Auditing and Assurance

The study discusses the auditor’s risk with a view of assessment of key audit risks which threatens auditor’s independence. It also reviews the cases of failure for Enron, Worldcom and Lehman Bros and any moderated about the lessons which has been learnt pertaining to accounting profession from these collapses. The study concludes that auditors need to be more vigilant and responsible in identifying and reporting nonfactual financial information to avoid any detrimental long-term impact on the value of the firm.

Running head: AUDITING AND ASSURANCE
Auditing and Assurance
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1
AUDITING AND ASSURANCE
Synopsis
The topic of the study relates to discussing the auditor’s risk with a view of assessment of key
audit risks which threatens auditor’s independence. The second section of the study have
reviewed the cases of failure for Enron, Worldcom and Lehman Bros and any moderated about
the lessons which has been learnt pertaining to accounting profession from these collapses. The
three main risk in auditing is seen with inherent risk, control risk and detection risk. The
arguments have suggested that there is much greater responsibility related to the compliance with
several types of regulatory initiatives such as improvements in corporate governance
requirements and understanding the risk management. Auditor’s independence is considered as
the independence of the internal auditor and external auditor from parties who have financial
interest in a business which is being audited. In case the role of auditor involved with the design
of compliance system within the company, then the independence from the company seen to be
becoming more difficult to achieve. The lessons drawn from the collapse of Enron, Lehman Bros
and WorldCom have conformed some notable improvements for treatments associated to off-
balance-sheet dodges. The American accounting standards have aimed to improve their standards
to impose more rigorous principles which relates to adoption of a more rigid audit program.

2
AUDITING AND ASSURANCE
Table of Contents
Introduction......................................................................................................................................3
Defining Audit risk......................................................................................................................3
Undermining ideology for auditor independence........................................................................3
Reviewing the literature of Failure of Enron, Worldcom and Lehman Bros..............................5
Lessons drawn by the accounting profession from these collapses.............................................6
Conclusion.......................................................................................................................................7
References........................................................................................................................................8

3
AUDITING AND ASSURANCE
Introduction
The independent audit of companies relied on several types of key component for
supporting capital markets and regulatory framework. The various types of concerns expressed
by the regulators are often expressed by the regulators and observers with sufficient
independence and competency as per the approved audited accounts. The restatement pertaining
to Enron accounts and failure of Lehman Bros is seen to be an obstruction towards justice against
a firm which may have devastating effect associated to loss of confidence and integrity of an
audit firm. Despite of this loss, companies such as Enron, Worldcom and Lehman Bros have
severely compromised with independence in appearance. The main incidents relate to failure of
auditors to identify and report the nonfactual financial information which has a detrimental long-
term impact on the value of the firm. In addition to this, failure by the auditors in identifying the
report on misleading financial information have been expressed with serious concerns pertaining
to the regulators who can also undermine the stability of the capital markets (Ackermann &
Marx, 2016).
Defining Audit risk
Audit risk relates to any instance of projecting met really incorrect information even after
having an audit opinion which states that financial information is free from any material
statements. Due to the investors, stakeholders and creditors, audit risk may possess several
instances of legal liability pertaining to perform audit work (Griffiths, 2016).
Undermining ideology for auditor independence
Based on the establishment of audit risk modelling as per SAS 300 is beneficial in
recognizing overall risk of audit. This is considered as the inappropriateness of the audit opinion
pertaining to financial statements. The three main risk in auditing is seen with inherent risk,
control risk and detection risk. It needs to be understood that in and risk is defined as the
condition of an account balance or a set of transactions which relates to material statement either
when aggregated with misstatement or individually in other classes or balances irrespective of
the associated internal controls (Smetanko, 2014). On the other hand, control risks are those risks
which relate to misstatement is as and when they occur and cannot be prevented, corrected or
detected in a certain time as per internal accounting control system. The detection risk is seen to

4
AUDITING AND ASSURANCE
be consisting of those risks which are having substantive procedure of detecting material
statements (Borkowski & Gaffney, 2018). The control risk and inherent risks are referred to
those which are already incumbent or present by default in a company. It needs to be also
understood that detection risk lies within the auditors. The consideration of substantive testing
preceded by the auditor is seen with the function of assessment associated to the level of control
risk and inherent risk related to a particular company (Zamboni & Litschig, 2018).
In general, some of the audit forms have assessed risk by replacing the combination of
control risk and inherent risk. On the other hand, the business risks are referred with those
measures in which risk pertaining to the audit entity is not achieved according to its objectives.
Therefore, business risks are closely related to objectives of the business rather than financial
statement audit. The procedure of audit can be considered before cost on the risks relating to
material statement in the financial statements as well. This approach is regarded as the main
consideration for adding value to the auditors which may be conducive for improving the overall
performance of the business and managing of the risks at the same time. There are several
suggestions pertaining to the literature which have stated that big farms have been able to
differentiate the value of auditing by adoption of several types of business risk assessment
procedure which are closely aligned with the objectives of management along with consequent
risk compromising with the independence of the auditors. However, there are several
counterbalance measures which are acquired by the auditors for better knowledge and know-how
of understanding the business (Chen et al., 2015). Several other arguments have suggested that
there is much greater responsibility related to the compliance with several types of regulatory
initiatives such as improvements in corporate governance requirements and understanding the
risk management. In case the role of auditor involved with the design of compliance system
within the company, then the independence from the company seen to be becoming more
difficult to achieve. Such an issue raises several factors which are often criticized by the
management (Chan & Vasarhelyi, 2018).
It needs to be also understood that independence of mind relates to that state of mind
which allows provisioning of opinion without affecting our compromising with professional
judgement and thereby permitting an individual to act according to objectivity, professionalism,
skepticism and integrity. The independence as per appearance defined by IFAC needs to be
understood as per the avoidance of circumstances and facts which have a significant and

5
AUDITING AND ASSURANCE
reasonable effect on the informed third-party along with several types of members of assurance
team. Some of the well distinguished model of political cognition needs to be taken into
consideration with the conventional, conventional and post-conventional. The pre-conventional
concept relates to placing of self-interest above the interest of society. On the other hand, the
conventional interest pertains to conformity of an individual to sensitive affiliation of attributes.
The postconventional theory relates to the individual judgements in conformation with the
ethical norms according to society’s rule (Cohen, Krishnamoorthy & Wright, 2017).
Therefore, auditor’s independence is considered as the independence of the internal
auditor and external auditor from parties who have financial interest in a business which is being
audited. The independence factor needs to be accessed with integrity and objectivity approach.
This concept is required with the auditors in carrying out their duties with the objective and free
manner. The independence of the internal auditor related to the independence from the parties
who might be interested in harming the results of an audit report. Similarly, the specific
functions of internal management issues are considered with inadequate risk management
programs, poor governance and internal controls (Sakr et al., 2017). The independence of the
external auditor is discerned with the various types of Independence factors from the parties were
having an interest in results disclosed in the financial reports of the company. This is depicted in
support of audit committee pertaining to the client company and contractual reference code is
generally provides the independence relating to management and code of ethics (Rakhmanova,
Nagumanova & Naumova, 2016).
Reviewing the literature of Failure of Enron, Worldcom and Lehman Bros
The collapse of Lehman Brothers in 2008 is identified as one of the largest instances of
bankruptcy in the history of the United States. However, such a failure is identified as only the
beginning of series of events which has rippled through the market. The failure of the company
cannot be seen with a single cause. Some of the well noted reasons leading to the failure of the
bank can be identified with the debt load of American households, action by the feds, the
regulation of the economy, traders of Wall Street and rating agencies. The aforementioned
factors are some of the reasons which are responsible for credit crisis at Lehman Bros. The bank
was accused of selling CDO to its clients and taking short positions which have eroded the value
of the securities. Goldman Sachs catalysed the process by shortening the mortgage bond market
which triggered a plunge in the sub-prime market (Parwada et al., 2015).

6
AUDITING AND ASSURANCE
Enron was formed in 1985 followed by a merger among Houston Natural Gas Co. and
Omaha-based InterNorth Inc. The company’s failure was triggered in 2000 after CEO Jeffrey
Skilling found a way of hiding the financial losses pertaining to trading and other operations.
This act was known as market to market accounting which involved measuring of value of the
security as per present market value rather than book value (Chernov & Sornette, 2016). In terms
of auditing this is seen as a breach of audit fraud and failure to comply with relevant audit
obligations. The collapse of Enron Corporation led to affect thousands of employees of Wall
Street to its core. The approach of market to market practice made the company appear more
profitable than it was in real. In order to accommodate the mounting pressure of liabilities it
further adopted to several unscrupulous auditing measures which led to use of off-balance-sheet
special-purpose vehicles to conceal the toxic and debt assets related to creditors and investors.
The primary reason of these SPVs where focused with accounting of realities than operating
results (Gambacorta & Mistrulli, 2014).
WorldCom started its business in 1983 with set to create its long-distance telephone
service provider plan as its initiation. Due to questionable accounting practices and
misrepresentation of $ 3.8 billion in capital expenditure, thousands of employees and
shareholders were affected. Despite of increasing cash flow is and profit over four quarters for
misrepresentation of capital expenditure, the firm’s net actual loss was revealed in the long term.
The company revealed its expenses by reducing the overall book value of the assets which
required simultaneous increase of value of goodwill. In addition to this, the internal
investigations revealed that investors were unaware of alleged fraud which pushed its stock price
to $ 64 for each share (Dibra, 2016).
Lessons drawn by the accounting profession from these collapses
The lessons drawn from the failure of Lehman Bros in accounting profession needs to be
understood with avoiding unachievable business strategy. Lehman made a deliberate decision for
fastening the growth strategy. In doing so, they switch to a low-risk brokerage model to a high-
risk capital-intensive model which needed them to buy assets and store them in opposing to
acquiring the assets and primarily moving them to a third party. There had been several instances
of mismatch in the illiquid investments required, short-term and long-term debt which raised the
audit risk. Therefore, in general companies needs to adopt a capital-intensive model if the
benefits outweigh the costs (Ahluwalia et al., 2018).

7
AUDITING AND ASSURANCE
The lessons drawn from the collapse of Enron have conformed some notable
improvements for treatments associated to off-balance-sheet dodges. The American accounting
standards have aimed to improve their standards to impose more rigorous principles which
relates to adoption of a more rigid audit program. In addition to this, the effort made by the
company to ensure realignment of the audit procedure is focused on increasing interest of
shareholders. Several other companies are seen with the need of maintaining stronger non-
executive directors’ attention towards devoting more time for better audit plan. The American
audit standard have also taken several actions for avoiding an instance of market to market
accounting which involved measuring of value of the security as per present market value rather
than book value.
The aftermath of WorldCom collapse has focused on preventing companies in ambitious
investments and availing of easy credit options which may violate the debt equity ratio of the
company. The important measures taken by the companies after failure of WorldCom was
identified with focusing on core competencies rather than short-term growth. By 2000, the
telecom industry identified that WorldCom was covering up for its losses by inflating the total
assets by up to $ 11 billion. This made the company the largest contributor to the fraud in US
history. As a result of such a breach of corporate culture, the newer accounting practices have
ensured strengthening the leadership aspect to avoid such instances (Chernov & Sornette, 2016).
Conclusion
The learnings from the auditor risk is identified with condition of an account balance or a
set of transactions which relates to material statement either when aggregated with misstatement
or individually in other classes or balances irrespective of the associated internal controls. On the
other hand, control risks are those risks which relate to misstatement is as and when they occur
and cannot be prevented, corrected or detected in a certain time as per internal accounting control
system. The independence as per appearance defined by IFAC needs to be understood as per the
avoidance of circumstances and facts which have a significant and reasonable effect on the
informed third-party along with several types of members of assurance team. The important
lessons drawn from the collapse of Lehman Bros, Enron and WorldCom needs to be understood
with avoiding unachievable business strategy.

8
AUDITING AND ASSURANCE
References
Ackermann, C., & Marx, B. (2016). Internal Audit Risk Management in Metropolitan
Municipalities.
Ahluwalia, S., Ferrell, O. C., Ferrell, L., & Rittenburg, T. L. (2018). Sarbanes–Oxley Section
406 Code of Ethics for Senior Financial Officers and Firm Behavior. Journal of Business
Ethics, 151(3), 693-705.
Borkowski, S. C., & Gaffney, M. A. (2018). Transfer Pricing and FIN 48: How Managers
Attempt to Mitigate Audit Risk. Management Accounting Quarterly, 19(2).
Chan, D. Y., & Vasarhelyi, M. A. (2018). Innovation and practice of continuous auditing.
In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing
Limited.
Chen, Y., Gul, F. A., Veeraraghavan, M., & Zolotoy, L. (2015). Executive equity risk-taking
incentives and audit pricing. The Accounting Review, 90(6), 2205-2234.
Chernov, D., & Sornette, D. (2016). Dynamics of information flow before major crises: lessons
from the collapse of Enron, the subprime mortgage crisis and other high impact disasters
in the industrial sector. In Disaster Forensics (pp. 175-221). Springer, Cham.
Chernov, D., & Sornette, D. (2016). Dynamics of information flow before major crises: lessons
from the collapse of Enron, the subprime mortgage crisis and other high impact disasters
in the industrial sector. In Disaster Forensics (pp. 175-221). Springer, Cham.
Cohen, J., Krishnamoorthy, G., & Wright, A. (2017). Enterprise Risk Management and the
Financial Reporting Process: The Experiences of Audit Committee Members, CFO s, and
External Auditors. Contemporary Accounting Research, 34(2), 1178-1209.
Dibra, R. (2016). Corporate Governance failure: the case of Enron and Parmalat. European
Scientific Journal, ESJ, 12(16).
Gambacorta, L., & Mistrulli, P. E. (2014). Bank heterogeneity and interest rate setting: what
lessons have we learned since Lehman Brothers?. Journal of Money, Credit and
Banking, 46(4), 753-778.
Griffiths, P. (2016). Risk-based auditing. Routledge.

9
AUDITING AND ASSURANCE
Parwada, J. T., Shen, J., Siaw, K., & Tan, E. K. (2015). The Value of Institutional Brokerage
Relationships: Evidence From The Collapse of Lehman Brothers.
Rakhmanova, I. I., Nagumanova, R. V., & Naumova, N. A. (2016). Application of Fuzzy Sets
Theory to Assessment of Audit Risk in a Tax Audit. International Business
Management, 10(27), 6149-6152.
Sakr, Y., Rubatto Birri, P. N., Kotfis, K., Nanchal, R., Shah, B., Kluge, S., ... & Vincent, J. L.
(2017). Higher fluid balance increases the risk of death from sepsis: results from a large
international audit. Critical care medicine, 45(3), 386-394.
Smetanko, O. (2014). Improvement of Internal Audit Planning Method through Application of
Risk Card by the Indices of Value-Based Management System of Joint-Stock
Company. Accounting and Finance, (2), 144-154.
Zamboni, Y., & Litschig, S. (2018). Audit risk and rent extraction: Evidence from a randomized
evaluation in Brazil. Journal of Development Economics, 134, 133-149.