AUDITING II (UDE 2005)

LEHMAN BROTHERS
SCANDAL
ATHIRAH BINTI JAMALUDIN UDE190161

FARAH YASMEEN BINTI MOHD EMRAN UDE190165

LEONG JIT LOONG UDE190174

NURATIQAH HAZIRAH BINTI MOHD HAFIZ UDE190202

QISYA MIRZA BINTI HAMIZI UDE190212

 BACKGROUND OF LEHMAN BROTHERS

Lehman was highly leveraged

A global financial services and financed its long-term
company whose bankruptcy was investment acquisitions primarily
largely triggered by the with short-term borrowing that
subprime mortgage crisis in Its investment portfolio needed to be rolled over
2008 increased, even during the frequently
subprime mortgage crisis that
gripped the U.S. economy from
2007 through 2008
Lehman changed its business Lehman would enter into an
model from being primarily a arrangement with an entity that
broker and underwriter to had funds to invest for a short
acquiring large amounts of period of time in exchange for
investment assets for its own specific securities
speculation
 WEAKNESSES AND
RECOMMENDATIONS OF
LEHMAN BROTHERS
SCANDAL
 EXCESSIVE RISK-TAKING WAS
REWARDED BY MANAGEMENT
WEAKNESS
 Lehman's Chief Risk Officer,
Madelyn Antoncic said that
many of her risk-
management strategies were
overlooked by the top
management. This can be
seen when the rigor of risk
management did not last too
long.
 The top management tried to
keep ahead of rivals who still
used high-risk tactics, and
they also felt the company
was too smart to fail.
RECOMMENDATION
EFFECTS
 In 2007, several individual risk
thresholds have regularly been
violated and not remedied such
as risk limits for its principal
investments, concentration
limits for its leveraged loan and
commercial real estate business
 There was so much uncertainty
in the company that many
executives emailed each other
asking whether they really had
those limits.
 The culture of the
company would benefit
from clarification as to
what is required from
managers and staff
 Clear communication as
to what constitutes
permissible conduct and
what does not, as well as
the bandwidth of
acceptable deviations
from the specified goals
such as the risk tolerance
must be provided.
 WEAKNESS
ILLIQUID ASSETS
 The rise in Lehman’s net assets
was partly due to the
accumulation of potentially
illiquid assets that were not so
liquid, particularly during the
downturn.
 Lehman’s holdings of these
illiquid assets have increased
from $86.9 billion at the end of
2006 to $174.6 billion at the
end of 2008.
EFFECTS
 As a result, they were unable
to retain their trust because a
variety of market factors had
left them with a vast
accumulation of illiquid
assets, along with
deteriorating prices that
mainly contained residential
and commercial real estate.
RECOMMENDATIONS
 The management shoud have
made a better contingency
plan to avoid liquidity risk
from the start.
 Looked for an expert auditor
that has a specialty in
observing financial statement
of their company or receive
an advice.
 WEAKNESS

N CE  Lehman Brothers were extremely confident when they were making

F IDE investments as they saw that their profitability increased rapidly

C ON
VER  Management thought that it would make more money to own these assets, but
O its timing could not have been worse, as real estate prices have been falling

EFFECTS

 As they were very confident about their

profitability they started making irrational
RECOMMENDATION decisions when investing without even
considering the risks. They fell deep in debt as
they did not realize that irrational decisions
 Lehman brothers should have considered the risks that were made.
they might face upon investing.

 Hire a third party for an 'outsider view' on the situation,

such as risk analysts and financial advisors.
 IMPRACTICAL STYLE
OF MANAGEMENT

RECOMMENDATI EFFECTS WEAKNESS

ON
 The directors of  This can lead to reduce  The company had to predispose
management should work quality, which is the firm to high-risk borrowing
have a regular review on due to the unrealistic from the repo market.
the management report expectations, employee
and budget forecast to may be forced to rush  High staff turnover rate as Fuld
ensure everything is work, not work properly has impractical expectations
going according to the and thus, poor work where the staff will not be able to
appropriate target that quality happens achieve. Even if the wages are
the company is aiming staggering.
 IMPROPER PRACTICES OF ACCOUNTING
STANDARDS & ETHICS
WEAKNESS EFFECTS
• The Lehman Brothers have • Broke the code of integrity
manipulated their financial & professional behavior
statements
• Combination of bad ethics
• Portrays that they have no & flawed risk management
authorization of procedure brought collapse to the
company
RECOMMENDATIONS
• Appoint an officer to
overview their financial
statements
• Appoint one a supervisor to
have close supervision on
each accounting activity
 THE FRAUD TRIANGLE
PRE SSUR E
o Fuld was very aggressive that he
eventually led the company to
commit fraud and so the company
could earn more money. Due to that,
Fuld may get more incentives.
o The business cycle stated that the
negative cash flows that Lehman was
running prior to the bankruptcy which
caused Lehman unable to meet its
current obligation due to the fact that
they have been the top investment
bank in the United States
O PPO RTU N ITY
o Lehman recognized a
loophole in the accounting
standard (repo 105)
language regarding
repurchase agreements and
took advantage of it.
o They attempt to hide true
amount of leverage and used
loan as sales to reduce its
liabilities.
R A T I O N A L I Z A T I ON
o The SEC knew that Lehman
reported amounts in its reported
liquidity pool that the SEC did not
believe were actually liquid.
o They also knew that Lehman
exceeded its limits on risk control,
and the SEC should have known
that Lehman manipulated its
balance sheet in order to make its
leverage appear better than it was.
Yet the SEC did not take decisive
action
CHALLENGES FACED BY
AUDITORS IN ENSURING
GOOD INTERNAL
CONTROL ARE IN PLACE
 01 REVENUE RECOGNITION

When performing the audit procedure, the audit evidence received can turn out to be weak or too
vague. This will then interfere with the auditor’s procedure when carrying out the audit activity hence will
make it hard for the auditors to produce a professional judgement or assurance.

Auditors must have robust knowledge regarding revenue recognition to carry out a smooth procedure
as well as to provide a tangible evidence on what the organization requires. Moreover, it has been proven
that some subtle manipulation that can vitiate the true position of the financial statements hence the revenue
that needs to be recognized by a business enterprise can somehow be adversely affected if it is not
effectively checked.

To ensure the authenticity of the evidence, they also need to conduct a substantive test with additional
precautions. This requires the auditor to undertake a few steps in response to the assessed risk of material
misstatements which are test the operative effectiveness of the internal control, determine whether
events that has occurred is up to date of the auditor’s report and others.
 02 FRAUD
If a blatant fraud is ignored unless proved otherwise, the auditor as well as the
management are liable. It may arise due to the override of internal controls by management.
When carrying out their audit, the auditor has to set aside all assumptions and apply
professional suspicion. The appropriateness of journal entries will ensure that the chances of
collusion are lower. Segregation of duties should be in place. It should be notified for any
inappropriate or unusual activity. It should be notified for any inappropriate or unusual activity.
For fraudulent intentions and prejudices, any provision or accounting estimates should be
properly inspected. Therefore, it is important to review management judgments and assumptions
related to important accounting estimates retrospectively.
 03 INVENTORY

Some businesses are skipping with doing inventory checks because it is

inconvenient or too expensive to do so. They also believe it is a hindrance to
the regular workflow. Audit firms are also known to have failed to address the
relevant assertions when attendance is concerned with stock taking. The auditor
should therefore check the existence and condition of the inventory by
conducting control tests. Last but not least, necessary and sufficient audit
evidence should be obtained to confirm the accuracy of inventory taking
procedures for management.
 04 ENGAGEMENT LETTER
It has always been a challenge to prepare a nearly flawless letter of engagement. It is a
requirement for compliance with different accounting principles. It is one of the conditions to
agree on the terms of the audit engagement. It provides better communication and
comprehension of the auditor's responsibilities and the management's responsibilities. However,
conflict resolution arrangement between client and auditor may arise as well.

Such letters could restrict third-party liability to auditors by, for example, mitigating legal
costs and other prosecution costs, making clients with sufficient resources sharing third-party
liability costs against auditors, or preventing actions against auditors that relied on fraud. Lastly,
these letters could be a challenge to auditor as it included clauses to remove or restrict the
liability of auditors and to defend them from clients that are false .
 05 PUBLISHING AUDIT REPORT

Audit reports are one of the least-liked aspects of an auditor's work. Audit reports take
longer period of time to complete than anticipated, which typically results in them being
released later than scheduled. The general assumption is that the audit reports will be
officially released no later than one week after the audit has been carried out. This could be
better for companies who provide their audit checklists in their audit report. The audit report
must be drawn up in order to clearly explain audit results to management so that they can make
appropriate decisions.

Not to mention that numerous paragraphs in the audit report are important for investors to
evaluate a company. For instance, the emphasis in the paragraph of the matter specifies those
matters of significance which the auditor may wish to highlight. It therefore means that there is
no improvement in the view of the auditor with regard to the matters in question. However, it is
necessary to understand that particular fact.
 In order to have a good effect on the future of audits, companies must
C consider the main issues currently facing the audit profession so that
they can recognized the needs to be addressed by future audits.
O
N
Auditors should know what to change in order to face such
C impact and challenges on their career. They should concentrate
on consistency, and it encourages good to become auditors.
L
U
S The audit of the future needs more experience in fields outside
the historical expertise of the auditor.
I
O
The auditors must challenge its activities in order to push
N progress, to be creative and to remain relevant.
 THANK YOU Link for Presentation:
https://www.youtube.com/watch?v=qF4L7KBuXzA&feature=youtu.be