Financial Crisis And Accounting Sphere: Liabilities And Changes Required

Background

Describe about the Financial Crisis for The Accounting Sphere.

The representation of financial audit has jurisdiction outside the accounting sphere involving the followings apart from the knowledge in accounting: informatics, mathematics, knowledge of financial analysis, knowledge of economics, judicial information, and ethics. The financial audit’s pluridisciplinarity can be explained in the following way: there must be verification of the financial audit in relation to the financial statement’s compliance with reality as well as the observation of the rules, principles, and the criteria established for presentation and registration related to the accounting information. In the time  of financial crisis, a number of issues cropped up questioning the jurisdiction of the auditor’s role that were subjected to high level inquiry (Christodoulou, 2011). It is the time that is featured with the financial and economic reform process, the objective of which is implementing and promoting methodologies that are harmonized with good practice.

The purpose of this paper is making the audit firms aware of the liabilities that are in place in the time of the financial crisis. The accounting standards are also addressed and changes required are recommended.  The report is prepared for Sally Smith to narrate the auditor’s liabilities with special mention of Lehman Brothers’ case.

In the times of financial instability, the logical step can be followed that has been necessary in understanding the crisis concept. The difficulties in the form of social, political, economic etc are manifested featuring testing, disorder, and tension in the society. The economic crisis takes place because of the economic activities’ difficult conditions, decline or stagnation in the economic activity, or a slowdown portending change. The financial crisis is a sign of economic crisis reflecting financial system that has been involved in mistrust (Clinch et al., 2012). This has been a drop in the stock exchange’s transactions, characterized by the market mechanism’s disorder.   

There is need for the financial systems for higher transparency with respect to a number of aspects. Firstly, there have been certain players in the financial market, in the likes of hedge funds having an important role in the mediation. However, this does not have the bindings of strict rules related to the reporting (Blume and Voigt, 2010). Their activities’ regulation can be established as to the way report would be reducing the volatility in the time of worsening of the market condition.

The financial instruments being developed makes it a difficulty in determining price for them. However, the questions are raised at the same time related to the investors bearing the risk.  The possibility related to the correct assessment of the risk and identification of the origin bearing the risk can be a helping hand in improving the supervision and the regulation of the financial system. The additional problem lies with the review model with respect to the performance of the investment portfolio and the identification of the ways in preventing risks.

Discussion

ISA 200 talks about the general principles and the objectives that govern the financial statements’ audit. The objective of the financial statements’ audit is enabling the auditor in expressing opinion on the extent of the preparation of the financial statement. This is according to the applicable framework of the financial reporting. The conduction of the process of audit should be according to the procedures pertaining to the professional and legal standards (Riksrevisionen, 2010). The report of the auditor is being signed and transported to the shareholders and the owners of the company.

The professional can have the responsibility to issue an opinion on the entity’s financial statement. In this respect, the auditor is responsible, although it is subject to substantial liability. In the time of performance of audit mission, there is assuming of considerable responsibility by the financial auditors as rendering the professional services’ nature and the audit engagement (Riksrevisionen, 2010). The initial assumption related to the liability of the auditor has been the audit engagement’s wordings.

During the financial crisis 2010 and 2011, the audit became a high profile political issue. In the US, Brussels, and UK, the worldwide financial crisis has led to the making of series of inquiries that are of high level and related to the audit’s effectiveness (Larsson, 2011). In other countries, such as Singapore, regulators engage actively with stakeholders in accessing the way of enhancement of the audit.   

The Green Paper on audit that belongs to the European Commission was subject to debate in Brussels in 2011. This ultimately led to the legislation in relation to the auditing profession of Europe (Larsson, 2011). The Financial Services Commissioner of EC, Michel Barnier, at a high level summit gave a warning in Brussels that status quo cannot be maintained.

The House of Lords Economic Affairs Committee in UK conducted an inquiry, which is highly critical in nature and into audit competition (Jackson, 2009). The Office of Fair Trading requires the complexity of the issues to be under examination by a body that is better resourced compared to the Parliamentary committee.

The Public Company Accounting Oversight Board in United States examined the needs in relation to the changes of the auditor reporting model that was pursued with the consultation of various stakeholders (Jackson, 2009). The senate of United States has taken hearing where the standard setters and the regulators have been asked to provide evidence related to the accountancy profession’s role to prevent another financial crisis.

The dominance of the Big Four in the audit market in Lord’s enquiry’s directly focus and one of the EC Green Paper’s key issues. This oligarchy pose a systematic risk and fear related to the turning into three drove of the four and its consequences that both enquiries sought answering. It is hard to find the solution. The FRC (Financial Reporting Council) in the register of the UK City have set out for the audit firms, companies, and investors, a Market Participants Group. FRS in June 2010, in the Progress Report made admission that till date the evidences are limited that there is major impact with recommendations on the market concentration and the arising of the risk from that concentration (Vandervelde et al., 2009). In fact, there was admission from the FRC that there was increase in the concentration.

There is agreement of ACCA regarding the fact that greater market competition could be beneficial. In the banking sector, the institutions exist that are so big that they hardly can fail. This is seizing to be a healthy sign.  There is no reason to believe that it is appropriate with regards to this kind of regulatory action. Neither it is appropriate that in the market; there would be artificial intelligence, such as to put caps on audits in terms of numbers that is allowable to any firm to be carrying out (Dijkman, 2010). The companies are possessed with the rights of appointing any firm of their choice and this kind of regulatory intervention that tries in bucking the market is not supportable.

There is lack of involvement and apathy among the shareholders in the companies owned by them, which points towards the long term answer that must persuade them with the outlook that the serving of their best interests is through the audit marketplace which is healthy and competitive, and not an oligarchy (Gorton and Souleles, 2005). Albeit, the global companies that are the largest, requires inevitably the large global firms’ services, the shareholders and the directors of other listed companies must be considering whether or not servicing of the other audit firms can be as effective.

In case of liabilities, auditors have a duty of care towards their audited entities. This has the involvement related to the lawful responsibility in carrying out the work with competence and skills, which the end users and society is liable to be expecting (Elder et al., 2009). Where, there is existence of duty, and work is seized to be carried out with respect to the required standard, such as end users are equipped with right of taking legal action against the auditors in seeking compensation with regards to the loss caused by their negligence.    

This exposure with regards to the liability is generally considered as something good. This is because the concentration of it is directed at the advisers’ mind driving customer care and quality. If there is no motivation of the advisers with respect to the retribution prospect for work of poor quality, and there is a threat that there would be failing by them in exercising the right level of care and skills. This is the reason that it is not advocated to free auditors from liability related to the sub standard work and mistakes (Elder et al., 2009). However, the example of Andersen is a thought over that collapsed in the scenario of post Enron scandal because of the ruining of its name. This indicates the equality in financial risk and reputational risk that acts as an incentive in giving the advice in best possible manner.

There are reasons to believe that in certain cases, the rules pertaining to the liability of the auditors are seemingly unreasonable leading to consequences that are undesirable. The reference here is based on the several and joint liability existing in UK and several jurisdictions based on common law across the world. In this system, the party owing the duty of care and claiming to have the sufferance of loss is allowed in suing any or all parties that are responsible for creating that loss. The point that is important here is that when there is consideration that one of the parties is in a better position making it probable that it will be in a position in paying the claimed damages, while the plaintiff can have the choice of suing that party only with a let off of the others (Blommestein, 2009). There is need for the auditors of having indemnity insurance of professional nature that is considered to be the best targets, which is known as ‘deep-pocket syndrome’.

The state of affairs like this can lead to a couple of results. Firstly, if there are constraints for the auditors in terms of the threats emanating from getting sued, they will be unwilling of getting involved in works that features innovation producing benefits to the stakeholders. In fact, the profession of auditing is being regularly accused that it very conservative. The couching reports are in legalistic and defensive terms as there is concern of avoiding litigation. In this point of time, when regulatory bodies and the stakeholders are looking increasingly for auditors in providing assurances on newly formed areas, such as the effectiveness of risk management in companies, the auditors are needed to be willingly expanding the work scope that cannot happen without the litigation threat be removed, which can destroy them (Huber et al., 2009). Secondly, with the direct relevance to the competition issue, the threat of suing can be a disincentive to the firms of smaller size getting involved with larger companies’ audit. Even, the firms having resources, experience and skills to be taking on the audit of larger companies, it may be compelled to be refraining from such a commitment if the associated risks  with regards to the audit failure is enough of wiping out the company.

The role of the audit firm (one of the big 4s), Ernst & Young in the collapse of Lehman Brothers cannot be undermined. It is being argued that Ernst & Young had the prior knowledge regarding the Lehman Brothers’ transaction of “Repo 105”. The Ernst & Young had an agreement of paying $10 million to the New York state for settling the lawsuit, where they have overlooked the Lehman Brother’s accounting gimmick. Lehman Brothers was accused of hiding billions in bad deals.

Lehman Brothers, in 2001, considered a scheme called Repo 105 where they attempted in selling bad debts temporarily. This was under the condition that Lehman Brothers would be purchasing them beck within 10 days. The premium of 5 percent was paid for this service and not the usual 2 percent. In the balance sheet, the worst deals was excluded that made it look like the bank being financially healthy than what it was in reality (Singh. and Aitken, 2009).

The Repo 105 was purchased by the corporations such as, UBS of Switzerland, Mitsubishi UFJ Financial Group, Mizuho Bank, KBC Bank of Belgium, and Barclays. However, there had been no law firm in US that recognized this novel technique as true sales.

Ernst & Young entered the picture at this time as they were contacted by Lehman Brothers for auditing their bank books. The Ernst & Young, between 2001 and 2008was paid by Lehman Brothers to the tune of $150 million for certifying the financial statement of the bank as being accurate and true.

The bank, however, collapsed in September 2008 that triggered the economic crisis globally. The state attorney general of New York, in 2010, sued Ernst & Young because of its failure for reporting the scheme. The Ernst & Young, in October 2013, agreed in paying $99 million for settling the lawsuit that the investors of Lehman Brothers brought about (Desmond, 2008).

The practice of collection of the third party evidence has been a normal practice. However, there is greater emphasis of the evidence whose origin is from outside, being regarded as stronger compared to the evidence that originates internally. The judge in the Pacific Acceptance case was of the view that if the certificates were not to be ascertained physically by the auditors, there should be ascertainment as the third party system’s reliability (Johnson, 2000, pp.62-72). In addition, there should be obtainment of corroborative evidences by the auditors. For example, if a company has invested in another company, the dividends that there may be can be checked with the inspection of cash book entry and dividend warranty.

The classic case of Kingston Cotton Mills Ltd (1896) had the judgment that it is the auditor’s duty in probing into the depth only when there arousing of a suspicion. The statutory auditor brought the weakness to the managing director’s notice that alerted the management, which is held judicially to be one responsible primarily for the protection of the company assets. This can be put up as defense against any subsequent claim for the information to be passed on to the management (Aspen, 1981).

There have been some recommendations in this paper with an intention of allowing the audit market for working more efficiently and, in long and medium term, increasing the choice of audit. The inclusive recommendations are: (a) reduction in the directors’ perceived risk, which have chosen the auditor that is non-Big four; (b) measures of the demand side to be making the boards with more accountability for the shareholders; and (c) the measures of the supply side having intention of encouraging the non-Big Four offering the services of the audit to the entities of the large public interest.

The recommendations that could be forwarded in 2008 to the member states that provide encouragement to all of them to be limiting the audit work liability. However, no evidence have been found that there can be any effect detrimental to the audit work quality, be it statutory cap or means other than that.

Conclusion

The massive scale of financial crisis pervading the globe and in the several countries and the bailouts of banks with the taxpayers’ money makes it right that the accountants and the auditors’ role must be questioned. In spite of the inquiries taking place, there has been no argument with regards to the necessity of the audit.

The audit firms that are biggest in the business are best placed for innovation in meeting the needs of the market and a willingness of taking on a superior role, especially if the issue of the corresponding liability is addressed. This profession is often attributed with a defensive mindset with a replacement of pre-crisis mindset by an acceptance that there is desirability and necessity for change. The Lehman Brothers case demonstrates that there is considerable liability on the part of auditors towards the third. The auditors can be sued on this ground and force them to return the benefits they received from their clients having obligations to the third parties.

References

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