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Auditing: International Financial Management

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Questions:

1. What is audit and assurance service?

2. What are auditing standards?

 

Answers:

Introduction

This report is based upon the case of Lehman Brothers, as the firm was collapsed in the year 2008 and gave birth to the global financial crisis. In the report discussion is done about the auditing standards as they are important to be considered by the auditors while preparing an audit report of the firm. The case of Lehman Brothers pointed toward the auditing issues which was related to the collapse of the firm; these issues are also discussed in the report (Obana, 2015). Beside this, the Key Audit Matters that should be communicated are also discussed as to make the auditor`s report free of influence and to maintain independency of the auditor for creating audit report of the firm, developed auditing standard i.e. ASA 701, is also being discussed in the report.

The term ‘audit’ can be defined as a systematic inspection and verification of transaction records, books of account, physical assessment of inventory and other important document of a firm by an auditor to ensure that proper documented system is followed to record the transactions. An audit is carried out to determine the accurateness of financial statements of organization. Organization can appoint external audit firm to audit its financial statement or an internal audit department can be formed (Spencer , 2011).

Whereas assurance services can be described as a type of professional service which is generally provided by CPAs. Assurance services involves review of certain financial transactions or documents such as- financial website, loan and contract. This review endorses the validity and correctness of the financial document or transactions ( Fernando, 2012). All audit services are assurance services, as the audit is one of the type of assurance engagement which particularly inspects financial statements for fairness and truth; but on the other hand, assurance engagement is very wide subject.

Auditing standards can be defined as a set of guiding principle which outlines the accountabilities of the auditors which should be followed by them while conducting an audit of the firm. Auditing standards ensures consistency, accuracy, verifiability of actions taken by the auditors in preparing audit report ( Porter, Hatherly, & Simon, 2014).Standards of auditing involves objectives for the auditor, laidback with requirements in addition to related solicitation and other instructive material for audit of financial statements. As per the auditing standards, it is obligatory for the auditor to possess adequate proficiency and training in order to perform training as well as independency should be there while preparing report as the auditor must not come in the influence of the firm to prepare audit report ( Thibodeau & Freier, 2013). Auditing standard also implies that the auditor shall carry out due professional care not only at the time of audit process but also at the time of preparing audit report.

 

Communicating Key Audit Matters in the Independent Auditor’s Report: Key maters

Key audit matters can be described as the main aspects of the audit; these aspects should be communicated by the auditor independently without undergoing through the influence of firm owners. ASA 701`s main features are as follows-

  • Mandating the communication of key audit matters in the audit report of listed entities prepared by the auditor.
  • key audit matters is defined as those matters in the professional judgment of the auditor were of most significance in the financial report`s audit(Obana, 2015).
  • How the key audit matters should be determined by the auditor.
  • How the key audit matters shall be described by the auditor in the audit report.

The enclosure of key audit matters in the audit report is intended to highlighting those matters which were the most significant in judgment made by auditors in the course of the audit. While determining the key maters it is important for the auditor to consider these aspects:

  • Areas of higher risk of financial statements misstatement.
  • Significant judgments of auditor as well as estimation vagueness.
  • Significant events or transactions(Obana, 2015).

While describing the key audit matters in audit report it is requisite to involve:

  1. How the addressing of matter was done in the audit.
  2. The reason to consider matter as significant for audit
  3. Mention the associated disclosure.
 

Auditing Issues Surrounding the Collapse of Lehman Brothers

Collapse of Lehman Brothers took place in year 2008. Ernst and Young were recruited as auditors, to audit the firm`s financial statement. Auditing issues related with collapse of Lehman Brothers were analyzed as the accounting methods used by Ernst and Young were questionable. Repo 105 was being used to present financial transactions that helped in making superior results than they are in real. The use of Repo 105, concealed bank`s failure and then auditors also obscured this fact. Impaired liquidity assets were used by Lehman Brothers and Ernst and Young were aware of this fact. This is one of the issue which was related with the collapse of the firm, as the auditors were known about the facts but they concealed this fact instead of revealing the facts. Another issue of collapse of the firm, related with the auditing was that, GAAP principles were not followed by the auditors (Davies, J., 2014).

In the case of Lehman Brothers, GAAP principles were not followed by the Ernst and Young as they did not disclosed the fair and true financial statements in public. But the auditors stated that they have followed the GAAP, and reason of firm`s collapse was not mistakes of accounting. But contradictory to this, Ernst and Young were recruited in the firm in 2001 and bankruptcy was filed by the firm in year 2008; that time also firm`s accounts were audit by the Ernst & Young. ( Thibodeau & Freier, 2013) One of the other issue related with the collapse was that signs of failure and mismanagement of accounting books were given by the internal auditors of Lehman Brothers but these signs were being ignored by Ernst & Young and that created blunder in the financial market. Therefore, tis can be analyzed that auditing issues were also related with the collapse of Lehman Brothers` firm.

 

Relate the issues that led to the development of the new auditing standard ASA701 Communicating Key Audit Matters in the Independent Auditor’s Report.

The issues which were related to the collapse of Lehman Brothers` firm also led to the development of a new auditing standard ASA 701 Communicating KAM (Key Audit Matters) in the independent Auditor`s Report. As the case of Lehman Brothers gave rise to global financial crisis. Many facts were ignored and many facts were concealed by the auditor firm which tend to creation of vague audit reports of the firm (Ho., 2012). This auditing standard was required to protect the human rights or we can say, to protect the rights of stakeholders. In the case of Lehman Brothers, accounting books were not being checked in proper manner. Failure as well as mismanagement of the books were being ignored which displays that Auditor firm did not discharge their responsibilities ( Perler & Howard M. , 2010). This is one of the issue which led to the development of new standard for auditing, as the international auditing standard are not followed in the case. It is the responsibility of the auditor to go through the accounting books of the firm and present a fair and adequate audit report of the firm. As the audit report states the financial condition of the firm and this report is also facilities the stakeholders in the process of decision making. Creating an audit report on the basis of vague account books was an issue which led for the development of the new standard of auditing (Dagwell, Lambert, & Wines, 2012).

Auditor firm also concealed the facts as the Repo 105 was being used to manage the accounts and to provide superior results; which were only vague or nothing else. This issue was also a reason for the development of the auditing standard 701. As per the general principles, it is obligatory to disclose the fair and relevant information through the auditor in its audit report. But in the case of Lehman Brothers, auditors did not disclosed the important information in their reports and concealed the facts (Well, 2017). This was an issue in terms of fair auditing and the need to develop a new standard in order to follow the international standards for accounting arouse. As the key audit matters were not determined by the auditor firm. Vague audit report provide vague information about the firm`s financial condition (Obana, 2015). Therefore the opinion given by the auditor firm Ernst & Young was also vague.  Key matters which were important to be communicated in the audit reports were concealed. Auditor firm was informed about the mismanaged account books by the internal auditors of the firm but this information was ignored by the Ernst & Young auditor firm. Mismanaged accounts books provided irrelevant information about the transactions and other facts and these books of accounts were assessed to make audit report of the firm. Use of mismanaged account for making audit report resulted as false audit report of Lehman Brothers. This result as making false impression on the stakeholders. As the stakeholders analyze the opinion of auditors given by them in their audit report of a listed firm. These issues led for the development of a new standard for auditing as there was need to communicate the key matters of audit in the auditing report; so that relevant information shall be provided in the audit report which display the real condition of the firm and the stakeholders of that firm shall get aware about firm`s economic conditions. As this information supports the stakeholders to make decisions, such as investors after getting information about the firm through its audit report can make decision whether to invest in that firm or not. In addition to this, if the firm`s audit report communicate the key matters then proper information can be provided to the public and the rights of stakeholders can also be protected. The issues discussed in this part, are also a reason which recognized the independency of auditors in terms of discharging their accountabilities in fair manner ( Perler & Howard M. , 2010). It is believed that Lehman Brothers paid high fees to the auditor firm Ernst and Young which might influence the auditor firm to create audit report by concealing the facts and failing of the independency of auditor resulted in degradation of audit report of firm and this issue led for development of the new auditing standard.

If ASA701 Communicating Key Audit Matters, standard were there at the time of collapse of Lehman Brothers, then what are the matters that auditor will disclose in his audit report.

Lehman Brothers` bankruptcy case gave birth to the global financial crisis and this led to the development of a new standard for auditing i.e. ASA 701 which implies communication of Key Audit Matters in the audit report (Wells, 2013). This standard was came in to force after the collapse of the Lehman Brothers firm but if the ASA 701 was there at the time of collapse of the firm then the key matters which would disclosed in the audit report are-

  • Use of Repo 105- The accounts of the Lehman Brothers were prepared by using Repo 105, which helped the firm in making better results instead of disclosing the real one. The use of Repo 105 for accounting transactions concealed the bank`s failure. This fact was also concealed by the Ernst & Young in their audit report. If, the ASA 701 was there at the time of collapse then it was obligatory for the auditor firm to include this as Key Matter in their audit report and disclose the fact that accounting transactions of the Lehman Brothers was done by using Repo 105 and the fact of bank`s failure would also be informed through the key matter.
  • Use of impaired liquidity asset- Another Key Matter which could be communicated in the audit report was that, Lehman Brothers was using their impaired liquidity assets. This information could be regarded as important to be communicated in the audit report. As this key matter could help the stakeholder to make decisions. In addition to this, this key matter could also disclose fair views of the auditor in the audit report of the firm.
  • Mismanagement and failure of books of account- One of the foremost key matter that should be included in the audit report of the Lehman brothers was of mismanagement of accounts books( Thibodeau & Freier, 2013). The internal auditors of Lehman brothers tried to provide the signs of mismanagement as well as failure of accounts books. These signs were ignored by the auditor firm. But in case the ASA 701 is applied in the case of Lehman Brothers then this matter should be included as the Key Matter in the audit report of the firm. The auditor shall communicate through the key matter of mismanagement of accounts of books by firm in the audit report so that it could be analyzed that the accounting transactions might be vague and irrelevant.

These are some of the Key Matters which should be included in the audit report of Lehman Brothers o that important information could be communicated to the members of organization or to the stakeholders so that crucial step shall be taken in order to manage the issues.

 

Conclusion

Auditing is crucial for verifying the transactions made in the books of accounts of a firm. As it can be identified that transactions are made in proper and fair manner or not, through the auditing. This can be concluded from the report that the auditing plays an important role for ascertaining the financial condition of a firm, but meanwhile it is important also that the auditors shall follow general principles of auditing so that fair audit report could be presented by them. It is concluded that the auditors shall disclose relevant information in their audit report so that stakeholders of the firm can make proper decisions. 

 

References

Eun, C. (2009). International Financial Management. McGraw-Hill Higher Education.

Fernando. (2012). Business Ethics and Corporate Governance. Pearson Education.

Perler, J., & Howard M. , S. M. (2010). Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports,. McGraw Hill Education.

Porter, B., Hatherly, D., & Simon, J. (2014). Principles of External Auditing. Wiley.

Thibodeau, J., & Freier, D. (2013). Auditing and Accounting Cases: Investigating Issues of Fraud and Professional Ethics. Wiley.

Belmont, D. P. (2011). Managing Hedge Fund Risk and Financing: Adapting to a New EraSep. Wiley.

Brigham , E. F., & Ehrhardt, M. C. (2015). Financial Management: Theory & Practice: Theory and Practice. Cengage Publication.

Dagwell, R., Lambert, C., & Wines, G. (2012). Corporate Accounting in Australia. Pearson.

Davies, J. (2014). “Global Financial Crisis – What caused it and how the world responded”, Canstar.

Elliott, L. (2011). “Global financial crisis: five key stages 2007-2011”, the guardian.

Flores, C. (2011). "New Trends in Auditor Liability", European Business Organization Law Review (EBOR), vol. 12, no. 3, pp. 415-436.

Greite, S. (2013). The Development of the Australian Accounting Standards After the End of the G4+1. Grin Verlag.

Kimmel, P. D., & Weygandt , J. J. (2013). Accounting Principles.

Mitai, S. (2013). Your Guide to Finance and Investments. Network 18 Publications.

Norgren, C. (2010). “The Causes of the Global Financial Crisis and Their Implications for Supreme Audit Institutions”, Riksrevisionen. 

Obana, J. (2015, 10 30). How to Determine and Communicate Key Audit Matters (KAM) in the New Auditor's Report. Retrieved from www. linked.in: https://www.linkedin.com/pulse/determination-communication-key-audit-matters-new-obana-cpa-mba

Spencer , K. H. (2011). The Essential Guide to Internal Auditing. Wiley.

Well, J. T. (2017). Corporate Fraud Handbook: Prevention and Detection. Wiley.

Wells, J. T. (2013). Principles of Fraud Examination. Wiley.

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