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Lecture #6 Nov 27 2013.docx

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Chris Liboiron

Lehman Brothers and Madoff – The Blame Game Lehman Bros – Introduction • Investment bank o Deal with mergers and acquisitions • 700 bill bankruptcy • 10 trillion dollars of paper gain was wiped out • Lehman tried the enhance a ratio o Window dress its earning • Look pass the whistle-blower Lehman Bros – Auditing Issues • Financial attribute of a investment bank o Leverage o Look at your assets and compared to ur equity o They had an 30:1 ratio and thought it was too high • Created their own metric o The net leverage ratio o Got a 16:1 instead o Same as the regular one, but takes out the assets that are the most stable o Decreased it with what’s called Repo 105  Sell assets but have an contract to repurchase them later on  This is not a sale, but more like a debt o All firm says u can’t use the loop hole • Main issue with Repo 105 o Why didn’t they look at the contract o Economic substance of this is actually a loan • When Lehman was developing its REPO 105 accounting policy, did EY have a responsibility to be involved in that process? IN general, what role should an audit firm have when a client develops an important new accounting policy? Comment on an audit firm’s responsibilities during and following that process. o No  Management’s responsible for policy o But auditor has the responsibility of understanding the policy and determine if it is appropriate under the circumstances • Do you agree with the assertion that “intent doesn’t matter” when applying accounting rules? That is, should reporting entities be allowed to apply accounting rules or approved exceptions to accounting rules for the express purpose of intentionally embellishing their financial statements or related financial data? Defend your answer. • Do auditors have a responsibility to determine whether important transactions of a client are “accounting motivated”? Defend your answer o Using accounting standards…….. o SocGen  Recognize loss in the previous year, but should have recognized it the current year o Lincon savings  Guy lent someone to another person and sells it back the original guy • William Schlich implied that EY’s British affiliate had the responsibility for reviewing the legal opinion issued by a British law firm regarding the treatment of Repo 105s as sales of securities. Do you believe that Schich or one of his subordinates should have reviewed that letter? Why or why not? In general, how should the responsibility for different facets of a multinational audit be allocated between or among the individual practice offices involved in the engagement? o The engagement partner that signed the report and is responsible • Lehman’s net leverage ratio was not reported within the company’s audited financial statements, but rather in the company’s financial highlights table and MD&A section of its annual report. What responsibility, if any, do auditors have to assess the material accuracy of financial data included in those two sections of a client’s annual report? o No  They don’t have that accountability and responsibility  They don’t have to recalculate everything  But if they do find out there as a problem, then it is their responsibility • The Repo 105 transactions reduced Lehman’s net leverage ratio from 17.8% to 16.1% at the end of fiscal 2007. Do you believe that was a “material difference”? Why or why not? • In general, what responsibilities do auditors have to investig
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