Role of Accounting and Audit in the Recent Financial Crisis

Background

This study will try to elaborate the following main points concerning accounting and auditing with the aim of evaluating their contributions to the recent global financial crisis:

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  To disregard the main principles of accounting,

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  The widely use of fair value accounting over cost-based accounting,

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  Incorrect and misleading financial and audit reports,

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  Defaults of the legal institutions in the formation of the accounting standards,

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  The applications of creative accounting,

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  Lack of transparency and weaknesses in the auditing process.

As Hyman Minsky pointed out long before the recent crisis, the finance sector has a tendency to cause crisis because of its nature, which may lead to instability. For this reason, it needs to be regularly audited (Hic, 2009). The principles of accounting such as the principle of regularity, the principle of consistency, the principle of sincerity, the principle of permanence of methods and the principle of prudence need to be emphasized because these principles have been disregarded recently by some companies (Kutlan, 2009). Among these principles, prudence concept is perhaps one of the most related principles with the recent financial crisis. The principle of prudence means that if the market value falls below the cost of the asset, the company must recognise the loss straight away, but if there is an expected profit, it should wait until the asset is sold before the profit is recognised (Butler, 2009). The recent financial crisis has indicated that financial tables prepared according to the International Financial Reporting Standards (IFRS) cannot provide trustworthy and sufficient amount of information about the company to the outside users such as investors, creditors, potential investors and the government.