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Auditing BUACC3741

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Answer No. 1

The collapse of Enron Corp. was unexpected and sudden. It was the first in a sequence of many crucial accounting scandals in the corporate world that had shaken the stock market. In December 2001, only a few months prior to their filing of bankruptcy, Enron was regarded as one of the fastest growing corporate houses in the USA. Their annual revenues grew substantially from around $10 billion in the 1990s to $139 billion in 2001. This rise in revenue had put them in the fifth position in the Fortune 500 list. Enron’s main operations in the energy division were doing alright but the problem arose due to their investment in the sophisticated internet and communications businesses, especially the “dot com” investments. Enron foresaw, like many other companies, there the future on the Internet. Enron then invested in the market heavily and took a debt load in order to gain capital for its purchases. In 2000, when the dot com came crashing, the return from these huge investments withered away but the debts remained. They were also facing huge losses in their foreign operations in India, the UK, and South America. Companies losing money after investing somewhere is not something new but the major problem for Enron was that they could not deal with this crisis judiciously. The public accounting statements of the company were not linked to Enron but to their other entities. When this fake story was busted then more than 80% of Enron’s profits had disappeared and the company crumbled. An independent auditor is required to certify the accounting statements of public corporations as per the federal securities law. Arthur Andersen, Enron’s auditor, neglected the unethical practices that were happening in the accounts division and was also complicit in designing financial transactions and structures that were very complex and promoted treachery.

A certificate by the auditor shows that the financial statements that are under review have been made according to the generally accepted accounting principles (GAAP). GAAP was violated by Enron and they manipulated the numbers of accounting standards permit corporations. The FASB sets the accounting standards for the companies and is a non-governmental organization (Le Maux and Morin, 2011).

Another case is the failure of Lehman Brothers in the year 2008 which was the biggest case of bankruptcy in the history of the USA. The report of their bankruptcy created ripples in the stock market. There were many reasons and agents who were responsible for this disaster. Their fall was triggered by the sub-prime crisis in 2007. The company had cash flows in the negative and was unable to meet its obligations (Dutta, et al., 2010) Moreover, Ernst & Young, who were the auditors, turned a blind eye to all that was going on mainly the manipulations in the balance sheets since the early 2000s. They were thinking that Lehman had used Repo 105, which was an accounting maneuver which was used for terming a repurchase agreement in the short run as a sale, and did not disclose it to the government and even to the rating agencies, investors including their board of directors (Johnson and Mamum, 2012). In an effort to achieve their planned strategy of high growth which at that time did not appear to be attainable, their managers decided to use manipulative and corrupt ways to reach their objectives. One of them was the use of Repo 105 in the wrong way in order to show healthier financial conditions. Lehman Brothers even after knowing that the Repo 105 was a legal procedure they used it wrongly to acquire new loans by producing manipulative financial statements. The accounting standards had opened the way for the managers to take undue advantage of these practices. The accounting standards need to be improved to stop these kinds of unethical practices in the future (Greenfield, 2010).

Answer No. 2

The ISA 315 has provided certain guidelines for the auditor so that he can properly understand the organization and its environment and also the internal control. These guidelines are pertaining to the auditing complex financial instruments. For the auditor, getting to know the organization is a long process of retrieving and analyzing the information during the audit. The interpretation that the auditor obtains helps him to make a plan the audit and use his judgment. In the financial instrument, the magnitude of the deals in any organization establishes characteristics and size of the controls. It also comprehends how they are monitored which helps the auditor in understanding the extent and nature of the audit process. There are some key components of the process and subsequent internal control with respect to an organization's complex transactions of financial instruments. There has to be the development of a perspective which will determine the extent of risk that the company is ready to accept when doing any financial deals like policies for funding complex financial instruments and the process in which the activities are run. Then, a process for a new type of transaction of financial instruments that will consider the aspects like legal, accounting, other market-related risks etc. Moreover, there is the need to process the dealings of financial instruments which includes assets and cash. Then risk management is another aspect of the auditing process. The auditors need to assess internal and external risks and device plans in order to overcome them. Business risks must be identified which use complex financial instruments. It is essential for the management to determine how significant and damaging will be the risk. They need to identify the level of approval for the various financial instruments, set some limits for the exposure that can be managed and also monitor the process at a pre-decided interval (Verleun et al., 2011).

Answer No. 3

A plausible reason for the perceived disclosure overload problem can be the frequently applied financial statements format. So, we could contemplate using alternative forms options for restructuring the format that has also been applied by other organizations. We are of the opinion that these particular alternatives will provide the chance to strengthen the effectiveness of the organization while communicating any information related to finance. Although, all the alternatives may not be fully implemented instantly if we consider the current IFRS. It is also understandable that the determination of one single alternative way which would the best is not an easy task. So, every organization must go through the particular facts and circumstances, and also the particular needs of its key users, including limitations and restrictions related to the jurisdiction.

In compliance with the Conceptual Framework for Financial Reporting of IASB, the fact that it will be comparable with the other organizations can be considered a qualitative feature which will magnify the significance of the information that is pertinent and judiciously promoted. Thus, during the process of the notes format development, the concerned people must contemplate the methods undertaken by other contemporaries of this industry with a view to facilitating the users to further construct practical differentiations. Moreover, the consistency factor must be kept in mind with respect to financial information. The organizations must disclose and put forward information in the form of financial statements by incorporating the similar format from time to time. We believe that a change should only be incorporated only when it benefits the financial statements by underlining the appropriate information much more constructively than the system that is presently followed (Yen at al.,2018).

The financial statements are used as a medium to find certain information about an organization on an impromptu basis. So, the users will value the content listings and the summary pages and this will empower them to comfortably point out the necessary data which they intend to find out. Including content listing ahead of the notes is a common practice. Although, even today, many organizations do not produce financial statements which include such a summary. There are many other ways if we want to better the navigation of the financial statements, for example, cross-references and traditional headers, section signs, highlighters etc. Many organizations in an attempt to revamp their financial statements have decided to display all of the judgments, accounting policies, and estimates along with the pertinent note.

One more debatable perspective is the one in where they will disclose the policies which will not follow the standards directly. Then, grouping the disclosures by nature can be another alternative form of disclosures and accounting i.e. the notes will be grouped by nature and will be split into categories to help the users navigate within the financial statements. For example, an organization may put together their disclosures like corporate data, risk related disclosures etc. There can also be another combined alternative which will be achieved by combining order based on importance and also grouping by nature. Through this alternative, the organizations may contemplate expanding the efficacy of their financial statements. This can be done by grouping disclosure based on nature and then ordering them on the basis of their significance.

Answer No. 4

The going concern assumption theory is significant for the accounting profession as it is a crucial part of audit theory and practice. The going concern assumption theory is essential for the evaluation and preparation of the financial statements. Apart from this, it is also considered as a primary notion for obtaining a sustainable future for the organization. For the purpose of risk management, the role of internal audit has changed over the last few decades. The internal audit engages, for its practices, the risk-based aspect. Moreover, it also helps in determining the process of risk management. Internal auditors provide consultancy services and also keep track as to how the guidance is being followed and how the risk can be minimized by the management and guarantee stability (Foster and Shastri, 2016).

The consequences of the financial crisis and the bankruptcies that followed have been difficult for both stakeholders and entrepreneurs. Now, they all agree that to be safe from such uncertainties it is better to take measures for early risk management with respect to the external environment of the organization including their financial position and sustainable development. The identification and risk management process in connection to the assumption of going concern plans to define the nature of the risks that haunt the activities of an organization and their working process. In order to hedge those risks, it is essential to gather adequate information to make sure that the risks are identified and also classified for the goal of successful risk management. The risks can be categorized as external or internal, objective or subjective, financial or legal etc. With a view to achieving proper coordination between the external and internal auditors, it is essential that the risks are systematized with respect to the going concern assumption, keeping in mind the guidelines of the international auditing standards (Masyitoh & Adhariani, 2010).

Firstly, for the purpose of risk analyzing, the components related to the going concern assumption a scale must be properly developed that both internal and external auditors can use. The scale would be based on the assumption that the risk related to the going concern assumption can be studied over a period of complete cycle i.e. from the beginning to the end of the crisis. It can depend on the 5 point rank scale in order to determine the risks. When a risk won't have significant impact on the financial situation of the firm then it can be termed as negligible and will not have any effect on the going concern assumption. The risk is moderate when the effect will be on a particular sector in the duration of one or two years. Lastly, the risk will be considered high if the effect is spread through many sectors. Secondly, another way to comfort the stakeholders from the risk of any financial failure will be through the development of a matrix for risk assessment which will be used for every risk element related to the going concern assumption. The matrix will help the auditors to identify, process probable risks through a scale. Thirdly, another way will be to find out the likelihood of the occurrence of any risk, its frequency, importance, and the consequences. Here, the aim will be to categorize and rank the risks and select a method keeping in mind the procedures of internal audit and the resources available.

References:

  • Dutta, S. K., Caplan, D., & Lawson, R. (2010). Lehman's $hell Game. Strategic Finance, Vol. 92(2), pp. 23-29.
  • Foster, B. P., Shastri, T. (2016). Determinants of going concern opinions and audit fees for development stage enterprises. Advances in Accounting, Vol. 33, pp. 68-84.
  • Greenfield, H. (2010). The decline of the best: An insider's lessons from Lehman Brothers. Leader To Leader, Vol. 55, pp. 30-36.
  • Johnson, M., & Mamun, A. (2012). The failure of Lehman Brothers and its impact on other financial institutions. Applied Financial Economics, Vol. 22(5), pp. 375-385.
  • Le Maux, J., & Morin, D. (2011). Black and white and red all over: Lehman Brothers' inevitable bankruptcy splashed across its financial statements. International Journal Of Business & Social Science, Vol. 2(20), pp. 39-65.
  • Lehman Brothers Holdings, Inc. SWOT Analysis. (2008). Lehman Brothers Holdings, Inc. SWOT Analysis, Vol. 1.
  • Masyitoh, O., & Adhariani, D. (2010). The analysis of determinants of going concern audit report. Journal Of Modern Accounting & Auditing, Vol. 6(4), pp. 26-37.
  • Snowdon, C., Steinberg, D., & Lippman, M. (2009). Managing the bankruptcy of Lehman Brothers. International Tax Review, Vol. 49, pp. 3-6.
  • Verleun, M., Georgakopoulos, G., Sotiropoulos, I., & Vasileiou, K. Z. (2011). The Sarbanes Oxley Act and Accounting Quality: A Comprehensive Examination. International Journal Of Economics & Finance, Vol. 3(5), pp. 49-64.
  • Yen, JC., Lim, JH, Wang, T., Hsu, C. (2018). The impact of audit firms’ characteristics on audit fees following information security breaches. Journal of Accounting and Public Policy, Vol. 37(6), pp. 489-507.

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