Memo: Why do Audits Fail? Evidence from Lincoln Savings and Loan
This study done by Merle Erickson, Brian Mayhew, and William Felix describes and examines the audit procedures applied to a set of material transactions from the Lincoln Savings and Loan audit failure. They suggest alternative procedures, based on information available to the auditors at the time of the LSL audit. The study also provides a starting point for future research to evaluate the conclusions reached using more controlled settings or larger data sets.
The five main points given in this research study are:
1. The authors noted that the LSL auditors had apparently followed standard audit procedures yet they still ...view middle of the document...
Secondly, they could have learned that the real estate market in Phoenix was in a significant downturn with fewer new housing developments starting. Another thing that could have been very beneficial for the auditors is knowing that most of the funds used to finance the sales came from one single LSL subsidiary, which meant all the risks of the sale remained with LSL. And finally they would have discovered that many real estate sales transactions that defaulted would affect the parent company and not be isolated to a subsidiary that was partially kept off the books.
4. The authors’ description of the audit failure at LSL leads us to discover a better understanding of to conduct a risk based audit. Their concept is simple; by understanding the nature of the business, management’s motivation, the clients control system and the complexity of their transactions, the auditor can better determine the risks. Auditors should focus greater skepticism and audit testing on the accounts that contain the highest risk of material misstatement. I can relate this to the article I presented over, Risk Management in Client Acceptance Decisions by Johnstone and Bedard, where they examined the three types of risk: audit risk, client business risk, and auditor business risk.
5. The study concludes that if the auditors would have followed a risk based approach they would have seen that there were significant...