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Auditing Assurance & Services

Executive summary
This paper evaluates the issues with regards to the potential responsibility of the auditor,

especially in times of financial crisis or an economic meltdown that can result in detrimental

consequences. It also highlights the potential of class action that can be brought up against

auditors. It is a fact that financial crisis creates significant blow on the existence of an economy

as well as corporations. This also enhances the duty of auditors and other financial regulators.

Within this critical perspective, the nature of the auditing profession does come into question and

it also intensifies the public discontent with regards to the operations carried out by the auditors.

Moreover, most of this highly strong notion tends to go down due to the inherent memories of

the wide variety of corporate collapses that took place. They were stopped when a new financial

crisis arose. Within this pivotal aspect, the report elaborates the significant role of auditors and

highlights the importance of the auditor’s opinion with regards to the financial statements.
Contents
Executive summary ....................................................................................................................................... 2
1 Introduction .......................................................................................................................................... 4
2 The auditor’s responsibility in adverse financial conditions ................................................................. 5
2.1 Auditor’s opinion .......................................................................................................................... 5
2.2 Going concern ............................................................................................................................... 7
3 Inherent limitations of an audit ............................................................. Error! Bookmark not defined.
4 Managing exposure to liability.............................................................................................................. 9
4.1 Liability Limitation Agreements (LLA) ........................................................................................... 9
5 Conclusion ............................................................................................................................................. 9
6 Recommendations .............................................................................................................................. 10
References .................................................................................................................................................. 12
1 Introduction
From a historical perspective, the financial crisis of 2009 has been highly glorified as a result of

the consistently enduring discussion within the accountancy profession. Along with that, it also

highlights the relevant financial press that surrounds it for analyzing the inherent nature of the

rights, duties and liabilities associated with the auditor. Moreover, it also focuses on the

prospective risk that a potential lawsuit against auditors for the collapse or demise of a financial

institution will have a detrimental impact on their existence. One of the most prominent

examples in this regard has been the unfolding case of the historic bankruptcy of Lehman

Brothers (Christensen et al, 2015). Due to this reason, it is mainly due to the reference to such

infamous past scandals that individuals are able to better evaluate how dilemmas in the modern

era have gained significance and they have also spiralled down within a new cycle of growth and

development (Mügge & Stellinga, 2015). This research report highlights the financial regulatory

approach along with the liability of auditors and also integrates the notion of class action that

could be brought against auditors from their clients. By evaluating and analyzing the consistent

growth and developments that has been made with regards to the potential liability that auditors

face as a result of the global financial crisis, the study would provide an insight within the

evolving nature of the audit and policymaking along with the potential implications required for

the results of regulatory endeavours in this area.


2 Analysis
2.1 Research on Potential responsibility of auditors in financial crisis
From a business perspective, the financial crisis could be considered as a potential opportunity

for correcting certain highly pivotal aspects of the financial regulatory system along with the

limitations that are inherent with it. It is also pivotal with respect to the measures that

governmental and non-governmental institutions would be taking. However, it would also have a

significant influence on the time that is required for controlling the crisis associated with it. Not

only they are important in the short term but they are of significant importance in the long term.

Within the short term, they can help in finding ways through which confidence of the investor

could be restored. In the long term, it can help in solving problems that are associated with

modification of financial principles that would prove to be a guiding principle for reforming the

relevant standards (Mugge & Stellinga, 2015). This could relate to assuring accountability,

improving transparency, ensuring market regulation, ensuring financial markets integrity and

enhancing the level of coordination and cooperation among all stakeholders.

2.1.1 Auditor’s opinion


From a financial perspective, the most important responsibility of an auditor is towards

formulation of an opinion with regards to the financial statements and whether they can provide

a true and fair view of the firm’s financial statements. However, there are situations in which an

auditor is not able to provide any opinion with regards to the financial statements. Such scenarios

would arise where mission and vision of the company was not comprehensive or where the

financial statements failed to comply with the relevant financial standards (Tarca et al, 2013).

Within this scenario, if the auditor provides an adverse opinion, it would illustrate the fact that all

the matters within the financial statements would portray reality. In such a scenario, the

responsibility of the auditor is extracted from the importance of the true and fair view. Moreover,
the responsibility of the auditor may decrease or increase due to the occurrence of events within

a specific scenario. This can also be reflected within IAS 10 “Events after the balance sheet

date” (Walton, 2016). From a financial perspective, IAS 10 means “those events that are

favourable and unfavourable and arise between the financial statements have been prepared and

the date that they have been authorized to be presented. Within this scenario, there are two key

points to be noted: -

 Providing evidence of conditions that existed when the financial statements had been

prepared (adjusting events that had lead to the preparation of financial statements)

 Indications that the conditions had occurred after the financial statements had been

prepared (events that do not lead to adjustment of financial statements).

Within this pivotal standard, the manager evaluates the material significance of events before

deciding if it is essential for making any adjustment to the financial statements. Within this

scenario, it is difficult for the auditor to evaluate whether the true and fair value of the items

within the financial statements would be established.

The importance of general principles that surround audit of financial statements has been

asserted in ISA 200 (Glaum et al, 2013). It states “The core objective of audit of financial

statements is allowing potential auditors to provide an opinion on the degree at which financial

statements would be prepared and whether they or not they comply with the relevant accounting

standards”. It is a fact that the audit of financial statements should be done with adherence to the

relevant procedures along with the relevant financial and legal standards. After the audit of the

financial statements, the report is signed by the auditor and sent to the company’s shareholders

(Dewing & Russell, 2004). Due to the fact that auditors are recognized as professional that are
held responsible for giving a true and fair view of an entity’s financial statements, they have a

significant amount of liability to assure that the statements reflect a true and fair view of the

company’s financial position. Whenever auditors are required to perform an audit, they are

levied with a great amount of responsibility primarily due to the terms of their audit engagement

as well as due to the nature of financial services they have to offer.

2.1.2 Going concern


Within the auditing and finance profession, the notion of going concern has certainly been one of

the most fundamental issues that have surrounded auditors specifically when the global financial

crisis had initiated in 2007. Within this pivotal framework, firms are required to prepare financial

statements on the assumption that they would be able to continue in business for the foreseeable

future for a specifically defined period (Dewing & Russell, 2002). If an organisation intends to

close down its business operations after its reporting date, then this will certainly have a

significant impact on the overall value of the firm’s financial statements along with having an

alternate for the preparing of company’s accounts (Dewing & Russell, 2008). Within the

framework of the international auditing standards, it has become pivotal for auditors to evaluate

whether the notion of going concern has been associated with preparing and presenting the

financial statements that would adhere to the relevant accounting framework. However the

overall expectation for auditors and accountants to evaluate importance of going concern has

often been misunderstood and is directly interlinked with expectations. A similar issue arose in

November 2009 when the UK Financial reporting committee (FRC) had provided a substantial

level of guidance for evaluating and addressing the risks related to liquidity and going concern

that have been faced by financial institutions at the start of the credit crunch (Arnold, 2012). It is

still highly evident as an essential part of the essential inquiry that had been started in March
2011 being an essential proof of its ongoing potential despite of the potential stability of capital

markets since 2008.

2.2 Application of a class action of a global firm against Lehman Brothers


A key issue that auditors have to analyze with respect to the negligence that can arise from their

practice is class action. From a theoretical perspective, class actions rest on a highly simple

business proposition. They can be defined as self-selected class representatives along with their

lawyers. They are supervised effectively by their court and could also represent various class

members through a group that is adequately well placed for overcoming individual rights of all

associated members (Drinnan & Campbell, 2015). Within this notion, interests could be

represented by persons and institutions not that are selected by constituencies for their life. The

issue of class action can also be integrated with this research as the core perspective of this study

is to assert the fact that the position of auditors within the financial arena is comparatively unique

when compared with other professions (Mügge & Stellinga, 2015). The reason for such a pivotal

opinion is based mainly on the inherent nature of audit along with the inability of the auditors for

controlling the task with respect to the claims that are associated with it. The exposure of

auditors along with the unlimited liability with respect to an extremely wide range of claimants

does exceed the sensitivity of this profession to a huge extent (Combarros, 2000). The type and

nature of risk involved in the project can certainly help in effectively distinguishing the liability

of the auditors from the different professions that are associated in this framework. This pivotal

issue was also raised by The International Federation of Accountants (‘IFAC’) with regard to

section 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial

Statements’ (Christensen et al, 2015). It states that “when owed to the associated limitations of
an audit, there is a risk that some of the material misstatements that are related to financial

statements would certainly not be detected, even if the audit has been planned effectively”.

2.3 Managing exposure to liability


2.3.1 Liability Limitation Agreements (LLA)
Since the financial recession of 2007/2008, auditors have been allowed within the terms of the

Companies Act 2006 for using the Liability Limitation Agreements (LLAs) as they can help

them to reduce the threat that derives from client litigation matters. From a theoretical

perspective, LLAs could be defined as clauses that have been built within the terms of a financial

engagement that would impose a limitation on the amount of compensation that would be

required from the auditor (in case of negligence). However, this agreement has to be approved on

an annual basis by shareholders and should also be upheld by judges whenever any adverse

scenario arises in this regard (Cooper and Robson, 2006),

Although this scenario may sound straightforward on paper but it does have inherent limitations

associated with it. One of the core limitations comprises of how to elaborate the cap limit.

Another inherent issue with it is to decide what would be reasonable and fair whenever

shareholders or company directors have to set the terms of the engagement as this could only be

done after litigation has been brought into consideration (Cooper et al, 1998), It is only open to

interpretation and understanding of the courts or the regulatory authorities.

3 Conclusion
The research has certainly revealed some pivotal attributes with regards to auditing and

accountancy. With regards to the audit of financial statements, the most pivotal factor is to

evaluate and analyze whether the financial data has been appropriately recorded and it reflects

the financial scenario in a correct manner. For having a thorough understanding of the financial
statements, it is essential that the auditor must have comprehensive experience with regards to

interpretation and collection of data. Within this pivotal scenario, the transparency of financial

statements would be scrutinized along with the auditor’s accountability. Such an objective would

only be achieved if there has been an establishment of a strong and binding relationship between

all the associated stakeholders. It is pivotal for auditors that the audit of the financial statements

has been done with adherence to all the rules and regulations of relevant accounting standards.

This would call into question very few elements that would raise any question with regards to the

potential liability of auditors.

4 Recommendations
 From the perspective of class action, it is difficult to integrate class action within an

individual based legal system. The difficulties along with the extra administration

associated with the work does place several obstacles for the claim to be successful. The

fact should be noted that auditing and producing a comprehensive set of financial

statements within this highly complicated global economy has been a technique that

relies mainly on judgments that would arise from experience along with having a highly

sophisticated understanding with regards to economics, business and accounting. It is

essential to note that an audit of financial statements does require a huge amount of

judgment, decision making and subjectivity than it can ever be recognized. To avoid any

potential class action that could be brought against them by clients, auditors should be

vigilant when providing their opinion or judgment.


 Another important fact to be recognized with respect to class action is the extent of the

liability of the auditor. Due to the fact that financial audits tend to be carried out by

commercial and retail organizations, the overall extent of the liability of an auditor would

certainly matter a lot to audit firms as it does significantly affect the extent to which the

profitability of the firms is affected in this regard. Within this pivotal framework, a low

liability threshold for a consistent range of associated indeterminate parties would

certainly propel potential for abandoning audits for a company.


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