describes the basic principles which govern the auditor's professional responsibilities and which must be complied with whenever an audit is carried out ...

4. An audit is the independent examination of financial information of any entity ... when such examination is conducted with a view to expressing an opinion thereon ...

6. The Standards set out in this Statement are mandatory ...

21. Auditors shall obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable them to draw reasonable conclusions therefrom on which to base their opinion on the financial information."

It was also submitted to me that Term of Appointment B must be interpreted so that an adverse finding could not be made unless I am able to conclude that no reasonably competent auditor could have expressed the opinion which the joint auditors expressed and that the incorrect opinion was a contributing cause to the financial position of the Bank and Bank Group as reported in February 1991.() I think this submission goes too far because such a finding would, in my view, correspond with a finding on the principal elements of a cause of action against the joint auditors for negligence. Term of Appointment B does not require this. A professional person may be wrong without being negligent. In my opinion Term of Appointment B requires me to assess the appropriateness and adequacy of the External Audit having regard to what a reasonably competent auditor should have concluded to be proper in the circumstances. It is for others to determine whether there has been negligence on the part of the auditors which caused a loss.

 

45.2 NATURAL JUSTICE PROCESS

 

The Investigation has proceeded according to the rules of procedural fairness, also referred to as "natural justice", which in summary require me to give parties affected by my possible findings a reasonable opportunity to place evidence and submissions before me in rebuttal of possible adverse findings.

The procedure adopted by the Investigation, which was approved by the Supreme Court in proceedings commenced by certain former Non-Executive Directors of the Bank,() involved the release of draft reports containing my tentative findings. Draft reports were released to the joint auditors of the Bank in October 1992 to enable them to place evidence and submissions before the Investigation.

The draft reports released to the joint auditors in October 1992 indicated, in relation to sources of information available to the Investigation, that I had retained experts to advise me in relation to auditing standards, practices and procedures concerning the audit of banks and financial institutions, and the application of those standards, practices and procedures by the external auditors in the years under review.

As noted above, the Investigation took the form, initially, of a review of the joint auditors' working papers with respect to the external audit of the accounts of the Bank and Bank Group for each of the six financial years under review. The review of the working papers was undertaken with assistance from Deloitte Touche Tohmatsu and Ernst & Young, and expert assistance with regard to applicable professional standards and practices was provided by those two firms and by Coopers & Lybrand.

The tentative draft reports released to the joint auditors in October 1992 contained certain tentative adverse findings with regard to the appropriateness and adequacy of the External Audit.

The draft reports released to the joint auditors set out the substance of the advice I had received concerning the respects in which the external audits were tentatively thought to be inappropriate or inadequate having regard to applicable professional standards and practices. The advice of the three firms of consulting accountants assisting me was obtained in the course of my discussing with them and settling the draft reports containing my tentative findings. Accordingly, their advice was reflected in the draft reports.

Substantial written submissions were provided by the joint auditors through their solicitors in December 1992, including reports in December 1992 and February 1993 by an independent expert retained by the joint auditors to express an opinion on the provisions for doubtful debts in the years ended 30 June 1989 and 1990.

Hearings were held in February, March, April and May 1993 for the purpose of the joint auditors giving oral evidence and submissions to the Investigation. Before finalising my views I gave careful and detailed consideration to the extensive evidence and submissions adduced on behalf of the joint auditors.

 

45.3 SCOPE OF INVESTIGATION

 

Since commencement of operations of the State Bank on 1 July 1984, the Bank has prepared for audit, on a financial year basis, accounts comprising a Profit and Loss Statement, Balance Sheet and Notes to the accounts. The Bank has also prepared for audit on a financial year basis, commencing with the year ended 30 June 1986, a Source and Application of Funds Statement.

The accounts of the Bank comprise, in addition to the Bank's own accounts, group accounts for the Bank and its subsidiary companies.

During the period under review, Price Waterhouse were engaged as auditors of Beneficial Finance and its subsidiary companies, and KPMG Peat Marwick and predecessor firms were engaged as auditors of the Bank and other subsidiaries.

Accordingly, the investigation into the appropriateness and adequacy of the External Audit has proceeded, and this Report will deal, separately with respect to those external audits, for each of the financial years ended 30 June 1985 to 30 June 1990. This Volume of the Report, comprising Chapters 45 - "The External Audits of the State Bank: Introduction" to Chapter 53 - "The External Audits of the State Bank: Findings and Conclusions", reports on the investigation undertaken in regard to the external audit of the accounts of the Bank and the group accounts of the Bank and its subsidiary companies. Chapters 54 - "The External Audits of Beneficial Finance: Introduction" to Chapter 60 - "The External Audits of Beneficial Finance: Findings and Conclusions" of this Report comprise the report on the investigation undertaken in regard to the external audit of the accounts of Beneficial Finance and the group accounts of Beneficial Finance and its subsidiaries.

The Investigation involved the review and evaluation of the audit process applied by the appointed auditors in relation to the accounting records and `group' or `consolidated' accounts for each of the financial reporting years ended 30 June 1985 to 1990. The audit process comprises three main phases, notably, planning of the audit, execution of the audit, and concluding and reporting on the audit. These phases were examined in terms of the Accounting and Auditing Standards of the Professional Accounting Bodies and the Statutory requirements applying at the relevant time.

 

45.4 INFORMATION SOURCES

 

The main information sources used in the investigation of the External Audits of the accounts of the Bank included:

(a) Annual Reports of the Bank containing the financial statements and the Auditors' Reports.

(b) External Auditors' Working Papers which record the auditors' planning, procedures and conclusions drawn from the evidence obtained.

(c) Audit Policy and Procedure Manuals, Directives and Guidelines issued by the External Auditor firms, for the purpose of providing professional guidance to their staff when conducting audits.

(d) Correspondence between the Bank and External Auditors, including engagement letters and management letters.

(e) Transcripts of evidence, resulting from interview proceedings with the External Auditors.

(f) Board Minutes and Papers and Executive Committee Minutes and Papers.

(g) Information arising from the investigation into the Internal Audit activity of the Bank, presented in Chapter 23 - "Internal Audit of the State Bank", of this Report.

(h) Information arising from the investigation into the External Audit of Beneficial Finance Corporation Limited, addressed in Chapters 56 - "Review of the 1985, 1986 and 1987 External Audits of the Beneficial Finance" to Chapter 59 - "Review of the 1990 External Audit of Beneficial Finance".

(i) Advice of experts retained by me to advise on auditing standards, practices and procedures concerning the audit of banks and financial institutions and the application of those standards, practices and procedures by the external auditors in the years under review.

(j) Evidence and submissions of the External Auditors following release of my tentative findings in October 1992.