Potential Liabilities of the Global Financial Crisis - Coursework Example

Potential Liabilities of the Global Financial Crisis Name Institution Course Date Potential Liabilities of the Global Financial Crisis Executive Summary The global financial crisis affected the operations of different financial institutions and affected the condition of audit companies. Auditors are blamed for not performing their watchdog function in preventing the financial crisis. They did not perform their role with diligence and care and this resulted to significant losses to creditors and shareholders. There are a number of potential liabilities that face the auditors as a result of global financial crisis. For instance, since 2008, there have been a number of changes that have affected the audit industry. Audit companies have faced reduced income level partly due to low audit fees. Also, there has been overregulation of the audit industry that impacts audit companies in terms of documentation requirements and enhanced legal exposure. Additional costs have also been incurred in an aim to improve the quality of audit services. In order to minimize these challenges, changes need to take place in the audit sector. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Overview of the Financial Crisis 4 The Global Financial Crisis and Auditor Liability 4 Auditor’s Liability of the Financial Crisis 5 Duplicitous Financial Reporting and Audit Failures 5 New Legislation, Regulations and Standards 5 Audit Costs and Fees 6 Negative Changes in the Auditing Profession 6 Recommendations 6 Conclusion 7 References 8 Introduction The collapse of the Lehman Brothers brought a lot of fear around the global financial market. Literally, financial institutions stopped lending to each other due to the rise in the interbank borrowing (Blundell, Atkinson and Lee, 2008). Although different officials in different countries tried to solve the problem by injecting liquidity into the financial market, the financial crisis had already made a huge damage. The result of the global financial crisis has affected the operation of accounting institutions. The Global Financial Crisis is known to have begun in the month of July, 2007 together with the credit crisis which was a result of the loss of confidence experienced by the investors in the United States (Blundell, Atkinson and Lee, 2008). By 2008, the crisis had deteriorated in a greater scale since stock markets globally were crashed and became highly volatile. As a result of the crisis, the Fed and the Treasury intervened in order to prevent the spread of the crisis. This global crisis affected quite a number of financial institutions around the world (Blundell, Atkinson and Lee, 2008). This report will evaluate the liabilities of the global financial crisis. It will first highlight the events of the crisis and will evaluate the challenges and effects of the global financial crisis on international accounting. It will also describe some recommendations to solve the challenges of the crisis. Overview of the Financial Crisis The global economy experienced one of the dangerous problems in the year 2008 from the time of the Great Depression of 1930s (Erickson, 2010). It began when the prices of homes sky-rocketed in the United States suddenly turned downward. It spread fast to the whole U.S. financial sector followed by other financial markets out of the U.S (Erickson, 2010). The victims of the losses in the United States included; banking industry, insurance firms, biggest mortgage lenders and biggest commercial banks to mention a few. The downfall was not only experienced by the financial sectors in the United States but also by companies which depended on credit (Blundell, Atkinson and Lee, 2008). It contributed to the failure of several businesses, decline in economic activity and debility of customer wealth. The Global Financial Crisis and Auditor Liability The global financial crisis has reflected the mistrust in the financial system. Although the global financial crisis has had a huge impact on the global economy, it can be seen as an opportunity to correct some aspect of the financial system (Berkmen et al., 2009). Auditors are said to have played a major role in the global financial crisis. For a long time now, they have been criticized for failing to detect misstatements and financial problems in large businesses. Auditing has evolved over the years from just routine book checking to an important element of governance in businesses (Berkmen et al., 2009). Factors such as globalization, accounting standards, information technology, regulation governing entities among others impact the role of auditing profession. The global financial crisis resulted in credibility predicament in the audit work. An example of the consequences of the financial crisis is the passing of Arthur Anderson and the reduction in the number of large audit firms. In addition, the crisis also led to the intervention of the government and regulators in the audit firms’ operations (Knechel, Salterio and Ballou, 2007). It led to the rise in new laws and standards governing the audit work. It also led to a large number of scandals in the audit profession. Many changes were called for in the way auditors’ practices their work. There has also been debates with regard to auditor independence, overall responsibilities of the auditors, and the appositeness of consulting services. The theme of most debates are based on the question of whether there is any wrong with the audit profession and what can be done to improve it (Knechel, Salterio and Ballou, 2007). Auditor’s Liability of the Financial Crisis Duplicitous Financial Reporting and Audit Failures The global financial crisis has been blamed on fraudulent financial reporting which led to losses for creditors and other shareholders (Knechel, Salterio and Ballou, 2007). The fraudulent financial reporting was blamed on audit failures since they forgot to perform their watchdog function objectively. The audit industry failed to identify the major reasons for the crisis which could have prevented it from happening. For instance, one of the audit firms criticised for audit failure is Ernst and Young, Lehman’s auditor. In 2008, the company knew the operations of Repo 105 but did not disclose it (Knechel, Salterio and Ballou, 2007). In addition, PricewaterhouseCoopers was blamed for not issuing disclosure of AIG’s risk management issues. Due to their failures, the magnitude of challenges facing auditors during the post financial crisis increased considerably. There have been a number of concerns about the audit sector during the post financial crisis era (Burton, Wilks and Zimbelman, 2011). The chief accountant of SEC, Kroeker argued that the audit industry has performed poorly due to its failure to detect financial abuses. And as such, there should be a mechanism to deal with such misconducts. Pressure has been put on auditors which impacts their ability to do their work as a result of the global financial crisis (Knechel, Salterio and Ballou, 2007). New Legislation, Regulations and Standards Due to financial crisis, the government responded by implementing new statutory laws and standards that governed the audit to prevent future failures (Turner, 2009). The new laws and legislations were meant to consolidate the auditors’ independence as well as improve the quality of their operations and activities. For instance, in Australia, the Sarbanes-Oxley Act was implemented to improve auditor’s work while in South Africa laws such as Auditing Profession Act were established (Bell, Landsman and Shackelford, 2001). The Auditing Profession Act offered a stricter regulation that governed audit firms from reportable irregularities. A consequence of the regulations was that more irregularities were reported compared to those reported before the laws were introduced. Although they were able to improve the quality of audits, they led to a number of challenges to the auditors (Bell, Landsman and Shackelford, 2001). For instance, the laws led to increasing costs for the audit profession. Due to the new regulations imposed on the audit industry, there was a more stringent documentation and reporting requirements that were challenging to audit firms (Barron, Pratt and Stice, 2001). In addition, the new laws as well as strict documentation requirements has led to increased legal exposure for auditors. According to Temkin (2008), the introduction of the new audit regulations and laws has brought about more harm than good. They have been criticised for harming the ability of audit firms to attract and retain staff. The ex-CEO of ACCA Allen Blewitt explained that the auditing profession since the introduction of the new regulations have suffered dramatically (Bell, Landsman and Shackelford, 2001). The sector lost most of its staff by 2013 as a result of overregulation in the midst of financial crisis. As reported by Tenkin (2008) in the light of the over-exaggerated audit regulations, there will be only four existing auditing firms in the next ten years; KPMG, PricewaterhouseCoopers, Ernst and Young as well as Deloitte. Audit Costs and Fees Due to the global financial crisis, the cost of performing audits has greatly augmented. Since the crisis, there has been a theatrical increase in staff salary, technology costs as well as professional indemnity insurance (Berkmen et al., 2009). All these have contributed to increase in audit costs and costs. Since the crisis has led to high inflation, most clients are reluctant to pay extra audit fees. Auditors end up doing extra work for lower fees which will eventually affect the ability of audit firms to retain clients. The audit fees have really reduced since 2006 which has forced companies to reduce the amount of time spent on audit work. Ericksson (2010) argues that audit fees are supposed to be higher enough to motivate auditors to do their job effectively instead of doing paperwork quickly and mindlessly. In order to the financial crisis in the future, the auditors in different countries have been forced to be more careful and extensive in controlling audit risk. To do this there are additional costs that have been incurred (Burton, Wilks and Zimbelman, 2011). Negative Changes in the Auditing Profession The global financial crisis has led to a number of changes in the audit industry. Companies today do not request for auditors unless it’s a situation or circumstance that the law obliges them to (Bell, Landsman and Shackelford, 2001). The operations of audit companies are influenced by legislations that oblige business owners to request for auditors based on the type of the business and the scale of the company. The regulations instruct that companies with net income of more than 100 million HUF and above to employ an auditor or carry out audit operations (Bell, Landsman and Shackelford, 2001). Up to 2008, companies with income of 50 million and above required hiring of an auditor. The limit changed from 50 million to 100 million due to the financial crisis. And due to this, many audit companies suffered from decreased income as well as lack of audit work. In addition, many audit companies which were obligated to audit are forced to accept low fees from clients. Some companies have lost important clients due to demanding high fee (Knechel, Salterio and Ballou, 2007). Recommendations Policy-makers across the globe have been focused on solving the consequences of 2006 financial crisis on the global financial system (Bell, Landsman and Shackelford, 2001). To be specific, governments are offering macroeconomic incentives through monetary policies in order to reverse the impacts of the crisis. The audit companies have also been affected by the crisis and there is need for credible steps to restore their health and avoid future crisis (Erickson, 2010). Although governments have tried to restore the audit industry through implementation of new regulations and laws, there have been little changes. In order to ensure that audit firms avoid the same mistakes that caused financial crisis, audit firms should adhere to ethics of the audit ad accounting profession and should prepare financial statements and carry out audit works in accordance with the ethical standards set (Bell, Landsman and Shackelford, 2001). In addition, there is a need for rehabilitation of auditors since it is reported that weak scientific qualification contributed to the ignorance that led to global financial crisis (Bell, Landsman and Shackelford, 2001). Also, since the new legislations implemented to govern the audit companies have been linked to several challenges, there is need to minimize and give some independence to audit companies. Overregulation will affect the future of auditors and thus laws and regulations controlling audit work should be kept at minimal (Blundell, Atkinson and Lee, 2008). Conclusion To sum it up, the global economy experienced one of the dangerous problems in the year 2008 from the time of the Great Depression of 1930s. global financial crisis was caused by a number of factors including the ignorance and failures of the auditors. This crisis led to downfall of a number of financial institutions and global economy. The challenges facing auditors are numerous and very complex. The global financial crisis has been blamed for duplicitous financial reporting blamed on audit failures since they forgot to perform their functions quantitatively. Due to their failures, the magnitude of their challenges during the post financial crisis intensified. In addition, the cost of performing audits increased considerably while the fees reduced immensely. Auditors have also been careful and extensive in controlling audit risk which requires additional operational costs. The government has responded to financial crisis by implementing new statutory laws and standards governing the audit. The new laws and legislations have improved the quality of audit work but have led to a number of challenges. References Barron, O., J. Pratt, and J. Stice, 2001, Misstatement Direction, Litigation Risk, and Planned Audit Investment. Journal of Accounting Research, Vol. 39 no.2, pp. 449-462. Bell, T., W. Landsman, and D. Shackelford, 2001, Auditors’ Perceived Business Risk and Audit Fees: Analysis nad Evidence. Journal of Accounting Research, Vol. 39 no.1, pp. 35-43. Berkmen, P, Gelos, G, Rennhack, R and J.P. Walsh 2009, ―The Global Financial Crises: Explaining Cross-Country Differences in the Output Impact‖, IMF Working Paper 09/280. Blundell-Wignall, A, Atkinson, P, and S. H. Lee 2008, The Current Financial Crisis: Causes and Policy Issues, July 2008. Burton, F. G., T. J. Wilks, and M. F. Zimbelman. 2011, The impact of audit penalty distributions on the detection and frequency of fraudulent reporting. Review of Accounting Studies, vol. 16, no. 4, pp. 843–865. Eriksson, C 2010, ―The EU Regulatory Response to the Financial Crisis‖, Consultant report, Swedish National Audit Office. Knechel, R.W., Salterio, S.E. & Ballou, B 2007, Auditing Assurance & Risk. 3rd edition. Canada: Thomson South Western. Temkin, S 28 April 2008, Auditing braces itself for exodus. Business Day. Available from: http://www.businessday.co.za/articles/article.aspx?ID=BD4A743612 Turner, A 2009, ―The Turner Review – A regulatory response to the global banking crisis‖. Available from: http://www.fsa.gov.uk/pubs/other/turner_review.pdf Read More