Role of the Auditors Before and After the Financial Crisis of 2008 - Essay Example

The Role of the Auditors: Financial Crisis of 2008 Table of Contents Introduction 3 The importance of the Auditors 3 Role of the Auditors before and after the Financial Crisis of 2008 4 Conclusion 6 Reference 8 Bibliography 10 Introduction The business ethics and compliances are inevitable aspect for maintaining standard corporate governance. The financial frauds in business world leads to weaken the market as shareholders lose their confidence in the market for investment purposes. In this case, the external financial auditors play very important role. The primary objective of a financial auditor is to detect and prevent the financial frauds and scams (Basu, 2009, p.1.11). According to Rezaee and Riley, “Fraud is commonly referred to as an intentional act committed to harm or injure other securing an unfair or unlawful gain” (Rezaee and Riley, 2009, p.5). The financial auditors are responsible for conducting auditing process to assess the validity and reliability of financial activities and financial statements. In this respect, auditors’ negligence may produce very serious issues like a financial crisis. Many critics believe that the due to the auditors’ negligence, the financial crisis of 2008 became more intense than it would have been otherwise. This essay will attempt to deal with the role of auditors during the financial crisis of 2008 and current trend of auditors. In order to meet this objective, this paper will discuss some important areas. Firstly, the importance of auditors will be discussed and followed by their role before and after the financial crisis. This section will critically analyse overall discussion. Finally, this paper will conclude by summing up the important finding of this paper. The importance of the Auditors The auditing process of a company involves the verifications of the financial and accounting information revealed by an organization. The financial information or financial statements are disclosed by the publicly listed companies for the investors and other external users. These financial statements are verified by auditors to measure its accuracy, reliability, transparency and validity before publishing. The responsibilities of auditor include several duties that must be met by them. Firstly, they must verify that the organization has maintained proper accounting records. Secondly, they must tally historical accounting record and financial statements. Thirdly, they must verify that whether the organisation has followed proper legal regulations for disclosing the financial report. Finally, “auditors encourage or assist managers and other internal stakeholders in developing or improving one or more of an organization’s performance management systems or the managing for results processes that depend on them” (Auditor Roles, 2010). The financial regulatory body of a country is responsible for developing standard auditing policies. For example, the ‘Auditing and Assurance Standard Board’ (AUASB) is an Australian government body that is responsible for “making auditing standards under section 336 of the Corporations Act 2001” (AUASB, n.d.). Role of the Auditors before and after the Financial Crisis of 2008 The financial crisis of 2008 revealed many issues and negligence of many organisations and the regulatory bodies. Many critics have claimed that auditors’ silence and negligence was the one of the major reason for financial crisis of 2008. The collapse of Lehman Brothers was a massive shock for the US economy. The US bank used the ‘repo 105’ that misled the entire market. “Unlike typical repo transactions, Lehman treated Repo 105 transactions as sales for accounting purposes” (Schapiro, 2010, p.6). The banks during the financial crisis failed to identify to take necessary steps to reduce the liquidity risks. Moreover, many banks hid their poor conditions by showing wrong financial statements. In this case, the auditing firm of Lehman Brother was aware of this fact. The Ernst & Young was the auditors of Lehman’s accounting information and it helped the bank to hide $50bn debt for the market. However, this auditing firm was charged against this professional negligence by regulatory bodies of US (Inman, 2010). This silence of the auditing firms encouraged the companies to take unnecessary risk through various complex financial instruments like repo 105. Prem Sikka analysed the various unqualified opinions given by the auditing firms to companies at the eve of financial crisis. The following table shows the details of these Auditors and distressed Banks. Table 1: Auditors and distressed Banks (Source: Sikka, 2009, p.3) In this entire process, the regulators of the auditing policies were the main responsible as they were unable to control the unethical practices by the banks and their auditing firms. Prior to the financial crisis, the World Bank attempted to develop and implement international auditing standards for bringing stability in business world. The World Bank’s “Report on the Observance of Standards and Codes (ROSC)” mentioned several challenges relating to the successful implementation of accounting and auditing standards (Hegarty et al, 2004). However, the RSC was proved ineffective in controlling the financial crisis during 2008. After the financial crisis, the regulatory bodies realized the major drawbacks of the prevailing auditing policies and hence, they have taken necessary steps to improve the auditing standards. For example, the Financial Services Authority (FSA) and the Financial Reporting Council (FRC) of UK has developed proper auditing standards after the financial crisis. The policies implemented by these two regulatory bodies strive to meet the primary objectives of auditing and the auditors by increasing their attentions toward the management biases and errors (FSA and FRC, 2010). However, the Association of Chartered Certified Accountants (ACCA) organised a roundtable for discussing the role of auditors for financial crisis and its future. The participants critically analysed that auditors could not be blamed solely as management, stakeholders equally contributed in the financial crisis of 2008. This meeting focused on limited and particular responsibilities of auditors (ACCA, 2010). For developing better auditing policies, it is very important to guide and control the auditing firm and their areas of the responsibilities must be clearly defined. Conclusion The auditors are responsible for detecting and preventing the unethical practices in financial activities. Auditing firms has significant contributions in financial crisis of 2008. However, the entire blame cannot be put on the auditors solely as the managements and the Board were engaged in unethical practises. The regulatory bodies were also responsible in this respect as they failed to notice unfavourable conditions. After the financial crisis, many regulatory bodies of the accounting and auditing standards realised that some necessary revisions in auditing policies is necessary. In this respect, the regulators must communicate the specific responsibilities of auditing firms and it should develop certain policies for increasing the transparency between the auditors and business organisation. Reference AUASB. No date. Standards and Guidance. [Online]. Available at: http://www.auasb.gov.au/Standards-and-Guidance.aspx. [Accessed on November 07, 2010]. ACCA. 2010. Auditor Roles. 2010. Framework of Auditor Roles and Practices with Respect to Performance Measurement. [Online]. Available at: http://www.auditorroles.org/exemplary-practices/framework-of-roles-and-practices.html. [Accessed on November 07, 2010]. Basu, S. K. 2009. Fundamentals of Auditing. Pearson Education India. FSA and FRC, March 2010. Enhancing the auditor’s contribution to prudential regulation. [Pdf]. Available at: http://www.fsa.gov.uk/pubs/discussion/dp10_03.pdf. [Accessed on November 07, 2010]. Inman, P. March 14, 2010. Auditors face inquiry call after Lehman revelations. [Online]. Available at: http://www.guardian.co.uk/business/2010/mar/14/reform-demands-auditors-lehman-brothers. [Accessed on November 07, 2010]. Rezaee. Z. and Riley. R. 2009. Financial Statement Fraud: Prevention and Detection. 2nd Edition. John Wiley and Sons. Sikka, P. 2009. Financial crisis and the silence of the auditors. [Pdf]. Available at: http://www.wu.ac.at/taxmanagement/Institut/Mitarbeiter/Hoermann/antibilanz/downloads/financialcrisisandthesilenceoftheauditors.pdf. [Accessed on November 07, 2010]. Schapiro, M. 2010. Lehman Brothers Examinerżs Report: Congressional Testimony. DIANE Publishing. Hegarty, J. Gielen, F. and Barros, C. H. September 2004. Implementation of International Accounting And Auditing Standards. [Pdf]. Available at: http://www.worldbank.org/ifa/LessonsLearned_ROSC_AA.pdf. [Accessed on November 07, 2010]. Bibliography Cocke, H. 1980. A summary of the principal legal decisions affecting auditors. Ayer Publishing. Rittenberg, L. E., Johnstone, K. and Gramling, A. A. 2009. Auditing: A Business Risk Approach. 7th Edition. Cengage Learning. Soros, G. 2008. The new paradigm for financial markets: the credit crisis of 2008 and what it means. PublicAffairs. Stevenson, K. 1990. The Changing role of auditors: and the audit relationship. Business Law Education Centre. Zhang, P. G. 1995. 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