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E&Y and Lehmans – Another 2 cents March 16, 2010

Posted by Audit Monkey in The Joy & Pain of Internal Audit, The State of the British Nation.

Don’t worry, I’m not being pernickety and claiming that the Repo’s 105 used by Lehmans to reduce the Balance Sheet liabilities were understated by 2 cents.  I thought I might as well add my 2 cents to the debate which is currently brewing over E&Y’s alledged negligence in failing to spot the accounting substance behind Lehmans use of Repo 105’s to reduce leverage. In plain language, a bit of good old-fashioned ‘window dressing’.

For those in the dark, a bit like myself until a couple of days ago, Repo 105 and Repo 108 to be precise, were repurchase and resale agreements which Lehmans used to secure short-term finance.  The ‘accounting problem’ is that these were treated as ‘sales’ transactions in the Profit & Loss rather than debts and loans in the Balance Sheet. Lehmans also used the loan monies received to pay off other liabilities in the Balance Sheet.  In toto, the effect was to reduce Balance Sheet liabilities and leverage and show a more healthy financial position to the outside world than otherwise would be the case.  Then after the reporting period, e.g. year end, Lehmans would ‘correct’ the books to the true position, once the Auditors, our good friends at E&Y had left stage right.  Ergo sum (I love a nice bit of Latin to sound flash and half-educated), it is alledged that E&Y let the use of Repo 105’s go unchallenged and have been very naughty, i.e. negligent.  For those wishing to read chapter and verse of this episode, the Valukas report is online.

Sounds juicy but at a guess I’m sure that Lehmans went down with a massive hole in it’s Balance Sheet which a few Repo’s wouldn’t have covered. Of course, this has precipitated a wave of articles in the Financial Press arguing for auditors to be ‘allocated’ to FTSE 100, banks and no doubt every other Tom, Dick and Harriet so that auditors aren’t compromised by conflicts in interest, i.e. ignoring Balance Sheet ‘indiscretions’ in order to maintain their audit fees. One columnist wanted the FSA to be the official arbitrator and a central pot or scheme which auditees paid into. I am quite sceptical whether this will occur in terms of sheer practicality and complexity. It will be interesting to see how episode this develops.

“Keep smiling through, just like you always do,
‘Til the blue skies drive the dark clouds far away…”


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