Auditing New Century Financial Corporation Essay

Pages: 5 (1635 words)  ·  Bibliography Sources: 1  ·  File: .docx  ·  Level: College Senior  ·  Topic: Accounting

Auditing New Century Financial Corporation

KPMG served as the independent audit firm of several of the largest subprime mortgage lenders. Identify the advantage and disadvantages of a heavy concentration of audit clients in one industry or sub-industry

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The problem with having too many clients in one industry / sub-industry are: they can have undue amounts of influence and obvious errors will be continually ignored. In the case of clients having undue amounts of influence, the more a particular auditor is involved in the sector, the greater the chances are that various team members will be familiar with a number of insiders. This is problematic, because this relationship that they have with various corporate officials, means that they can influence the kind of personnel that will be selected to perform the audit. As the company can claim how they want the best auditors, who will do the most detailed analyzation of their books. Yet, beneath the surface this is ruse to find those individuals that will: overlook various issues inside the company's books and report that they are in line with different regulations. Over the course of time, this allowed a number of different discrepancies to occur in the earnings that were reported to: investors and regulators (versus the actual amount that a company is making). A good example of this can be seen with New Century Financial, as they would continually have problems with the auditors that KMPG was sending. On the surface the company was claiming that they wanted the best accountants. However, underneath it all they wanted someone, who would report that there were no dramatic material changes in their earnings. Once this occurred, it meant that it was only a matter of time, until the actual numbers began to deviate dramatically from: the actual losses that they were posting. ("Mortgage Mess, n.d.)

Essay on Auditing New Century Financial Corporation Assignment

This contributed to obvious errors that were not being disclosed to: regulators and investors. Evidence of this, can be seen with the KMPG listing a non-material opinion of fact about New Century Financials earnings in 2004. As they would claim in this statement, that the actual numbers were not entirely accurate, based on the fact that they took into account a variety of assumptions to include: interest rates would continually remain at low levels and that housing demand will be strong. However, if there was any kind of shift from these conditions, this could mean that the company's profits will turn into losses. This is important, because the increasing amounts of influence that a company had over its auditor, had a direct impact upon the way their different financial records were: analyzed and reported. Once this occurred, it meant that obvious discrepancies in the subprime mortgage industry were written off as anomalies. At which point, the underlying risks were ignored, increasing the chances that some kind of financial implosion will take place down the road. ("Mortgage Mess, n.d.)

When you step back and analyze the situation, it is clear that if one particular auditing firm has too many clients in the industry, it can lead a number of problems. As they can influence the firms and the way various audits are being conducted. This is important, because once this begins to occur on a regular basis, it means that errors and discrepancies are overlooked. Over the course of time, this means that the company will be telling investors that their earnings and financial results are accurate (leading to higher valuations / profit margins). Yet, beneath the surface the real numbers are showing a far worse situation. At which point, the underlying risks of: a financial implosion (surrounding the company) increase dramatically. ("Mortgage Mess, n.d.)

As noted in the case, there was an almost a complete turn-over of the staff assigned to the New Century audit engagement team from 2004 and 2005. What quality control mechanism should accounting firms have in such circumstances to ensure that a high quality audit is performed.

The best mechanism for addressing this issue is to: bring in auditors that have no affiliation with the company or industry. The reason why you are using this approach is that, a particular company could be familiar with the different individuals and personalities. In the case of New Century Financial, they could use this information to tell the accounting firm, who they are comfortable with performing the audit on their records. This is problematic, because it is giving them undue amounts of influence in: deciding who will be conducting the review. ("Mortgage Mess, n.d.)

As a result, if the auditing firm had a mechanism that would bring in outside accountants, (that have no affiliation with the industry) this will improve the accuracy of the result. The reason why, is because company officials have no legitimate reasons for: not wanting a particular individual conducting the audit. This will reduce the chances of them: interfering in the process and will ensure that all of the auditors are objective parties. Once this takes place, it will provide the most accurate results and address any kind of discrepancies (by disclosing them immediately). If this kind of approach can be taken, it will make certain that the information that is being reported by the company is: accurate. Therefore, this mechanism can help to address: this conflict of interest and prevent the situation from becoming worse. ("Mortgage Mess, n.d.)

When you step back and analyze this quality control mechanism, it is clear that it can prevent conflicts of interest from occurring, by selecting auditors from outside of a particular industry. This will prevent companies from influencing, who will be selected to conduct the audit. Once this occurs, is the point that the information being provided will be as accurate as possible. This is because; the auditors will be objective in how: they are looking at and analyzing the information. At which point, its overall accuracy will increase dramatically. ("Mortgage Mess, n.d.)

Section 404 of SOX act requires auditors of a public company to analyze and report on the effectiveness of the client's internal controls over financial reporting. Describe the responsibilities that auditors of public companies have to discover and report (a) significant deficiencies in internal control and (b) material weakness in internal controls. Include a definition of each item in your answers. Under what conditions can auditors issue an unqualified or clean opinion on the effectiveness of a client's internal controls over financial reporting.

Auditors have a responsibility to immediately report any kind of significant deficiencies inside the corporation's balance sheet. This is important, because under section 404 of SOX, it is requiring that any kind of material changes, are disclosed to investors and regulators. At the same time, they have a responsibility to: help the company identify and improve weaknesses in the different internal controls that could be contributing to the problem. This is significant, because it will help a company be able to improve upon these issues, by having the auditor identify what challenges they could be facing. At which point, they begin introducing various mechanisms and controls for addressing the problem. ("Mortgage Mess, n.d.)

The basic conditions that auditors can use to issue an unqualified opinion is: based upon what they are determining is a material weakness. This is when, they have concluded (upon their own audit and evaluation) that the underlying risks are severe enough that some kind of: drastic actions need to be taken to disclose this information. As a result, if an auditor finds internal deficiencies, they can claim that these are not considered to be: a material weakness and begin offering unqualified opinions on the underlying earnings results of the company. This is important, because it shows how an accounting firm can find internal errors in the operating procedures of the organization. Yet, they do not directly disclose this as a violation of… [END OF PREVIEW] . . . READ MORE

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How to Cite "Auditing New Century Financial Corporation" Essay in a Bibliography:

APA Style

Auditing New Century Financial Corporation.  (2011, March 17).  Retrieved January 25, 2021, from

MLA Format

"Auditing New Century Financial Corporation."  17 March 2011.  Web.  25 January 2021. <>.

Chicago Style

"Auditing New Century Financial Corporation."  March 17, 2011.  Accessed January 25, 2021.