Accounting and Corporate Governance Essay Example for Free

Accounting and Corporate Governance EssayThe memo is to address the method of accounting maneuver of Lehmans Repo one hundred five (or 108) from perspectives of accounting and collective governance. The memo will illustrate the role of repo transaction in Lehmans business model, analyze the accounting irregularities regarding repo by Lehman, observe auditors role in these irregularities, and converse the corresponding accounting and corporate governance issues. In addition, the memo will provide recommendations on how to prevent financial institutions from abusing regulatory deficiencies by emphasizing on the importance of accounting regulation, auditors role, and business ethics. See more Recruitment and selection process essayThe major goal of Lehmans Repo 105 is to temporarily rack up troubled securities from its balance sheet go presenting favorable financial statements to its investors, creditors, rating agencies, and the unrestricted. By temporarily removing these securities from its balance sheet, Lehman made its leverage ratio much grimer. With low leverage ratio, Lehman would keep its credit rating at high level and maintained its customers confidence.A repo, or sale and repurchase agreement, is an agreement in which integrity party transfers to another party as confirmative for a short-term borrowing of cash, while simultaneously agreeing to repay the cash and take back the collateral at a specific point in time (SFAS 140). An ordinary repo should be treated as a financing transaction and should be accounted for as a secured borrowing. An ordinary repo is a commonly-used form of secured loan between financial institutions. In fact, repo does not excite real frugal substance.However, by the Repo 105 transactions, Lehman did the same(p) in an ordinary repo, but because the assets value were 105 percent or more of the cash received, accounting rules permitted the transactions to be treated as gross revenue rather than financing. Lehman aggressively employed Repo 105 transactions before inform periods at the end of 2007 and the first two take ins of 2008. During the reporting periods, Repo transactions helped Lehman extinguish assets from balance sheet and use cash received to payback short-term loans. In addition, Lehman did not report any liabilities that reflected the obligation to repay the borrowed funds.After the reporting periods, Lehman would borrow funds to repurchases the transferred assets. Then these assets would be reversed on the balance sheet again. The consideration is whether Lehmans accounting for Repo 105 violated the broadly received Accounting Principal (the GAAP). report of Financial Accounting Standards No. 140 (SFAS 140) provides the accounting road maps on repo transactions. A company is permitted to account for these transactions as sales only if the transferor surrenders control over the assets to transferees.To account for a repo transaction as a sale, all three conditions must be met 1) the transferred assets must be insulate from the transfer, 2) transferee has right to pledge or exchange the assets, 3) the transferor does not maintain effective control over the transferred assets. A typical repo contract can good meet the first two conditions. However, in order to take advantage of favorable accounting treatment as sales transaction, Lehman has employed some accounting maneuvers to meet the three condition.SFAS 140 (Paragraph 218) states that the transferors right to repurchase is not assured unless the repurchase price is 102 percent or less of the cash received, or the cash received is 98 percent or more of the value of the transferred assets. The Board believes that other collateral arrangements typical fall well outside that guideline (FASB, 2000, p. 91). The repurchase price of Repo 105 is 105 percent of the cash received, which is higher(prenominal) than the 102 percent guideline. As a result, Lehman could argue that Repo 105 did not meet the th ird condition of maintaining effective control, and then classified it as sales.Based upon the above analysis, Lehmans accounting for Repo 105 seemed to be technically in compliance with the U. S. GAAP. However, Lehmans bankruptcy examiner Anton R. Valukas (2010) provided evidence showing that Lehman intended to use Repo 105 to manipulate its 10-K and 10-Q financial reporting. Valukas argued that the classification of these repo transactions should be based on its economic substance rather than its form (such as the 102 rule). Since Lehman had clear intent to buy back the transferred assets under Repo 105, these transactions are clearly secured borrowing and should not have been recorded as sales.The obvious accounting irregularity is Lehmans failure of disclosing Repo 105 transaction in its quarterly and annual financial reports. Valukas (2010) report indicates that Lehmans SEC 10-K and 10-Q filing between 2000 to third quarter, 2007, regularly misrepresented some repo transaction as secured borrowings despite that it actually recorded as sales. In addition, Lehman neer get wordd its involvement in Repo 105 its 10-K of 2007 and the first 10-Q of 2008 (Chang et al, 2011).In fact, Lehman has aggressively involved in Repo 105 during the end of 2007 and first two quarters of 2008, removing nearly by $38. billion in fourth quarter 2007, $49. 1 billion in first quarter 2008, and $50. 38 billion in second quarter 2008 (Valukas, 2010). It is clear that Lehmans misrepresentation and failure of disclosure of its Repo 105 practice is material enough to mislead its investors, debtors, rating agencies and the public. As the auditor of Lehman Brothers, Ernst Young approved the use of Repo 105 transactions. These transactions were characterized as sales of assets and created a misleading picture of Lehmans financial position during the financial meltdown.Ernst Young said in a statement Our last audit of the company was for the fiscal year ending November 30, 2007. Our opinion indicated that Lehmans financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles, and we remain of that view. Ernst Young would like the public to believe their responsibility for Lehmans financial statements ends with the 2007 10-K. Actually, It does not. According to the examiners report, Ernst Young had fitting started planning for its year-end audit of Lehman when the firm collapsed into bankruptcy.Lehman remained an EY client until the bankruptcy in September 2008. This period included two more 10-Qs. But most impress for the auditors could be allegations in the examiners report that Ernst Young did not inform the audit committee on Lehmans board about a whistleblower who had expressed concerns about the repos to them. In a March 2010 letter to its clients, EY defended its audit work for Lehman. The letter states that Lehmans bankruptcy resulted from unprecedented adverse events in the financial markets, declining asset values, and loss of market confidence that caused a collapse in its liquidity.The firm believes the bankruptcy wasnt caused by accounting or disclosure issues, as Lehmans financial statements clearly portrayed it as a leveraged entity operating in a risky and volatile industry. The most telling assertion in the complaint concerning EYs alleged(a) misrepresentation of Lehmans compliance with applicable accounting standards is that EY didnt require the financial statements to reflect economic substance rather than just legal form. In other words, the complaint accuses EY of letting Lehman engage in transactions without business purpose in order to achieve a specific financial-statement result.The bankruptcy examiner said that the touch on function of Repo 105 transactions as employed by Lehman was to reduce its publicly reported net leverage and net balance sheet. Although Lehman knew that none of its couple companies were using the same accounting tricks to arrive the leverage numbers, it continued to rely on the use of Repo 105 substantially, at a level that is much higher than the originally defined materiality level by the management.As a consequence, it left Lehman with heavy concentrations of illiquid assets which could not be monetized to meet its current obligations (Lehman Brothers Holding Inc. v. Debtors, 2010). The inspector did not find supporting evidence to bring colorable claims (Lehman Brothers Holding Inc. v. Debtors, 2010) against Lehmans directors, however, they should have better monitored the managers.And the examiner did find sufficient evidence to support a colorable claim against certain senior officers for breaching their fiduciary duties to shareholders and other stakeholders because they failed to inform the public and shareholders about the substantial use of Repo 105 by non-disclosure of related information and by filing materially misleading periodic reports, which risked the company with potential liabilities a nd they also failed to advise the Board of Directors of the Repo 105 practice (Lehman Brothers Holding Inc. v. Debtors, 2010). The examiner also cerebrate that sufficient evidence existed that Lehmans quarter? nd Repo 105 practice was material and should have been disclosed in the financial statements.In addition, Lehman had an obligation to disclose required information relate to Repo 105 in its MDA statement. In terms of accounting malpractice, Lehmans external auditor, Ernst Young, was also held responsible for allowing Lehmans financial reports to go unchallenged. Ernst Young well knew the practice of Repo 105 adopted by the company, but failed to review the volume and timing of Repo 105 transactions, and failed to access the materiality of information omitted regarding Repo 105 transactions.Furthermore, Ernst Young failed to conduct investigations with regard to the concern about Repo 105 raised by Matthew Lee, then-Senior President of Finance Division. In conclusion, corpo rate governance was lacking twain internally and externally (Lehman Brothers Holding Inc. v. Debtors, 2010). The accounting irregularity of Lehmans Repo 105 practice partly due to the deficiencies of accounting rules, however, integrity or accounting professionals as well as business ethics also play an important role in the accounting malpractice.In 2009, FASB issued SFAS 166 to amend SFAS 140. These efforts could close some loophole in accounting standards. Good corporate governance requires not only effective board and ethical top management, but also reliable accounting forcefulness and independent outside auditors, to properly perform their jobs and fulfill their responsibilities, to create the check and balance that can maintain the financial health of a company and at the same time to reduce agency cost.In case when one party went badly, the others could and should be there to detect the potential problems and to monitor and correct the mistakes. In summary, the ethical cha llenges faced by EY in deciding how to address issues with a long-standing and profitable client may be faced by many public accountants. In fact, accountants in all areas of the profession frequently face similar ethical issues of simultaneously complying with their duties for faithful service and loyalty to their employer or client while respecting their responsibilities to other stakeholders. Doing the right thing for all concerned may sometimes be an impossible assignment. Guidance such as the overarching principles of honesty, fairness, objectivity, and responsibility contained in the IMA Statement of Ethical Professional Practice will go a long way toward helping all accountants to do the right thing. Doing the right thing is continuously the best policy in the long run.