Short answers:
1. You are correct - recording phone calls is illegal.
2. Use common sense and don't compromise yourself or your job. Personally, I wouldn't do anything.
Long answers:
1. A phone call is a private conversation and the recording of a private conversation is covered by the relevant state laws relating to listening devices.
For WA, the relevant law is section 5 "Regulation of use, installation and maintenance of listening devices" of the WA Surveillance Devices Act 1998. The effect of the WA law is pretty much the same as it is here in NSW, in that it provides a blanket prohibition on the use of any device to listen to or record a private conversation except in certain circumstances, two of which apply to everyday people like us.
The first circumstance is if the principle parties to the conversation consent to the recording either directly or by implication. In other words, when you provide a standard recorded announcement that "your call may be recorded [with or without a reason stated]", you may legally record the call until the other party explicitly states that they do not consent to this. Therefore, for any call that is recorded, you are required by law to automatically announce that this may happen in order to obtain "implied consent", or expressly inform the other party you want to record the call in order to obtain "direct consent". If the other party at any time states anything along the lines of "I don't want this call to be recorded" or "I want you to stop recording", then they have withdrawn their consent at that point and you are required by law to immediatly stop recording the call.
The second circumstance where an individual can record a conversation that they are a party to without the knowledge or consent of the other party, is if they have grounds to believe that "recording the conversation is reasonably necessary for the purpose of protecting their legal interests". This is NOT a blanket exception and can only be done where there is a pre-existing legal justification for the recording being made. In other words, in this case you must have "grounds" for making the recording both before the recording is made and before it can be accepted and used as evidence in any legal proceeding.
The maximum penalty for illegal use of a listening device in WA is $5,000 and/or 12 months imprisonment for individuals and $50,000 for body corporates. NSW is much harsher on individuals, with a maximum penalty of $11,000 and/or 5 years imprisonment, while the maximum for body corporates is similar to WA at $55,000.
2. As for what should you do? Well, that depends on how good your relationship is with your boss. If you get along well and you don't want them to get in trouble, then I would point out to them that they are risking a $50,000 fine if they get caught. If on the other hand you don't get along, then I wouldn't do anything and if they get caught - let them wear it. But if you decide to stay quiet, make sure that no-one else knows that you have prior knowledge that it is happening and what the penalties are.
If you want to consider the technicalities of what you are "obligated" to do, then you would need to look at whether or not you are actually "required" to report it, which would most likely depend on other legislation.
In NSW, the Crimes Act defines a "serious indictable offence" as being any offence with a maximum penalty of 5 years or more of imprisonment, or life imprisonment. Therefore this particular breach under the NSW Surveillance Devices Act is a serious indictable offence. Under the NSW Crimes Act, concealing a serious indictable offence is an offence in it's own right (max penalty of 2 years) unless you have "reasonable grounds" for not reporting it. So if you want to get technical, you would need to determine if you are required to report such an offence under WA law.
Link:
Western Australian Legislation - Surveillance Devices Act 1998
(There are download links at the right side of the page. The PDF is much better formatted than the HTML version.)