Auditing Assurance And Services: A Case Study On Lehman Brothers Essay.

The Bankruptcy of Lehman Brothers

Discuss about the Process of Auditing Assurance and Services.

Auditing is the process of inspecting different kinds of accounts of an organization. Many financial accounts need to be created at the time of carrying on the business operation of an organization. It is necessary to verify the viability of those accounts. The role of the auditors is to inspect those accounts of the organization by conducting various kinds of tests on those accounts. This total process is called Auditing (Louwers et al. 2013). There are certain liabilities that an auditor needs to remind at the time of performing the audit operation for an organization. These are called the liabilities of the auditors. It has been seen that the world economy often faces financial crisis due to some major reasons. As a result, the businesses around the world have to face the adverse effect of this financial crisis; and this fact contributes to the bankruptcy, winding-up and liquidation of top corporations. On the other hand, the burden of the auditors increases at this kind of times, as they have to face some potential liabilities while performing the audit operation. As a result, the auditors have to comply with additional rules and regulations of auditing as well as of the government (Donelson, Kadous and McInnis 2013). One of the greatest cases of bankruptcy in the world history is the case of Lehman Brothers. The company had to face some major financial crisis due to various reasons and the company went bankrupt. The aim of the report is to highlight the case of Lehman Brothers in order to evaluate the potential liabilities of the auditors at the time of financial crisis.

The case of the bankruptcy of Lehman Brothers is one the largest case of bankruptcy in the whole world. The company filed the petition of bankruptcy on 15 September in the year of 2008. At the time of bankruptcy, Lehman Brothers had total assets worth $639 billion and total debt worth $619 billion. The amount of assets of the company was more than any of the bankrupted company at that time like WorldCom and Enron; and this is the reason why the bankruptcy of Lehman Brothers is considered as the largest bankruptcy in the world till date. At the time of bankruptcy, Lehman Brothers was the fourth largest banking company in the world with an employee base of more than 25000 in the whole world. It is considered that the collapse of Lehman Brothers largely contributed to the global financial crisis as assisted in the erosion of more than $10 trillion market capitalization from the global equity market in the month of October 2008. It was the biggest decline in a monthly basis in the stock market at that period. In the year of 2007, the company closed many of their subsidiaries, as it might be the preparation of the petition of bankruptcy. In the year of 2008, the company was facing several losses due to the major crisis in the mortgage sector (Polito 2014).

Liabilities of the Auditors

The Lehman brothers incorporated Lehman Brothers in the year of 1850. The names of the three brothers are Henry Lehman, Emanuel Henry and Mayer Henry. The company had to face many difficulties and challenges in order become one of the largest business powerhouses in the world. However, despite facing all the difficulties, Lehman Brothers had to come to its knees after the decline in the mortgage market of that time. There were some specific reasons that contributed to the collapse of Lehman Brothers. In the year of 2003 and 2004, the economy of United States witnessed a boom period as the housing industry of the country was developing in a fact pace (Jones and Presley 2013). By watching the development in the housing sector, Lehman Brothers acquired five mortgage lenders. Initially the acquisition of the five companies seemed highly profitable for Lehman Brothers as the company registered record amount of revenue at that period. The company registered mortgages worth $146 billion that was 10 percent more than 2005. The company recorded record amount of profit from the year of 2005 to 2007 as the net income of the company was $4.2 billion and the amount of revenue was $19.3 billion (Quax, R., Kandhai, D. and Sloot 2013).

However, from the beginning of 2007, market situation was gradually started to change as the housing market in the United States was gradually entering into a downturn situation. The stock had its biggest drop in five years on 14 March 2007. Lehman Brothers still registered record revenue at that time even in the presence of various problems in the market. The downfall of the company was started from the month of August 2007 when the stock price of the company fell sharply due to the recession in the housing market in United States. As a result, Lehman Brothers did lay off 2500 employees who worked at the mortgage sector of the company and winded-up the BNC unit along other business units. On 17 March 2008, the shares of the company declined by 48 percent that was a real concern for the company (Fernando, May and Megginson 2012). On 9 June 2008, the company witnessed a loss in the second quarter worth $2.8 million and the gross assets of the company were decreased by $147 billion. Lehman Brothers stated reducing the cost of operation in various units, but stock of the company was plunging in rapid way. On 15 September 2008, the company totally collapsed and announced they bankruptcy. The Lehman Brothers collapse effect stayed with the global financial market for weeks. At the time of collapse of the Lehman Brothers, Ernst & Young was the audit partner of the organization. It has been said that the audit firm was well aware about the reasons of the collapse of the corporation. However, they did not take any actions against it. This act of Ernst & Young raises questions about the liabilities of the auditors at the time of financial crisis. It is desired that the auditors of any organization need to be more cautious at the time of economic recession (Fitzpatrick IV and Thomson 2016).

Although financial crisis has a negative affect the economy as well as businesses, it can be considered as the scope to change the loopholes in the financial system. There is a connection between financial crisis and the liabilities of the auditors that can be  raised due to the financial crisis. The main responsibility of the auditors is to deliver the responsible opinion about the financial statements of an organization stating that the statements are free from material misstatement (Xu, Carson, Fargher and Jiang 2013). Hence, at the time of financial crisis, the auditors have to face some more liabilities. The major liabilities are discussed below:

It is the utmost responsibility of the auditors to formulate an audit opinion based on the financial statement of the organization that reflects the correct are fare financial picture of the organization. The unqualified audit report indicates that all the aspects in the financial statement of the company correctly reflect the reality of the organization. At the time of financial crisis, the liability of the auditors increases even after the balance sheet date. It is the liability of the auditors to test and inspect the various documents of the company after the date of preparing the balance sheet to the date of preparing the financial statement of the organization. It is wholly based on the managers to decide the materiality of an accounting event. In this kind of time, it is the liability of the auditors to determine the fair value of the assets is properly established (Carson et al. 2012).

It is the liability of the auditors to ensure the quality control of the accounting works in the organization (Arruñada 2013). At the time of financial crisis, it vastly depends on the auditors to help the business organizations to retain the quality and control in the financial works. There are certain procedures that are applied by the auditors to manage quality control. The auditors ensure the quality control by competing and signing all the necessary sections of the audit program. This can be used as a proof in the near future. On the other hand, it is utmost important for the auditors to properly sign and date all the audit related documents in the organization so that the opinion of the auditors can be used as future references. One of the most important ways to ensure quality control is to analyze all the relevant financial balances of the organization. This is the main area in the financial statement where most of the manipulation and fraudulent is done. Hence, the auditors need to give special attention to this aspect. Another most important liability of the auditors at the time of financial crisis is to analyze and inspect all the amounts of profit and loss statements. There are instances where the amount of profit or loss was changed by manipulation to change the financial position of the organization. Thus, it is the extra liability of the auditors to check and inspect the various amount of profit and loss statement (Humphrey, Samsonova and Siddiqui 2013).

At the time of financial crisis, it is the liability of the auditors to evaluate the internal control system of the audited organization. It is necessary for every organization to have internal control system at the time of financial crisis so that the auditors can find manipulation and fraudulent in the financial statements of the organization (Brown, Pott and Wömpener 2014). As per the International Auditing Standard, two types of misleading information can be seen. They are Fraud and Error. This type of fraud and error collectively contribute to the financial condition of the country. At the time of financial crisis, it is the liability of the auditors prevents various kinds of frauds and errors in the financial books of the audited organization. On the other hand, at the time of financial crisis, the auditors need to implement effective internal control system so that the accounting of the organization can be done in the proper way. It is the financial liability of the auditors to detect frauds.

It is the liability of the auditors of any organization to check that all the accounting works of the organization is done by complying with the Generally Accepted Accounting Principles. The auditors also need to see that whether the organization is complying with all the rules and regulations of the government of the country. It is the liability of the auditor to follow all the guidelines and principles of audit profession. On the other hand, the auditors need to maintain the principles of auditors’ independence at the time of auditing (Johnstone, Gramling and Rittenberg 2013).

Another crucial liability of the auditors at the time of financial crisis is to make correction and adjustments in the financial statements of the audited clients. The auditors have to make necessary adjustments in the financial statements in order to make judgments on the financial position of the organization. Hence, it can be said that there is a direct liability of the auditors towards the financial statements of the audited organizations. At the time of auditing the financial statements, it is the liability of the management of the company to provide all necessary information to the auditors to in order to assist them in the auditing process (Lennox 2016).

There are other crucial liabilities of the auditors at time of financial crisis. The auditors are liable for any kind of criminal activity in the financial statements of audited client. The auditors are responsible to detect any kind of criminal activity in the financial documents like frauds, omission, manipulation and others. Another important liability of the auditors is to assist the central government of the country in investigating and collecting any kind of information. It has been seen that many companies become insolvent at the time of financial crisis. In this kind of position, it is the additional liability of the auditors to assist the organizations in the liquidation process (Ho, S.J. and Mallick 2015).

All these above-discussed aspects are the liabilities that an auditor has to face at the time of financial crisis. However, there are others reason apart from these major reasons.

The above discussion sheds light on the liabilities of the auditors at the time of financial crisis. It has been seen that the auditors have to face some additional liabilities in this kind of situation. Based on the above discussion, some recommendations are provided below:

• It is recommended that the auditors need issue their audit report based on the analysis of the financial documents of the audited client. At the time of financial crisis, the financial as well as accounting operations of an organization cannot be operated in a proper manner. Hence, it is suggested to the auditors that they should thoroughly examine the different accounts of the organization and pass the audit judgment according to the test results.
• It is recommended that the auditor should take all the necessary steps in order to maintain quality control in the operations of the audited organization. The auditors should maintain all the audit documents by signing them and keeping in a safe place.
• It is highly recommended that the auditors should take into consideration all the facts and figures of the profit and loss statement of the audited organization. This step needs to be taken so that the fraudulent and errors in the profit and loss statement can be identified.
• It is recommended that the auditors should make all the corrections and adjustments as per the audit test results. There should not be any kind of influence or biasness in the audit reports.
• It is recommended that the auditors need to check that whether the financial statement of the organization is complied with the Generally Accepted Accounting Principles (GAAP) or not.

Conclusion

This report is about the potential liabilities of the auditors at the time of financial crisis. In this regard, it was necessary to shed light on the collapse of Lehman Brothers. The report says that Lehman Brothers used to be one of the best housing mortgage companies at that period. However, due to the effect of economic downturn in the housing sector of United States, the company became bankrupt in the year of 2008. Auditing had a role to play in the collapse of Lehman Brothers as Ernst & Young, the audit partner of Lehman Brothers did know about the upcoming collapse. Hence, it can be said that the auditor have to face some additional liabilities at the time of economic downturn. Some of the major liabilities of the auditors at the time of financial crisis are discussed in the report. One of the major liabilities of the auditors is to examine the various aspects of profit and loss statement of the audited client. On the other hand, the auditors need to made sure that the audited organization is following the GAAP principles to make the accounting and financial statements. Other liabilities are discussed in the report. After that, some recommendations are made based on the study.

References

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