Auditing and Global Financial Crisis: Manipulation

Discuss about the Auditing and Global Financial Crisis for Manipulation.

 

Introduction:

Auditors have an important role to vet the accounts and financial statements of the business firms.This report discusses the liability of auditors towards the business enterprise and global financial crisis. This shows the impact of auditor’s liability over the financial institutions and other business firms. Apart from this, the global financial crisis was hitch for whole world’s economy it slashes down the economy in the financial year 2007-08. This report also discusses the contribution of auditing in emergence of global financial crisis. Global financial crisis affects the business of banking institutions and other firms such as Lehman brothers, and Enron. This report also accommodates the recommendations that can helpful in rectifying the auditing issues.              

Global Financial Crisis:

A crisis struck the almost whole word economy in 2007-08 mainly due to sub prime loans and in fall in the US real Estate market prices. This situation affected almost each economy across the world and had severe impact upon the banking industry, consumer’s pocket, and hit the finance industry badly such as Lehman brothers, KPMG, and other similar firms. It had the potential to affect the whole world’s economy and many people faced severe financial issues during this time. This event had the greater impact on the productivity of the many different economies and also affected the real economy (Cafruny and Schwartz, 2013). Some economists said that auditor and accountants were responsible for this crisis as they approved and made false financial statements, which was the cause of the crisis that affected the whole world during 2007-09.

Impact of Global Financial Crisis:

This crisis had severe impact on the growth of US, Europe economy, and rest of the world’s economy. The global financial crisis led banks interest rate and credit market towards at peak and due to crisis the price of bank share started to decline that affect the economy of the whole world. Along with this, at the time of global financial crisis, the rate of Australian GDP was 0.4% which was the higher than other nations GDP. This indicates that Australian GDP was less affected by the financial crisis but in comparison to other nations GDP, it is less affected (Haas and Lelyveld, 2014). Apart from this, the global financial crisis had significant impact on the banking and investment companies. The global financial crisis also was the negative impact on the US economy as the market of mortgage bond was badly affected by the crisis. And at this time of financial crisis the building industry of US was having 15% contribution to US economy, which was low. Before the crisis, Lehman brothers were the top investment bank in the world that invested a huge amount in subprime mortgages. But due to the financial crisis, the value of housing declined that created the loss of US$ 14 billion.  

It also led to Lehman brother towards the bankruptcy and collapse. Due to bankruptcy and collapse of Lehman, customers change their investment direction and start to invest in safe avenues (Malliaris et al, 2016). Furthermore, the global financial crisis also cause of the Greece insolvency that arises the issues related to famine and liquidity in Greece. From the financial crisis debtors become insolvent to pay loan that led to banks failure. Due to global crisis the global trade also declined by 13% in year 2009 that affected the economy development of worldwide.

Auditing:

Auditing is a systematic tool that measures the accuracy of financial statements and how effectively firm presents its accounts and statutory records. The history of auditing was developed from the starting of Securities and Exchange Commission. In the world first audits are identified in Athens, this time the revenue and expenditure of Greek were verified by the accountants (Stuart, 2012). Apart from this, auditors have the some liability under the law which helps the auditor in auditing; these liabilities include negligence liability, criminal and civil offense liability, and proportionate liability.

Auditor’s Liabilities Under Law: 

The auditors play a significant role in the businesses; auditors are the pillar of the company that guides company in creating financial strengths. The main responsibility of auditors is that they verify and provide their opinion to company in context of companies financial accounts. Apart from this, the common law liability of auditors arises when they don’t perform their duty well, creates fraud, and breaks the rules and regulations (Latimer, 2012). The negligence liability of auditors arises when it leads business towards the loss and lack professional skills of the accountant also leads to auditors besides the negligence. Due to negligence liability if organizations face loss than auditor will be liable for the company loss. Apart from this, an auditor can’t deform company’s financial statement. In this regard, auditor’s duty is they present the real picture of the business that helps the investors and stakeholders in investment related decisions. If, the auditor did not disclose the real picture of the company and investors and stakeholders suffer from the loss than auditor will be liable for their loss.

The auditor may be liable for the criminal activities. This type liability arises when auditors violate the rules and regulation of lawas then it comes under the criminal offence (Giove, 2015). If auditors break the rules and regulations and present the false financial report of company then stakeholder and investors can appeal for loss claim.

Liability of Auditors in Context of Global Financial Crisis:

Global financial crisis of the year 2007 had significant impact on financial institutions collapsed. It was also observed that many auditors provided unqualified audit reports that led to financial institutions towards the bankruptcy and collapsed. Apart from this, auditor’s report of the company’s financial statements presents the real and fair picture of the company’s financial position and all the investors and stakeholders accepts that in auditing and accounting process auditor and accountant followed all the accounting and auditing standards (Xu et al, 2013). Furthermore, the unqualified opinion of auditor in context of financial statements audit, it indicates that auditor agreed with the accounting principles and methods which are used by the company in the accounting process. Therefore, an auditor can be liable for the misleading and providing wrong audit opinion.

In the case of Lehman brothers, the Ernst and Young was the auditor. At the time of auditing, the Ernst and young used some unfair practices that help Lehman brothers to create manipulation in financial statements related to debts of Lehman. Along with this, audit firm did not disclose any information about fraud and didn’t give any opinion related to data manipulation. In this case, auditor also did not show their liability in presenting the financial position of Lehman brothers, which actually was. This was the cause of Lehman brother’s bankruptcy and it was the cause of huge loss to investors and stakeholders (Jones and Presley, 2013). Moreover, for this malpractice auditing firm settled the lawsuit by paying a fine of $8.5 million. This is a relevant example in this context that auditing firms do have significant liability in the case they fail to fulfill their duties effectively.

The cause of the financial institution's collapse and bankruptcy was that they didn’t include and record their assets and liabilities correctly in the financial statements; the result of this was the global financial crisis. At the same time worldwide, so many banks show their assets value high but actual value of assets was low. Moreover, auditor’s liability is that they review the financial statement of the companies and detect the errors and fraud that helps company in showing high profitability and good market share. Furthermore, audit report helps the investors and stakeholders in investing decision and if any auditor did not disclose the errors and fraud this leads investors towards the loss and affects the whole countries economy (Caanz, 2016). Apart from this, auditors also verify that in financial statements company mention all the information related to tax and debts, in this regard auditor also provide their opinion that how company can raise its profit.

In the case of Enron, the Anderson was the auditor that audits the financial statement of company. The company was under the huge debts since 1999, but at the time of auditing Enron and auditing firm did not disclose any information to public. This indicates that auditor did not found any error and data manipulation in its statements. Therefore, auditor was liable for misrepresentation, fraud, and wrong audit opinion. Along with this, Anderson and Enron manipulated in taxes which was the liability of company to pay but Anderson didn’t disclose it to public (Naylor, 2014). In this regard, auditing firm received the commission of $47.5million. In result of this; the Anderson’s CPA license and its rights related to auditing seized by the security exchange commission. This is another example where auditors have been held post a firm failed and it was found negligency and breach of duties by the auditors.

It is the duty of auditors that they ensure the company shows all the tax and debts provisions in its financial statements. But in case where company accountant did not disclose tax liability and debts in its accounting records according to Australian or other relevant accounting standards that is equal to international financial reporting standards, it is example of fraud and criminal activity on the part of the auditors and others involved. These type of business activities played significant role in the global financial crisis. Apart from this, a case where auditor can not find any errors and issues than auditor can argue that these errors and issues were not detected and auditor is not part of any fraud. It can be considered by law if auditors verify the statements according to audit plan that reduces the possibility of detecting fraud. Moreover, at the time of auditing, it is the liability of auditor that they present the fair picture of company and disclose all the information related to profit and loss (Lopez and Pitman, 2014). But if auditor did not disclose the information about the company profit and loss, and collueded with company in manipulating data; this comes under the fraud. Therefore, investors and stakeholders can claim for the losses. Apart from this, it is also liability of auditor that they provide their opinion related to increase of the profitability and reduction of the loss. This helps the company, investors, and stakeholders in earning more money.   

In case of AIG (American international group), the PwC was the auditing firm that audited the financial statement of AIG. The company manipulated their data to comply with the demand of the collaterals. The AIG was facing the loss of $5.1 billion at the time of auditing but auditor did not take any action and didn’t provide any opinion to reduce the loss of company. Along with this, PwC and AIG manipulated financial statement of company to show the profitability and they reduce the loss of $5.1 billion to $1.5 billion but PwC didn’t disclose it to stakeholders (Nigrini, 2012). In result of this, the security exchange commission charged fine of $97.5 million on the PwC auditing firm and auditors Greenberg and chief financial officer Howard smith were ousted. This is another case study that highlights the liabilities of the auditors if they are involved in some wrongdoings.

The auditor’s duty is that they ensure that company shows all the transactions and didn’t use any negative adjustment approach in financial statements. But in case where company and auditing firm did not disclose actual accounting data like profit and loss of company to public, according to accounting standards, this is known as fraud and misrepresentation activity. Moreover, in a case Mr. Moffitt J observed in Pacific Acceptance Corporation v. Forsyth (1970) 92 WN (NSW) 29 at 65): 'If fraud has taken place and is undetected by the auditor; he is blameworthy in the eyes of the law [but] only so far as he has been negligent in determining the scope and character of his examination' (Perkovic, 2016). Furthermore, it can be understood that auditor is expected by Australian law to make use of the professional skills and experience at the time of companies assets valuation. But on the other hand, there is some uncertainty is involved in describing the auditing limitations at making accounting estimates. It is also expected that an auditor have the knowledge about the business company and its customers during the auditing work. But it is not expected that an auditor can predict the actual market price of company’s assets in future. Along with this, the main responsibility of auditors is to provide opinion about financial statements that is the past record of business activities.

In case of Storm financial business falling, company followed the high risk business model. The Storm financial company executed the role of financial planner that helped customers in decisions related to investments. The Storm financial wants to maximize its borrowing fee therefore; it started to encourage its clients to borrow more funds. But Storm financial did not disclose any information about that they are putting their fund in highly risky securities that can raise huge loss. Clients of Storm faced financial loss of huge amount of money because the company didn’t have control on the investment that they made. Due to this, company was not able to set off the debts of $80 million that company had.Role of auditors are important in such situations that they could take objective view and highlight such observations in the business investments and accounts.

Recommendation:

During the world financial crisis; many companies had to face the bankruptcy and collapse; the reason behind this was that many companies and auditors were involved in fraud and manipulating the accounting record of company. On the basis of auditors liability; it can be recommended that international auditing and assurance standards board and other regulatory institutions should improve the existing standard of the auditors and develop an effective audit system that present fair picture of companies. Furthermore, to control the fraud and misrepresentation activities; regulatory institutes shall take strict action against the auditing firm and fraud companies. Moreover, financial institutions should focus on the financial performance of business and analyze the business risk that helps the investors and stakeholders in investment decisions. In some specific cases like Lehman brothers collapsed by the lending to sub prime borrowers and creating manipulation in financial statements, it is recommended that auditors verify the financial statements thoroughly and provide their true and fair opinion on the problems, which can be verified in statements.

Furthermore, auditing and accounting standards should be continuously improved and developed because these standards measure the quality of the audited report that is done by auditors. In this regard, auditing and accounting standards should be developed on the basis of financial reporting standards. Apart from this, there should be a transparent auditing system that can create trust among the investors, stakeholders, and public. This system can reduce the chance of fraud and misrepresentations. Auditors should be well trained according to audit standards; training of auditors can improve the auditing skills. Moreover, the accuracy of financial statements can be ensured by the crosscheck of statements under the guidance of auditing and assurance standards board and regulatory bodies.              

References:

Aragon, G. and Strahan, P. (2012) Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy. Journal of Financial Economics,103(3), 570-587.

Caanz, S. (2016) Auditing And Assurance Handbook 2016 Australia. Australia: John Wiley And Sons.

Cafruny, A. and Schwartz, H. (2013) Exploring the global financial crisis. US: Lynne Rienner Publishers.

Giove, F. (2015) Auditing Essentials.USA: Research & Education Assoc.    

Haas, R., and Lelyveld, I. (2014) Multinational banks and the global financial crisis: Weathering the perfect storm?. Journal of Money, Credit and Banking,46(s1), 333-364.

Jones, B. and Presley, T. (2013) Law and accounting: did Lehman Brothers use of repo 105 transactions violate accounting and legal rules?. Journal of Legal, Ethical and Regulatory Issues, 16(2), 55.

Latimer, P. (2012) Australian Business Law 2012. AU: CCH Australia Limited.   

Lopez, D. and Pitman, M. (2014) Auditor workload compression and busy season portfolio changes: US evidence. International Journal of Accounting, Auditing and Performance Evaluation, 10(1), 91-108.

Malliaris, A., Shaw, L. and Shefrin, H. (2016) The Global Financial Crisis and Its Aftermath: Hidden Factors in the Meltdown. UK: Oxford University Press. 

Naylor, T. (2014) How The Arthur Anderson And Enron Fraud Changed Accounting Forever. [Online]. Available at: http://www.benzinga.com/markets/14/04/4429482/how-the-arthur-anderson-and-enron-fraud-changed-accounting-forever (Accessed: 17 September 2016).

Nigrini, M. (2012) Benford's Law: Applications for forensic accounting, auditing, and fraud detection (Vol. 586). USA: John Wiley & Sons.

Perkovic, S. (2016) Liability of Auditors in the Common Law System – Australian Position. Available at: http://www.serperlaw.com/about-us/publications-and-articles/liability-of-auditors  (Accessed: 17 September 2016).

Stuart, I. (2012) Auditing and assurance services: an applied approach. US: McGraw-Hill/Irwin.

Xu, Y., Carson, E., Fargher, N., and Jiang, L. (2013) Responses by Australian auditors to the global financial crisis. Accounting & Finance, 53(1), 301-338.

 

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