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Audit’s Role During a Financial Collapse – Lessons Learnt Presented by Wendell E Lawrence Caribbean Governance Consultants Inc.

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Presentation on theme: "Audit’s Role During a Financial Collapse – Lessons Learnt Presented by Wendell E Lawrence Caribbean Governance Consultants Inc."— Presentation transcript:

1 Audit’s Role During a Financial Collapse – Lessons Learnt Presented by Wendell E Lawrence Caribbean Governance Consultants Inc

2  Do Auditors cause Financial collapse?  How should Auditors behave during a financial crisis?  Lesson Learnt during the 2007 Financial Collapse?  What future role could auditors play to help reduce the risk of financial collapse?

3  Most of the companies that in 2008 encountered financial difficulties or filed for bankruptcy or had to be bailed out, had published unqualified audit opinions in respect of the 2007 financial year.  House of Lords Enquiry allege that auditors were “disconcertingly complacent” about their role in the financial crisis

4  A former minister in Ireland described auditors as a ‘‘joke and a waste of time. They are lick-arses for the management of companies, because corporate governance doesn’t work in our society... The banks are in difficulty because of their auditing”.  What’s the point of having armies of number crunchers on fancy fees if they cannot spot the difference between a shack in Alabama and a triple-A security?” (The Daily Telegraph,8 22 October, 2008).

5  The implication of a financial failure immediately after an audit  The meaning of a clean audit report ◦ The Balance sheet as a snapshot of the state of affairs of a company ◦ Asset values depend not only on factor internal to the company but also factors external to the company ◦ The role of probabilities in asset valuation ◦ The expectation gap  To what extent should auditors be expected to predict the future

6  Regulators  Management  The Board  The Audit Committee ◦ Engagement of the External Auditor ◦ Continuing dialogue with the Auditor on auditing planning, risk and the progress of the audit ◦ Evaluation of the work of the Auditor (including independence) ◦ Close collaboration with the Internal Auditor  The Internal Auditor

7  A survey of the companies receiving bail out funds revealed that a majority of the Chief Audit Executives felt that internal audit could have done more to assist their companies identify key risks  The survey revealed that audit departments were impacted by the crisis and experienced significant budget cuts  Only 40% of companies surveyed in another study indicate that they have formal risk management systems. In many cases the recommendation of the internal auditor in relation to the establishment of risk management system or processes was ignored.

8  Exceptionally high leverage ratios did not result in going concern qualification ◦ Bear Stearns 33.1 ◦ Lehman Brothers 30 (3.3% fall in asset values makes it insolvent)  PCAOB inspectors identified “instances where auditors appeared not to have complied with PCAOB auditing standards in connection with audit areas that were significantly affected by the economic crisis, such as fair value measurements… off balance sheet structure…” etc.

9  The Netherlands Authority for Financial Markets carried out an inspection and found that there were serious shortcomings in 11 of the 18 Audits of Big Four Firms examined  In 2008 the Financial Times reported that banks had US$5000 billion of assets and liabilities off balance sheet  The case of TierOne

10  Auditors charge higher fees and expend more effort to reduce audit risk after a crisis (Chen & Zhang)  Auditors Less likely to issue a modified opinion during a crisis (Chen & Zhang)  Auditors less likely to resign during a crisis (Chen and Zhang)  Engagement effort and billing rate increase with risk (Bedard & Johstone 2004)  Riskier clients less likely to be accepted by auditors (Bedard & Johnstone 2004)

11  After a crisis the relative weight of relevant risk factors change significantly – it may also change during the course of the crisis  The exposure of an entity to a financial crisis will depend on a range of factors including ◦ The industry in which the company operates ◦ The entity’s financing or credit arrangements ◦ The nature and quantity of financial instruments held by the entity

12  Continuance of Client Relationship  Communicating with those charged with governance  Going Concern Considerations  Planning the overall audit strategy  Understanding the entity and its environment, and assessing and responding to the risk of serious misstatement  Auditing accounting estimates including fair value measurements

13  The External Auditor always share a significant portion of the blame  The need for Auditors and Supervisors to make greater use of External Experts  The enhanced regulations and standards pertaining to audits did not prevent the crisis  The need for greater dialogue between Auditors and Regulators  The need to reduce the expectation gap in relation to audit reports  The need for more comprehensive reporting in relation to risk

14  Audit Independence ◦ Non audit services ◦ Mandatory Rotation  Audit concentration ◦ Restrictive covenants ◦ Mandatory tendering for audit services  Audit Committees ◦ The Audit Committee should report to shareholders on its performance, the performance of the auditors, key areas of risk, and significant matters communicated to them by the auditors

15  The sharing of information between regulators and auditors  IFRS ◦ Mark to market, prudence, rules based  Going Concern ◦ All or nothing approach  The usefulness of Audit Reports ◦ New exposure draft  Expanding the role of the auditors ◦ Internal controls, corporate governance, business model

16  Auditors are not blameless in relation to their role in the Financial Crisis but they were not the cause of the crisis  After the financial crisis, Auditors significantly increased their effort (as well as the corresponding fees) with a view to mitigating audit risk  There are many lessons to be learned from the crisis by auditors but also by a number of other key players  Although audit risk cannot be eliminated entirely there is considerable scope for improvement in the conduct of audits

17 Wendell E Lawrence Chief Executive Officer Caribbean Governance Consultants Inc. Corner of New and Central Streets Basseterre St. Kitts & Nevis Email: Cell: +1(869)762-4069 Tel: +1(869)465-0051

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