Reasons of the Lehman Brothers’ financial collapse

The weak and ineffective audit is what led to the unexpected collapse of the investment company. The objective of the audit is to assess the financial condition of a business at that time and the forecasts for the foreseeable future, as explained by Millichamp and Taylor, 2012. Forecasting the financial results of an audited company helps ensure that the investment decisions that will be made by all stakeholders are correct and effective. These decisions are made regarding the projected financial future of the business. In this regard, the audit of Lehman Brothers was not so specific that a potential collapse would be detected and resolved.

Lehman’s commitment to subprime loans is explained by the fact that they predicted that housing prices would not go down and that market movements would continue. Their opinion was influenced by their negligence in their audit reports. Reports have not been able to make long-term projections accurately, taking into account market uncertainties and risks. This flaw has made them incapable of implementing prevention strategies when market conditions deteriorate. Their audit reports should have revealed the excessive borrowing that raised their leverage ratio (assets to equity) above what is required by US regulations. Their 2007 leverage ratio of 31: 1 was greater than US regulations by less than 15: 1. Nor did the independent auditor’s reports reveal or communicate the firm’s buyout transactions (called Repos 105 and 108 ).

Les Repos indicated that the company was selling assets worth 5% and 8% more than the amounts received as loans, respectively. This is described as 5% and 8% over-guarantees (Jones and Presley, 2013). The companies, however, presented their financial statements to deceive the stakeholders. The Rest: Pensions delivered operations were used to conceal the effect of the high leverage during the audit. Sharp (2010) reports that the company’s repurchase agreements have increased the balance sheet by $ 50 billion. The manipulative processing of the firm’s audit reports did not reveal the fact that between the 4th quarter of 2007 and the 2nd quarter of 2008, the firm consumed approximately $ 36.8 billion in US securities ) (De la Merced & Werdigier, 2010).

Another defect not detected in the audit reports was the fact that the rest repo entries corresponding to the liabilities section were not indicated. The firms policy to treat delivered pensions as sales was defended by their auditors, Ernst & Young, who said that audit standards

at the time supported this practice.The company generated approximately 64% of its revenue from its significant investments in the mortgage industry (McDonald, 2016). It financed its daily activities in the repo and fixed income and equity securities markets. Neither the Ernst & Young audit firm nor Lehman Brothers internal controls were able to detect the times and frequency of the rest transactions.

The audit should have been able to reveal whether Lehman Brothers had enough liquidity to resolve the pension situation, so that it could be able to maintain a good relationship with the creditors. Therefore, this information would also have revealed whether the company could maintain constant and continuous capital to finance its operations. A full audit report should allow the company to manage its balance sheet in response to market fluctuations as during the financial crisis in 2008.

The major issues that caused the collapse of Lehman Brothers is poor governance in terms risk management, according to their audit, they did not foresee any risk in their large investments. Organizations need to make sure they have a way to balance their levers and their bottom line. During periods of prosperity, the levers should be high and weak during recessions (Greenlaw et al., 2008). From this analysis, it is clear that verification problems were the primary factors in this unexpected collapse.

The financial downfall was not foreseen in the auditor’s report, which gave previously unqualified opinions. The credibility of David Einhorns winning business report was questionable. David was a US hedge fund manager at the time and his Lehman Brothers earnings audit report was not credible and authentic information was not released to the public. Following this report, the company announced a loss in the first quarter since the issuance of the IP introduction bear. The president and chief executive officer of the company then resigned, which led to the dismissal of the Chief Financial Office (CFO).

The company’s financial condition deteriorated further and a loss of $ 2.8 billion in the second quarter required the liquidation of $ 6 billion. Lehman Brothers then reported a loss of $ 3.9 billion in the third quarter and the situation was not helped either by impairments totaling $ 5.6 billion. The company’s share price fell 73% in the first half of September 2008 (Harris, 2013)