Auditing in the banking industry.

Auditing in the banking industry
Executive summary
Since the new auditing standard ISA 701 known as Key audit matters (KAM) was introduced,
there have been many reactions concerning the communication of these key audit matters and
their inclusion in audit reports. This paper defines what key audit matters are, responsibilities of
Auditors in determining key audit reports and the role of those charged with governance. It also
sheds light on how a matter qualifies to be a key audit matter. The paper talks about how
Lehman brothers rose in financial scales and their collapse after lying to their investors by using
the Repo 105 transaction to manipulate their transactions .we focus on analyzing key audit
matters in the banking industry and how they should be addressed.
Contents
Executive summary.........................................................................................................................1
Analysis and evaluation of key audit matters in auditing............................................................1
The fall of Lehman brothers.........................................................................................................3
Key audit matters in Banking Industry........................................................................................4
Key audit matter..............................................................................................................................5
How it was addressed......................................................................................................................5
Value measurement of derivatives...................................................................................................5
How to identify key audit matters..............................................................................................13
Conclusion.....................................................................................................................................14
References......................................................................................................................................15

Analysis and evaluation of key audit matters in auditing
Key audit matters (KAM) are issues communicated by those charged with governance, which is
considered of most significance in the auditing according to the judgment of an auditor
professionally.
Those charged with governance – these are people in the organization who have a role in
controlling the process of reporting about finances.
With the introduction of the new international audit standard ISA 701, it is a must for KAM to be
included in audits of all financial statements of listed firms. This regulation applies to all Sacco's,
insurance regulated firms and all companies that are governed by the capital market authority. It
doesn't matter whether the company is listed or non-listed.
According to Segal (2017) those charged with governance must receive communication from the
auditor concerning his roles, which relate to an audit of financial statements. The plan of how he
plans to carry out his audit, the identified significant risks, his view regarding the accounting
policies of the organization, financial statement disclosures and financial estimates, as well as the
obstacles, encountered while obtaining information among others.
For an auditor to confirm issues as key audit matters in the audit report, he must make sure these
issues have been communicated with those charged with governance. He must also put in
consideration matters that require the auditor’s scrutiny while compiling the report. For a matter
to qualify as KAM, the auditor must determine which matters we considered as most significant
and lastly, he must seek permission to look into sensitive matters (Jermakowicz, Epstein, and
Ramamoorti, 2018)

Many factors affect the number of KAM that should be included in the auditor’s report since ISA
701 doesn’t give a specific number to be included in the reports. The size of the organization
must be put into consideration, the nature of the business, the environment of the company, and
the actuality of the audit engagement. If the auditor includes many key audit matters in his
report, he makes his communication to become of less value.
The auditors are required to use simple terms in their reports and avoid issuing out original
information. The effect of the key matters included must be clearly described, but they must
prevent expressing an individual's opinion on the matters.
According to ISA 701, while including the key matters in the report, auditors ought to highlight
the KAM pointed out, give reasons why that matter is considered a KAM, refer the matter to
related disclosures, explain how the issue was addressed in the audit report, and provide an
overview of the procedures that were followed and their outcome (Prasad and Chand, 2017)
The fall of Lehman Brothers
Before the collapse of the Lehman brothers’ firm, the company was a member of the securities
and commodities exchange in the United States. It also held memberships on different
international securities exchanges like in Milan, Tokyo, London, Paris, Hong Kong and
Australia. With its headquarters in New York then, Lehman operated a network of offices in
different continents. It had offices in the Middle East, North and Latin America, Asian Pacific
and in Europe. With clients all over the world, the company specialized in investment banking,
capital markets and investment management serving the financial need of governments,
corporations and individual clients. For years, Lehman maintained its market presence in trading
and research, asset management, investment banking among others (Dodo, 2017)

Lehman Company misled investors in their audit report that was done by Ernst & Young. There
was a mishap in the financial statements of the report as the Generally Accepted Accounting
principles were violated. Lehman had assured their investors that the leverage of the will be
reduced through selling of the assets but this turned out to be a lie. Had Lehman not lied to its
investors they could have known what was going on after the fall, investors sued the company,
Investment banks, the company executives, and the auditing firm that was in charge of auditing.
According to Dutta and Cace, (2016), Lehman hid 50 billion dollars of borrowing by minimizing
the assets by an equal amount using the Repo 105 transactions that were concealed from the
investors on its way to collapse. Repo is a form of financing that allows the borrower to sell a
security for money then repurchase them later in a short period at a set price. Lehman used this
as a loophole by doing reports at the end of each quarter to balance the sheet then a few days
later; it would be reversed. In this case, the repo transaction complied with the GAAP rule, but
the financial statement did not comply. Report 105 is legal; using it to put the financial position
of an organization at risk is subject to imprisonment and financial penalties.
Ernst & Young came out of this case clean though the parties concerned felt it helped hide the
transactions in the financial statement prepared. According to Judge Kaplan, E & Y were not
aware of the modifications, and the charges against them were dismissed. These led to changes
in the regulations that govern accounting, and according to new rules by the Financial
Accounting Standards Board, repo transactions are now treated as borrowings. There was a need
to toughen the auditing standards to avoid fraudulent actions in companies. The financial
reporting Council also refused to take action against Ernst & Young in their involvement to the
collapse of Lehman brothers (Wiggins, Bennett, and Metrick, 2019)