Discuss about the European Business Organization Law.
Auditing is the process of checking and verifying the accounts and books of accounts of the organisation so that the shareholders and the public get actual face and position of the organisation. The report focuses on the liability of the auditors after the global financial crisis and the collapse of Lehman Brothers. The given scenario says that while working in the Chartered counting firm, a report has to be prepared for analysing the potential liability of the auditors that they have to face because of the global financial rises. The report discussed the introduction of the global financial crisis and the actual reason behind it. It also discusses that how auditors led to the situation and their role is discussed in relation to the scenario.
How the situation of Global financial crisis occurred?
As per Amadeo (2016), Global financial crisis is the period in which the markets face a difficulty of shortage of money in the economy. It is the situation which initiated in the year 2007 when the investors of US created a credit crunch. The federal bank of US released a lot of finance into the markets and in the next year i.e. 2008, the situation worsened. The banks created too much of money in a small period of time which lifted up the prices of the goods and services. People began to speculate on the financial markets. Slowly and gradually the amount of debt increased in the economy. Eventually the amount of debts became unplayable for the people because the amount of debts was more than the incomes of people. The payment of debts lead to the insolvency of banks and this finally led to the financial crisis. The people who borrowed too much were asked to repay their debts so they had to sell their assets soon. The prices of property and other products dropped and the banks cut down the lending to the borrowers further. This was the period of recession and credit crunch. As a result, the economy shrunk (Davies, 2014).
Collapse of Lehman Brothers and role of auditors
As per Wiggins, et al. (2015), Lehman Brothers was a firm providing global financial services and it was the fourth largest investment bank in US before it collapsed in the year 2008. Founded in 1850, the firm operated for 158 years. Lehman Brother appointed Ernst & Young as their auditor from past many years. These auditors were responsible for auditing the financial statements of the firm and present their option that the financial position of the company is presented in the rue or fair manner or not. Ernst & Young was responsible to detect the fraud, if any and communicate it with the audit board of the company.
In the year 2008, Lehman brothers declared itself as insolvent which was considered as the biggest insolvency in the financial sector. The firm was in debt with around $619 billion. With the bankruptcy, the 25000 employees of the bank got unemployed at once. It brought financial crisis globally. The bankruptcy led to the downfall of global equity markets and everything else was affected due to it. It was found after the insolvency that Ernst & Young used questionable accounting methods. It was found that the accounting transactions were done using Repo 105 which helps in making the results better than they are in real. It also concealed the failure of the bank and the auditors concealed this fact. Ernst & Young was believed to know that Lehman Brothers used their liquidity assets which were impaired. Ernst & Young was questioned on this case and it didn’t accept any wrong practices or knowledge about these findings. It was believed that Ernst & Young did not fulfilled its responsibilities and performed against the rules and responsibilities of auditors which is to disclose true and fair view of the books of accounts in public. From the year 2001, Ernst & Young was the auditor of Lehman Brothers. But in 2008, the firm filed for bankruptcy even when the books of accounts were verified by the audit firm Ernst & Young. According to Ernst & Young, they followed the generally accepted accounting principles (GAAP) and the collapse was not because of any accounting mistakes. This incident raised a debate on the role of independent auditors in corporate environment (Wiggins, et al., 2015).
Ernst & Young charged $31 million for conducting the audit of Lehman Brothers. It is found that the internal auditors of the company tried to give signs of failure and mismanagement of books of accounts but Ernst & Young ignored those signs which created the blunder in the financial markets (Chatterjee, 2015). It was also found that Ernst & Young was paid a very high amount for concealing these facts and numbers which is denied by the audit firm but the investors of Lehman brothers had big loss because of this incident and they filed a case against the audit firm. Later on, Ernst & Young paid $99 million to these investors just to settle the case in the later years (Elliott, 2011).
Auditors are responsible for checking and verifying the books of accounts of the companies to inform and present their fair and true opinion in the public. But the same did not happen in the case of Lehman brothers which led to the financial crisis at a global level. It also raised questions on the role of external auditors and their practices (Norgren, 2010). As per Flores (2011), the auditors are responsible for following the International Standards on Auditing for better and true representation of accounts of the company. The users of the financial accounts, the investors believe on them because they think of them as genuine and verified by the auditors. The auditors are liable to follow the professional standards and check each and everything genuinely so that true and fair view can be given. Once, the report is developed, it is to be signed by the auditors to showcase that it is the true opinion of auditor on the company’s financial accounts. If the auditors conceal the facts and real situation of the company, it is taken as crime and the auditors are believed to be involved in the fraud which is against the roles of the auditor.
The independent and external auditor is responsible for presenting his opinion on the company’s financial accounts which should be guarded with the accounting frameworks, rules and guidelines. An auditor is responsible to follow the ethics and do not misrepresent any fact or incidence which can affect the true and fair representation of the books of accounts or the audit report by the auditor. Auditors are responsible to go through the internal control systems of the company and do physical verifications wherever possible. They play a key role in ensuring and protecting the interest of the shareholders as the shareholders believe in the honesty of auditors and have faith on them. The external auditors increases and enhances the value of the audited books of accounts of the firms. The auditor is responsible for assessing the risks in the firm and also responsible for having an independent opinion. They should also have a strong evidence to form their opinion. An auditor should be independent which means that he should not be influenced by the client or any other third party. Failing to this will degrade the credibility of the audit report.
Auditors take huge amounts of fees for auditing the books of accounts which creates a responsibility to provide enough time, efforts and knowledge in presenting their fair opinion on those accounts.
Potential liability that auditors face as a result of Global financial crisis
Global financial crisis creates huge impact over the business as this result in impact over the performance of the business. It is the responsibility of the auditor to disclose all the aspects which it has analysed during the audit so as to present all the findings in front of the stakeholders of the business. The silence of the auditor over the financial statements of the company affects the responsibility of the auditor and various questions arise over the role played by the auditor (Amadeo, 2016). The responsibility or the duty of an auditor is to investigate the different aspects of business and present or disclose the findings in front of the stakeholders in a true and fair manner. Auditor need to identify the frauds which are perpetuated deep inside the business. An auditor has no responsibility for the decisions taken by the business and the enhancement or depletion in the performance and profitability of the business. Businesses focus over conducting audit for the purpose of checking the valuation methods selected by the business. In the case of Lehman Brothers, silence of the auditors over the financial statements of the company has disclosed the level of effectiveness of the role played by the auditors in performing their duty (Wiggins, et. al., 2015).
From the case of Lehman Brothers it has been analysed that various issues have been identified on the role played by the auditor of the company. It is the duty of auditor to perform their duties or role in a fair and honest manner. The auditors of Lehman Brothers were expected to give fair and honest views over the financial statements of the company so as to display the real situation of the company. Effectiveness needs to be maintained in checking the financial statements by the auditors as the frauds or issues have been identified in the financial statements. After disclosure of the financial crisis of Lehman Brothers the auditors need to be more aware and conscious (Amadeo, 2016). It was their responsibility to apply proper and effective checking techniques for the purpose of providing or disclosing the fair and honest views over the financial statements of Lehman Brothers. Auditors were being criticised for the Lehman Brothers case as this has affected the reputation or image of the auditors. For the purpose of gaining the trust again auditors need to work in an effective manner for presenting the fair view. Different standards have been set for the purpose of guiding the auditors for performing their role in an effective manner. These audit standards have been formed for maintaining the integrity of the auditor for ensuring the fairness of the disclosure of the statements. These audit standards acts as a strategies or solutions for the issues or the problems faced by the auditors during the audit of the financial statements (Wiggins, et. al., 2015).
Stakeholder trusts the auditor and assumes that auditor will act in neutral manner between the company and the stakeholder. The motive of the auditor should be to present fair views and conduct audit of the accounts or financial statements of the company. Auditors have right to reject the clients when any doubt or issue has been identified. As the frauds perpetuated in the company or in the environment of the company can affect the fair and honest representation of the financial statements of the company. The clients also need to provide proper space and freedom to auditors in checking the accounts so as to ensure that the audit is done in an effective manner. Auditor must feel free during the process of audit of the financial statements so as to maintain integrity (Norgren, 2010).
From the execution of this report it can be analysed that it is the responsibility of the auditor to provide fair and honest view of the financial statements of the company so as to analyse the financial condition in front of the stakeholders of the company. Stakeholders have substantial interest in the operation of the company and fair view need to be presented in front of them. In the case of Lehman brothers issues or suspicious activities have been identified by the auditors of the company. Different financial crisis have been analysed which have affected the financial statements of the company. From the audit of Lehman brothers auditors Ernst & Young have analysed that various aspects were hidden from the stakeholders of the company. It was a case of concealment of the information from the stakeholders. It is the responsibility of the auditor to ensure that the fair and true disclosure is done of the financial statements of the company which discloses the frauds or the issues affecting the interest of the stakeholders. After the occurrence of the case of Lehman brothers, integrity of the auditors is at risk which needs to be maintained. Different auditing standards have been prepared by the respective authorities for the purpose of providing support and help to the auditors in performing their duties well. These standards of auditing act as a solution for the issues or problems faced by the auditors during the audit of the financial statements of the company. These standards ensure that these cases are not getting repeated. Disclosure need to be done in an effective manner for providing fair presentation to the stakeholders of the company.
Recommendations need to be made for the purpose of enhancing the auditing process. These recommendations will help in the fair and honest representation of the financial statements and disclosure of the fair view. Auditors should be ensured that proper checking techniques are implemented and the standards of auditing are correctly followed. Internal audit must be conducted and the auditor needs to engage few auditors at the workplace of the company so as to keep proper and effective check. The auditors need to be set free for the purpose of selection of the client so as to ensure that no fraud is affecting the company and its performance. Proper and effective communication channel should be implemented so as to keep a proper check over the various activities of the company.
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.
Shah, A., 2013, “Global Financial Crisis”, Global Issues.
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.