Role of Accounting and Audit in the Recent Financial Crisis

Role of Accounting and Audit in the Recent Financial Crisis

Alev Dilek Aydin (Marmara University, Turkey)
DOI: 10.4018/978-1-4666-4707-7.ch076
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Abstract

This study aims to assess the role of accounting and auditing in the recent financial crisis. After each crisis, there have been serious discussions concerning the reasons behind those crises. However, no consensus has yet been achieved until now. In this context, the analysis of the relationships among financial crisis, accounting, and auditing is of utmost importance in better evaluating the structural reasons behind the crisis. There are several points that this chapter aims to analyze to indicate the contributions of accounting and auditing to the recent global financial crisis. These points are: impacts of disregarding the main principles of accounting, the wide use of fair value accounting over cost-based accounting, incorrect and misleading financial and audit reports, applications of creative accounting, and lack of transparency and weaknesses of the auditing process. The debates generally concentrate on the use of fair value (mark-to-market) accounting in the financial reports as opposed to the historical cost method. It should be emphasized that accounting is very important as a key mechanism of market economies, because of its crucial role in the functioning of the markets in accordance with the public interest. The chapter concludes with several suggestions by taking the fact into consideration that accounting and auditing systems should be revised for the better protection of interests of the third parties such as investors, potential investors, and the state.
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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:

  • To disregard the main principles of accounting,

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

  • Incorrect and misleading financial and audit reports,

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

  • The applications of creative accounting,

  • 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.

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