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What is Audit and Assurance Service?

Discuss about the Auditing for Prevention and Detection.

Lehman Brothers was US` investment bank and indulged in providing financial services. This firm was being established in 1850. Lehman Brothers` failure cause   global financial crisis. As in the year 2008, Lehman Brothers declared itself as insolvent. This reports is based upon the issues of auditing which were associated with the firm`s collapse (Shah, A. 2013). As the report discusses about the important terms such as- auditing and assurance services. Beside this auditing standards are also described in the report. As these standards frameworks some guidelines to be followed by the auditor so that unbiased audit reports could be presented by him or her. Issues identified in auditing process which led for the development of ASA 701 are also discussed in the report.

Audit can be defined as an official inspection and confirmation of transactions, records and accounts, specifically of financial accounts to make certain passivity to requirements. The main purpose of the audit is to verify performance, conformance or compliance. Certain audits have special administrative purposes like auditing documents, performance, risk or following up on completed corrective actions (Spencer , 2011). Generally there are two types of audit which are internal audit, carried out by the internal audit department of the organization; external audit carried out by the audit firm.

Assurance services can be defined as self-governing professional services which supports decision makers by enlightening the quality of information, or its perspective ( Thibodeau & Freier, 2013). Assurance services and audit are both different terms as the assurance services is wide in nature. Assurance services incorporates audit of financial statement and attest services.

Guidelines followed by the auditors while inspecting the financial statements as well as other data are known as auditing standards. Standards of auditing are publicized by authorities’ like- AICPA, IIA and GASA. The standards of auditing confirms the consistency, verifiability of actions and accuracy in the report of audit prepared by the auditor (Flores, C., 2011). In addition to this, auditing standards comprehends objectives for the auditors, interrelated with requirements and solicitation as well as other material which instructs for financial statement`s audit. Auditing standards states that the auditor should retain adequate skill to carry out its professional training and the auditor should also take care of independency while preparing an audit report of a listed firm. As the auditor`s report shall be free of any biasness and influence so that fair and adequate report of audit could be prepared by the auditor (Spencer , 2011). Beside this, the standard of auditing also guides the auditor to discharge due professional care while the process of audit is being going on till to the completion and preparation of the audit report.

What are auditing standards?

ASA 701 is an auditing standard which was being developed to safeguard the independency of the auditors. As in the influence of the firm the auditors used to manipulate the audit report. In addition to this, earlier, the important facts or the information which auditor come to across while making the audit report was also not used to be disclosed in the audit report ( Porter, Hatherly, & Simon, 2014).  Therefore, the new auditing standard was being developed so that the key matters of the audit report could be communicated to the members of the organization and to the stakeholders of that organization as well.

The term KAM can be elaborated as “Key Audit Matters” in the professional judgment of the auditors were of most significance in the financial statement`s audit of a listed firm of the current period. The key matters of an audit are selected from those matters which obliges for significant auditor attention to perform the audit (Flores, C. 2011).  The key maters are required to be communicated through the audit report as this audit standard supports the independency of the auditor.Following aspects are required to be determined for involving key matters in the audit report-

  • Areas of risk related with misstatement of financial statements
  • Estimation of vagueness and the auditors` substantial judgments.
  • Substantial transactions or events.

In addition to this, the key matters which are communicated in the audit report should be explained that why these are considered as significant for the report of audit, how the key matters are addressed in the report, as well as the associated disclosure shall also be mentioned in the independent audit report.

As per the general auditing principles it is obligatory to disclose the relevant and fair information in public in the report of audit of a listed firm. But in the case of Lehman Brothers, the auditor firm did not discharge their duties in proper manner. As various facts were being obscured by the auditing firm which put an impact on the stakeholders as fair information was not being given to them in the audit report. Repo 105 was used for the accounting of Lehman Brothers which put question on the fairness of auditing as the audit firm produce superior results through this accounting system and the real facts and information was manipulated and concealed as per the interest of the firm. Failure of bank was one of the reason of using Repo 105, but the auditor concealed this information and this can be treated as one of the issue associated with the collapse of the firm i.e. Lehman Brothers (Shah, A., 2013). Through Repo 105 the transactions were recorded in such way that stated liquidity for the company. Another issue linked with the collapse of Lehman Brothers is that, the auditors also disregarded the signs of mismanaged accounts` books of the Lehman Brothers. As the sign of mismanagement and fail of the accounting books was given by the internal audit department of Lehman Brothers but these indications was not considered by the external auditors of the firm and this inconsideration also led to the preparation of vague audit report and it also led to create slipup in the financial market. Beside this, use of impaired liquidity assets by the firm (Lehman Brothers) was also obscured by the external audit firm in the audit report (Elliott, L., 2011). Lehman Brothers, used impaired assets the impaired assets were recorded in the financial statements of company, in their carrying value that go beyond their fair value. Concealing the fact of usage of impaired liquidity asset put negative impact on the investors as they achieved higher loss due to this information. Hence this auditing issues can also be regarded as the reason for the collapse of the firm- Lehman Brothers.

ASA701 Communicating Key Audit Matters in the Independent Auditor’s Report: Key maters

The issues related to the collapse of Lehman Brothers led to the development or change as the new auditing standard was developed i.e. ASA 701. This standard implies that Key Audit Matters should be disclosed and communicated in the independent auditor`s report ( Perler & Howard M. , 2010). This standard was developed for the reason that useful information which could be helpful for the business organization as well as for the stakeholders shall be disclosed in the audit report.

Some of the issues that were taken as a reason for the development of auditing standard ASA 701 are given below:

Use of repo 105- Lehman Brothers used Repo 105 for maintain the accounting transactions. This was used by the firm to produce better results as in real the result were not good. Repo 105 can be defined as a trick of accounting through which short term loan of company can be classified as sales and the company can consequently use the cash income from assumed sale in order to reduce its liabilities. But the use of this technique i.e. Repo 105 was not disclosed by the Lehman Brothers to the rating agencies, government, to its investors and own board as well( Perler & Howard M. , 2010). It is analyzed from the case study of Lehman brothers that the one of the senior official of the company make warning about the use of repo 105 as when this information will be disclosed in the public or if the public will find out that the company is using repo 105 to manage its accounts then it will escalate “reputational risk”.In the audit process conducted by Ernst & Young, this case was ignored and disclosure of this situation was also not done (Well, 2017). This is against the GASA principles. As the auditor must disclose the relevant information in the audit report so that it can be identified that the accounting system is properly used or not. Lehman Brothers used this Repo 105 but this case was ignored in the audit therefore this can be an issue for the collapse of firm.

The firm was using impaired liquidity assets, which had less cost but this situation was also being ignored by the Ernst & Young while audit process, as this was an important information to be disclosed in the audit report (Obana, 2015). But this situation was concealed by the audit firm instead of being communicated to the organization`s members as well as to the stakeholders. It is obligatory for the company as per the standards that in case impaired assets are being used by the company then carrying amount of those assets should be decreased from the recoverable account. But in the case of Lehman Brothers, the use of impaired assets was not disclosed and the assets were presented in the financial statements in a carrying value that exceed their fair value. This situation led to the users of financial statements to make wrong decisions.

Auditing Issues Surrounding the Collapse of Lehman Brothers

One of the other issue responsible for the development of the auditing standard was that- the external audit firm i.e. Ernst & Young was informed about the mismanaged accounting books of Lehman Brothers, but the auditor did not consider this information and the audit was done ignoring this information(Elliott, L. 2011). Concealing the information in the audit report resulted as loss to the stakeholders especially to the investors. As the investors achieved loss due the audit report presented by the auditor in the dependency of the firm.

Issues discussed above can be treated as reason for the development of the new auditing standard. As through the above situations it can be analyzed that the auditor firm or the external auditor did not discharged their duties and responsibilities in fair way. As the influence of the organization or some other reason put an impact on the independent auditor`s report(Davies, J. 2014). The auditor obscured the facts and information which was important to be disclosed in the report of audit. Therefore this new auditing standard was developed with an objective to enhance the relevance and value of the report of audit.

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.

In this part of the report key matters which should be disclosed at the time when the ASA 701 was implemented in preparing audit report for Lehman Brothers when the firm was going to collapse are being discussed. In case, ASA 701 was there then the key maters that should be communicated in the audit report by the auditor are as follows-

  • Lessened liquidity assets- The auditor should disclose the use of impaired liquidity assets by Lehman Brothers in his audit report( Thibodeau & Freier, 2013). This was a key matter as the use of lessen liquidity assets could influence the stakeholders of the firm. Users of financial accounts used to make decisions about different aspects after considering the statements of the company. Therefore the financial statements should be presented in fair way so that the stakeholder may take correct decisions.
  • Repo 105- Lehman Brothers used Repo 105 for the accounting transactions. This was also one of the key matter that could be disclosed in the audit report of Ernst & Young. As this information is crucial to be communicated in order to make aware the members of organization and the respected stakeholders that to maintain the accounting transactions or to record the financial transactions Repo 105 is being used which influences the results and can change the real results as per the requirement( Perler & Howard M. , 2010). This situation should be considered by the auditor and included in the audit report of the firm so that they could be informed about the vague facts presented through Repo 105.
  • Mismanaged books of accounts- Internal audit department gave signs to the external auditor that the books of accounts of Lehman Brothers were mismanaged and the accounting transactions were not properly recorded(Spencer , 2011). This is also a key matter to be disclosed in the audit report of Lehman Brothers. The auditor should communicate this key matter to the members of top management of the firm. So that the firm shall consider this case as important issue which could affect the business and other aspects as well. One of the reason to consider the mismanagement of accounting book as to be disclosed as the key matter in the audit report is that books of accounts which are not properly managed or the transactions are not recorded properly can also put an impact audit report( Porter, Hatherly, & Simon, 2014). As the missing relevant information from the failed books of accounts leads towards preparation of the audit report which is unable to present improper information.

Conclusion

This report draws a conclusion that auditing plays an important role in inspecting and verifying the accounting transactions of listed firm. Auditor verifies the transaction system of accounts and prepares a report based on that assessment. This audit report provides a basis to the business organization to ascertain the economic condition and other aspects as well. General principles formed for the auditing should be followed by the auditors as it outlines the audit practices and lays emphasis on preparing and presenting a fair and adequate audit report without any influence. In addition to this it is also concluded that the auditors shall involve KAM in their audit report so that key matters of the audit shall be communicated to the top management or to the important stakeholders.

References

Amadeo, K. (2016). “2008 Financial Crisis: Causes, Costs and Could It Reoccur?” thebalance.

Chatterjee, P. (2015) “Ernst & Young Pays $10 Million To Settle Lehman Brothers Audit Failure Lawsuit”, CorpWatch.

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.

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

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.

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

Shah, A. (2013). “Global Financial Crisis”, Global Issues.

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

Wiggins, R. Z., Bennett, R. L.,  Metrick, A. (2015). “The Lehman Brothers Bankruptcy D: 1 The Role of Ernst & Young”, Yale program on financial stability case study, 3D-V1.

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

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