Audit Report of Lehman Brothers Leading Investment Banking Firms

Question: Discuss about the Audit Report of Lehman Brothers. Answer: Introduction: Lehman Brothers were one of the leading investment banking firms of U.S and was at the fourth number after Goldman Shacks, Morgan Stanley and Merrill Lynch. It went on for 158 years from 1850 to 2008 when it got shut and faced serious crisis at the time. This event left a mark in all the markets globally and lead to changes in many policies by the government. It also led to formation of ASA701 which included better auditing rules and all the reforms taking all the lessons from Lehman Brothers event. The event was sparked by undue negligence, financial crisis, mortgage crisis etc. and has been known as U.Ss largest bankruptcy till date. Lets look at all the points deeply in the assignment. Collapse of Lehman Brothers: Lehman Brothers Holdings Inc. was a firm which gave its financial services globally and on a large scale and thats why it was fourth in top investment banking firms in the U.S and dealing on a huge scale includes transactions worth millions which should be maintained and efficiently put into tests and audits with time. On September 15, 2008, the entity took a step to file Bankruptcy protection Chapter 11 which led to a chain of events from a disruption in its clients to massive losses in stock markets and even the assets were devalued by the rating agencies and that led to the collapse. Reasons for Bankruptcy Due to negligence of the auditors and carelessness what sparkled was U.Ss largest bankruptcy. It even uncovered the real reasons behind the financial crisis of late 2000s. After all the mess happening to the global markets Barclays announced its want to purchase the Lehman brothers Investment banking firm in U.S along with its new york headquarters and later on Nomura Holdings announced to buy Lehman brothers franchise in Asia-Pacific and also in Australia, Japan and Hong Kong. On 13th October same year the deal took place. At the time of bankruptcy Lehman Brothers had $639 billion in assets and $619 billion in debt and it left Word Com, Enron bankruptcies far behind. It had 25,000 workers working for the firm at that time. The subprime mortgage of U.S was the prime reason which nearly swept away the market in 2008. It led to erosion of $10 trillion dollars off the market cap of equity market. Markets went a maximum low point that following month. The firm was a small general store a t its starting and that led to a giant firm in the future and it went through a lot of depressions and even the two world wars. The three L(s) responsible: The depressions included railroad bankruptcy, 1930 great depression, Russian Debt default, Long term capital management collapse. We can see in its history that the firm had a lot of potential and survived a lot but the depression following 2000s hit it the worst and brought it to its knees. The Lehman Brothers playing at a large scale could not be underestimated but collapsed due to failure in being rescued from a government bailout. The whole event was a blast for the whole industry because the first thing that the amount to be administered was $600 billion huge and was nothing that the government has ever faced and it was a company which was widely spread due to a web of companies and that made everything very complex and unlike Enrons bankruptcy in 2001. The Lehman brothers failed because of some reasons. Now leverage played a big role in the failure starting from what leverage is then leverage is when you gear up in the good times which means that you borrow money from sources a nd then invest it in the places or assets which are giving good returns and that will magnify the gains by multiples. The average well maintained banks keep a leverage of 12 times which basically if explained means that for every $1 the bank can give a loan of $12 and if your assets are increasing then the gains will increase to its multiple but if they start falling the loss is going to be in multiples. Lehman brothers Inc. has a leverage of 44 at its extreme and which rose from 20 to 30 to 40 and then the extreme happened and which means if a person of $1000 wage had to buy house using $44000 mortgage. Due to that the borrowers were always in a fear of falling property price and increasing interests and the company was stuck in the same tornado. The man thing which lacked was not the lack of profits but the severe lack of cash. It was right that Lehman brothers started to face some serious liquidity issues and it lacked quick assets which meant that the assets which could be realised in very less time though it had a very impressive capital base and assets, liabilities volumes. As the whole market was feeling the crisis and other banks also realised what the company was going through and they then ceased all the lines of credits for the company to save themselves and that was the main reason for the collapse of any bank which is when they lose market confidence which means that the y have no market left to trade and do business with and the existence ceased because nobody could see the future of the company. Rivals and Financial Exposure Only several months ago the competent Bear Sterns faced the same crisis before JP Morgan Chase came to its rescue and helped it through its lack of liquidity. After the terrorists attacks in 2001 the market of properties commercial as well as residential saw a rise for 6 years and that because of the decreasing interest rates. In the three years before 2006 the market already started to fall and the point that Lehman Brothers was hugely exposed to the property market having around $61 billion worth commercial properties and as well as providing sub-prime mortgages which were loans given to families to buy houses having poor financial records in the past. It also had a lot of investments in Credit Default Swaps and Collateralized Debt Obligations in the same sector. As now the properties had started to crash and all the investments were devalued and it faced a loss of $6.1 billion due to that because it was caught somewhere which was impossible to get out of because prices of property crashed and arrears started to take place. The company had a long history of more than 150 years and that too as a NYSE giant for more than 15 years which was very impressive. So, at that time of the depression, rival companies like Merrill Lynch, Bear Sterns also faced the problems but survived because they had someone to buy the firm like JP Morgan to Bear Sterns rescue. At the time of depression Lehman Brothers were one of American Banks interests but because of Merrill Lynchs deal finalising before the chance failed and even Barclay wanted to buy Lehman brothers but failed because the U.K government blocked the way to invest into Lehman Brothers under some regulations and its marked in the books by the owners as a historic point known to be when Britain government destroyed Lehmans future. As the financials of the company were a mess so there last resort to borrow an emergency loan from the feds failed because their calculations predicted losses and even less collateral to honour the loan and even if they had received the loan it was impossible for the company to revive. At the end of the situation the public was already disturbed and frustrated from the financial markets and the idea of the feds rescuing a company like Lehman Brother and then putting losses of millions and billions on the name of taxpayers didnt entertain them and they couldnt be possibly revived and seeing a potential buyer the deal was done resulting in the sale of bank to another bank and losing everything and failing. Due to the leverage, point where the company has nearly no liquidity, losses, messed up balance sheet and no buyer ready to rescue the company it failed. Whom did it affect? This failure would have affected the population as a whole of U.S in indirect way but all of the burden was to be directly put on the institutional investors and the people who help the stocks and as a cherry on the top many of its products in insurance were spread and working around the wall street. The failure of the company made the public and the government realise what bad they did to the economy letting a giant company like that to fall and the whole global economy joined in the movement to bailout banks in their countries taking a lesson and U.S couldnt afford to lose another bank of this size. The drastic event for the whole global economy forced each and every company to take a lesson and change all the regulations regarding the auditing and that gave rose to ASA701 as a step by the government to save the existing companies from a failure due to reaching a circumstance like Lehman Brothers were caught into. The problem behind was that the feds didnt give any explanation for the bailout of the Lehman brothers. The feds kept silence and it was misunderstood by the investors and the public. The solution to that would be if the government provide a real and very clear reason behind not bailing out or bailing out of any organization according to the statue provided by the government. No one could have imagined that the government has to rescue any non-banking firm and the rule didnt exist till then so what government should have done was that to have adapted to new things in the market and provide regulations according to that. With the ASA701 the scope broadened in communicating the key audit matters. ASA 701 and improvements The scope of the standard included the significance of the above mentioned, the matters which should be stated and the matters auditors had most robust with to be communicated, the communication between both the parties would improve, and the assumptions about users of financial reports. Elements of the Auditors report were to be the opinion of the auditor on the business which can be of several types stating the condition and the data sufficiency of the report. When an adverse or qualified opinion is given by the auditor then all the reasons which led to the decision should be mentioned along with the report on insufficiency of any evidence. The determining of the key audit matters by the auditor is very necessary and it states that the matters most significance out of all the matters should be chosen, matters should be of the current year, and the matters which were the key matters should not be included in the report unless they are also present in the current year. The matters which are of significance to the auditor can be firstly performing the actions according to the risk assessment of the company and the higher the risk the better and higher quality evidence and in more quantity is required, matters that are challenging to the auditors and the matters which require a high level of assessment are some matters of more significance. Lessons from the event The success of the audit depends on its quality to determine the key areas of communication in the financial reports along with forming an opinion about the fullness of the financial reports of a company. The learning which all of us can take from the event can be that the price that we usually pay for the stocks we buy really matters because as seen in this case we could see that the markets went down drastically before the event in 2007 and it nearly went 57% down but if we would have invested when the people were taking their money away from markets fearfully we would have earned around 270% returns. One should never buy and keep all the shares of the same kind or of the same sector unlike 2000s when the internet stocks were eroded this time the shares that got affected were of financial giants and these companies were so big that there numbers affected the global markets directly and even there stocks were used in many retirement plans but now in the current from the 2011 the price of the financial stocks started to go up and make profits nearly doubling its value in the span of three years. Bow having the heart of a bull would have worked in this case because what happened in the circumstance was that people took around $500 billion out of the market in the fair of losing money but if they would have hold the stocks till date all of them gained around 230% till the market started facing bulls in 2009. People mostly consider the blue chip stocks as the stocks which can be invested in because they are the stable and slow growing stocks but the crisis showed that there are no shar es which are volatile and that we should always treat the stocks as they are which is volatile and nearly unpredictable. Even the dividends were unsure of because at the time of crisis when the financial stocks started facing such problems they even lowered the amount of dividends to keep them financially safe. All we could say after the event was that the markets closed at all time high but that was of no help to the people who had to quit some five years ago and the reason behind was the losses that they made because a portfolio has the maximum chance of earning at time when it is new and in the starting years of the portfolio investment. So in learning something from the event taking risks are very important to earn profits but the risk management and profile should be kept low in as to trade more safely. Summary: This assignment took us through the history of Lehman brothers to the failure and all the reasons that led to the failure. ASA701 is also explained further in brief so that an idea can be taken out about that. The major crisis which led to the failure and how the negligence of the system led to the biggest bankruptcy event in the history of U.S and the lessons which were learned by the institutions globally affected the public indirectly. The global downfall and the chain reaction which made the happening of one event after another gave the world a good lesson about what financial markets can be. References: ASA 701, (2015) Communicating Key Audit Matters in the Independent Auditors Report, Retrieved from https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf Indiviglio D, (2010), 4 Reasons Why Lehman Failed, Retrieved from https://www.theatlantic.com/business/archive/2010/09/4-reasons-why-lehman-failed/62588/ Arcy C, (2009), Why Lehman Brothers collapsed, Retrieved from https://www.lovemoney.com/news/3909/why-lehman-brothers-collapsed Investopedia, (2017), Case Study: The Collapse of Lehman Brothers, Retrieved from https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp Pozen R. C., (2009), Two Lessons from Lehman, Retrieved from https://hbr.org/2009/09/learning-from-lehman