Auditing Assurance and Services Liability

Discuss about the Auditing Assurance and Services Liability.

Introduction

To understand potential liability of auditors in case of financial crisis occurred related to corporate entity, we have to realize the role of auditors in corporate aspect. Audit is a process which is being done by professionals to investigate about certain happenings to derive its trueness and fairness so far its impact is concerned for the stakeholders. For this purpose auditors normally follow certain tested and prefixed methods of techniques to match the process of operation. This effort is necessary to gather evidence which is named as audit evidence and this evidence is necessary for furnishing a document which is called as audit report. This audit report will also contain auditors’ opinion which should be independent and responsible in nature to project the shortcomings of the operation of the entity.  This is possible through the practice of evaluation criteria which are generated from legal regulation and ethical practice by the auditors for the specific entity on which audit work had taken place (Accaglobal, 2015).

As this research paper is related to financial crisis and auditors’ liability in this respect, we have to understand financial audit with its features and probable outcome. Financial audit is not confined within the periphery of accounting activities only, instead it is also emphasizing on respective areas of economic and financial knowledge analysis, informatics, mathematics, logical information and ethics. The basic requirement of any financial audit must comply with reality related to financial statements along with the specific application of rules, criteria, observance and basic guideline which are mandatory for presentation of financial information. Financial audit operation is represented through the process of examining to ensure proper opinion related to financial information passed on to them as per generalized audit norms. Main objective of performing an audit operation is to ensure provision for the auditors through which they can made substantial opinion related to respective financial statements with the aspects of significance as per general framework of financial reporting (Todea & Stanciu, 2009).

Role of Auditors

Role of auditors is to ensure proper presentation of financial reports keeping in mind prudence with fairness and trueness of the reports. To ensure these aspects, auditors have to emphasize on the issues of finding audit risks so that those can be mitigated or maintained in certain level that those cannot affect the audit work. Moreover the audit work should overcome those risks so that proper exercise of professional expertise can be utilized to perform the job. There are three types of audit risks as defined by the audit manual- inherent risk, control risk and detection risk. All these risks are related to material misstatement which may be found during the course of audit work. Proper execution of audit work is started with audit planning. Detection of risks is the prime work in this segment. As the auditors are employed by the stakeholders of the business entity, it is to be ensured by them that audit report should feature all findings including the material misstatement of the financial information due to fraud and error. In order to ensure their independency, the auditors have two options- expression of qualified or adverse, or to withdraw from the assignment.  It is conferred by the accounting standards that the management of the entity is responsible for preparation and presentation of financial report with their due certification to discharge their declaration that the presented reports are true and fair to best of their knowledge, where as auditors have to certify the same by scrutinizing the audit evidences with their professional knowledge and skills to disclose that the reports thus presented are well with the conclusive remarks of true and fair without any material misstatement.  In the situation when industries are hit by financial crisis globally, the impact had shown in the enterprise as well as the government budgets.  In such situation of dire crisis, the role of auditors fetches more importance especially in the domain of estimation which is proved to be more unstable and uncertain. This situation demands more pro-activeness from the auditors so far their liabilities in perspective of professional and ethical aspects are concerned (Europa, 2004).

 Financial Crisis and Auditors Liability

To understand financial crisis in most logical way is to distinguish the period of financial instability to understand the concept of such crisis. This criterion is defined as projection of odd situations which causes difficulties in relation to several socio-economical factors which includes political factors too. The impact of crisis has effect in the society in the form of critical testing, disorder followed by subsequent tension. Financial crisis is caused by difficult situations of financial activities which includes break in the existing system, forced slowdown of economic activities resulting to economic stagnation. Financial crisis is defined as the projection of economic crisis which reflects features like distrust in the economic system followed by phenomenal drop in stock exchange transactions which is considered as the parameter of economy, along with disorder in market matrices (Dhanapal, 2013).

The positive impact of financial crisis may lead to rectify present system through implementation of new innovative ideas to overcome the drawbacks resulted for it.  But the rectification measures opted by the authorities will take reasonable time to make the market in stable condition through the solutions implemented for economic changes in long-term period. Basic requirement of these steps are to ensure restoration of confidence of the stakeholders of the market like investors and consumers.  Basic barrier towards adjustment of norms which is instrumental for reformation of financial system with the added focus on transparency through implementation of improved regulations on securities, providing assurance to proper market regulation in order to ensure integrity of economic market to strengthen the cooperative understanding between financial institutions globally. Need of the financial system is enhanced level of transparency in regard to different aspects like hedge funds which plays vital role in mediation without the bindings of stringent rules on reporting of their performance.  Good practice of introduction of strict regulation in these activities is capable of reducing volatile situation in the dire need of bad market condition.  Introduction of new financial instruments is not easy as the basic requirement of determination of their price is difficult along with the risk factors the investors have to bear for it. Basic need of this situation is correct assessment of risk factors with their identification related to origination of risk factors and this will be instrumental for improvement of regulation along with supervision of the financial system. As per International Accounting Standard 200 conforming about the objectives and basic principles of conducting a financial audit of any entity which states that the objective of audit activity of any financial information is to ensure enabling the auditor to express the opinion to the extent to which presentation of financial statement are being made with the materiality perspective as per the framework commonly acceptable and applicable for financial reporting. Ideal audit work should be processed as per guideline fixed to ensure professional and legal standards with the conformity of ethical standard compliance. Respective audit report is signed by the responsible audit team and submitted to the owners of the business entity, either in the form of owners or shareholders (Malb, 2013).

Professional auditors have their responsibilities to disclose their opinion on the financial information of the specific entity which is treated as responsible for liability on the part of the auditors. During the performance of any audit work, financial auditors have the assumption of great level of responsibility in the domains of terms of the audit contract, with the required level of professional services required for proper execution (Newbie, 2011).  

First assumption for this purpose of liability of auditors is considered as the content of engagement. While signing the appointment, the auditor has to confirm the definition of terms and the type of audit mission which is to be executed as per auditing standards, applicable review and insurance; setting of audit objectives with specific financial information which are to be audited with reporting framework of accounting under which they are prepared. During the process of determination of nature, longevity to the extent to which procedure of audit should be executed. It is also emphasized that during the process of evaluation of audit evidences with results, mandatory practice of professional disbelief should be applied by recognition of financial statements not with material misstatement which normally occurs due to error and fraud (IAS 200, paragraph 5). At times the detection process of material misstatement practiced through the audit assignment can prove inefficient which are hidden by the combining impact of people in the status of leadership with the charge of governance, third parties and employees of the entity.  Even with the best audit practice as per international auditing standard, risk of material misstatement as a result of fraud and error may sustain with best possible audit plan. In order to assess the work of the auditor with the analysis of responsibilities determined are done through different criteria like assessment of merits of procedures resulting from the application of those procedures; correlation between results found through these processes with the opinion of the auditor pronounced in the audit report (Curd & Hare, 2008). 

Case Study Lehman Brothers

Lehman Brothers had applied for bankruptcy disclosure through their petition dated 15^th September, 2008 as per Chapter 11 of Bankruptcy Protection. This application had made hue and cry in the market resulting unanticipated bubble burst in the United States financial market. Debates were raised that this happening has occurred due to the withdrawn Glass- Steagall Act by Washington. It is argued that the same withdrawal of act had found the status of Lehman brothers as the main contender in the housing sector segment of US. This happening has focused with the impact of more than 50% increment in revenue generated by Lehman Brothers in between the periods of 2004 to 2006 (Epiq, 2008). 

Ethical issues

This unwanted situation had occurred and put Lehman Brothers in wrong foot. This had neither happened for any single reason of drawback related to ethical judgment as executed by an employee who found himself misguided by the process; nor of its effort to prove to be an isolated happening which impacted the Wall Street at their worst image. In earlier days Wall Street had claimed the success for so many historical happenings. But the downfall of Lehman brothers’ had impacted with the effect of subsequent happening which were initiated by so many faulty steps as introduced by the group of identities including third parties.  Thus ethical issues were being affected by different level of actions made by those individuals which can be focused with the false statement of Chief Executive Officer Richard Flud with endorsement from Chief Financial Officer Erin Callan and subsequent negligence found on the part of official external auditors Ernst and Young, who had not discharged their duties honoring liability of auditors in this financial crisis (Douglas, 2009). 

Post Mortem of Lehman Brothers’ Bankruptcy

It was found through the process of investigation as admitted by Global Finance Controller through the statement that there was no material substance found in different specified transactions referred to Repo 105. Top level management of the Lehman Brothers’ in the form of CEO and CFO with their associates had somehow managed to hide with deliberate effort the impact of this strategy from the Board of Directors, rating agencies and shareholders. There was no appropriate reaction found from the auditors, Ernst and Young to alert the shareholders related to this malpractice pursued by the management of the company. Even with the fact that the management of Lehman Brothers could not be able to hide the fact with projected illusion for long term, ultimately the bubble burst had occurred in September 2008 which had resulted to penultimate declaration of bankruptcy disclosure by the company. Although there are three parties involved in this fiasco in the form of CEO, CFO and Auditors, we will discuss the role of auditor as the main subject of this discussion, who has failed to honor their professional and ethical liability in disclosing the reality which was root cause of this financial crisis (Economist, 2010).

Role of Ernst and Young

It was observed that Ernst and Young had not properly justified their role in this happening due to their casual and non-professional approach in this regard to discharge their duties. Outcome of the investigation had proved that Ernst and Young had not properly initiated action to substantiate their executive leadership to expose the problem such generated by the misrepresentation of Lehman Brothers’ management in relation to financial domain. It was expected that Ernst and Young would show respect to their presence in the company by honoring their professional and ethical standards as fixed by Audit mandate. They may be blamed for reacting in irresponsible way which had resulted to major level of negligence on their part with improper way to own up the liability. With the previous example of occurrence of Enron etc., it is observed that Ernst and Young had not met the coveted level to discharge their duties and their reaction in this regard which is considered as unethical. They have not acted in the happening with their proactive reaction and this can make situation which may force to raise fingers on their integrity, too. Timely intervention of the auditors by pointing the happenings to the Board of Directors may have been instrumental to resist the unwanted happening of fall of Lehman Brothers.  They have the right to ask for clarification of misleading treatment of financial instruments from the responsible persons of the company. It is the preamble of auditors’ liability to find out the audit risks in the forms of inherent, control and detection risk to search for material misstatement. The auditors had failed to react in this area and this had led to the debacle which had ultimately resulted to the fall of Lehman Brothers (Mahon, 2015). 

Conclusion

The appointment of the auditors is made through the shareholders and they are assigned to save the interest of the shareholders. Hence it is recommended as the first and foremost duty of the auditors to protect the interest of the shareholders or investors along with other stakeholders. The auditors are controlled by the general regulations to comply with the ethical discharge of their duties powered by professional knowledge and integrity. The profession has its own liabilities which are more required in case of the dire necessity of the situation. Recommendation for main focus of auditors’ liability is to find out audit risk and failing which they can be blamed for any unwanted happenings related to the business entity in which they are involved.

It is observed from above research article that liability of auditors cannot be denied in case of organized financial crime by the management which leads to financial crisis. Recommendations for auditors are to intervene in time by detection of audit risks related to material misstatement with the effort to mitigate them by the auditors can prevent such happening in due course to protect the company and its shareholders from its untimely death.   

References:

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Curd, R. & Hare, K., 2008. UK: Auditors´ Negligence: Liability To Company And Shareholders. [Online] Available at: http://www.mondaq.com/x/61268/Insolvency,+Administration,+Bankruptcy+and+Liquidation/Auditors+Negligence+Liability+To+Company+And+Shareholders [Accessed 21 January 2017].

Dhanapal, C., 2013. Liabilities of Auditors under Companies Act, 2013. [Online] Available at: http://studycafe.in/2013/12/liability-of-auditors-under-companies.html [Accessed 16 December 2016].

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Economist, 2010. A postmortem on Lehman Brothers. [Online] Available at: http://www.economist.com/node/15695099 [Accessed 21 January 2017].

Epiq, 2008. Lehman Brothers Holdings Inc. [Online] Available at: http://dm.epiq11.com/#/case/LBH/info [Accessed 21 January 2017].

Europa, 2004. A study on systems of civil liability of statutory auditors in the context of a Single Market for auditing services in the European Union. [Online] Available at: http://ec.europa.eu/internal_market/auditing/docs/liability/auditliability_en.pdf [Accessed 16 December 2016].

Mahon, K., 2015. Ernst & Young’s Involvement with Lehman Brothers’ Downfall. [Online] Available at: http://www.corporateresponsibilitynetwork.com/wp-content/uploads/regents_151204_ernst-youngs-involvement-lehmann-brothers.pdf [Accessed 21 January 2017].

Malb, M., 2013. The role of the Auditors Liability in the global financial crisis. [Online] Available at: https://prezi.com/vsujbqrl8kdw/the-role-of-the-auditors-liability-in-the-global-financial-crisis/ [Accessed 21 January 2017].

Newbie, 2011. Do we blame auditor for the financial crisis? [Online] Available at: http://accounting-newbie-bi.in/2011/02/do-we-blame-auditor-for-financial.html [Accessed 21 January 2017].

Todea, N. & Stanciu, I.C., 2009. Auditor Liability in Period of Financial Crisis. [Online] Available at: http://www.oeconomica.uab.ro/upload/lucrari/1120091/21.pdf [Accessed 21 January 2017].