Auditing, Assurance & Services ACC707 Individual Assignment Research Question Auditor’s Report The new auditing standard ASA701 Communicating Key Audit Matters in the Independent Auditor’s Report is...

Development of ISA 701 „Communicating Key Audit Matters in the Auditor‟s Report‟ after
the collapse of Lehman Brothers
Sagar Marasini
11500928
2

Table of Contents
Sl. No. Topic Page No.
1. Executive Summary 3
2. Global Financial Crisis 4
2. Lehman Brothers- Background 6
3. Reasons for failure of Lehman Brothers 7
6. Features of Auditing Standard, ASA 701 9
8. Key Audit Matters in Relation to Lehman Brothers 10
9. Conclusions 12
10. References 14
3

Executive summary
This report is an analysis of the issues related to the global financial crisis and collapse of
Lehman Brothers as the aftermath of the crash in housing market (subprime mortgage) and
the development of ISA 701 „Communicating Key Audit Matters in the Independent
Auditor‟s Report‟. The downfall of Lehman Brother had put lot of question marks on the
accounting and Auditing practices. The credibility of the auditor‟s report was at stake and
Investors were the hapless. In this report details of Auditing report has been used from
Annual report of Lehman Brothers filed in 2007. The report was unqualified and auditors
stated that the financial statements provided in the report are co
ect and that no misleading
or wrong information has been provided by the organization. This boosted the confidence of
investors and they relied on the report for the analysis. However, as it turned out later that it
was a case of complete misrepresentation and the company was involved in accounting and
auditing fraud.
A
ief introduction about the financial crisis is discussed before coming to the case of
Lehman Brothers. The regulatory body took a huge step to implement the ASA 701 in order
to keep the faith in the practices of the institution. The disclosure of Key Audit Matters in the
Audit report most likely would have avoided the collapse. The company‟s auditor believed
the accounts to be true and fair based on the fact that the company was following accounting
principles but did not look for materiality to the financial statements. The report provides the
details about the features and scope of the ASA 701 and how it is beneficial for the investors.
The loopholes in earlier practices have been covered up and auditor‟s are more accountable
of their opinion. The disclosure of Key Audit Material in the report has been mandated. The
objective of ASA 701 has been discussed in this report. It also explores the deficiencies in the
existing financial framework. Finally, the report concludes with the benefits derived from
introduction of ASA 701.
4

Global Financial Crisis
Financial crisis refers to the situation or an economic condition where the investors withdraw
their investments with the expectation that the value of their investment will drop in the near
future. In such cases, banks and other financial institutions lack liquidity or have shortage of
funds unable to fulfil the demand, then it is considered as financial crisis. As there is a trade
elation between the countries and all of them are inter-related, thus leading to financial crisis
globally. Inflation and overvaluation of assets are considered to be the major causes for the
financial crisis.
The global financial crisis during 2007-2008 is considered to be the worst financial crisis
since the great depression of the 1930s. Financial markets are volatile and are very sensitive
to the information and decisions of the corporations. Also, fraud, manipulation of information
and insider trading can affect the financial market leading to the economic crisis. To protect
the country from these, after the great depression, the US government created a regulatory
system and this system worked through 1960s.
The US subprime mortgage market is believed to be the major cause of global crisis during
2007-08 and also financial institutional flaws and the practice of New Financial Architecture
(NFA) during that period was considered be the another major cause for the crisis. During
1970s, with the Community Development Act in order to facilitate the low-income group,
anks and financial institutions were forced to loosen their credit policy and this lead to
subprime mortgage where the people with poor credit ratings were also provided mortgage.
The concept of subprime mortgage had begun to expand during early 2000s as the
government-sponsored enterprises, Freddie Mac and Fennie Mae had guaranteed the banks
and financial institutions. The Federal Reserve cut down the interest rates and this lead the
anks to lower their interest rates and thus resulting to housing boom. In the meantime,
5

investment bankers started creating Collateral Debt Obligations (CDO), combination of
prime mortgages and subprime mortgages and the investors were unaware about subprime
mortgage risks associated with the CDO. As CDO was heating up the market, the housing
market which was continually building up started to collapse. The housing prices started
falling and people started defaulting on their mortgage payment as they began to realize that
the market value was way too less than they had been paying. Due to this investors with CDO
tried selling them but there was no market for those thus making them worthless. This lead to
the liquidity crisis thus affecting the banking system. Two major...