Financial Reporting Scandals - Misinterpretation of Statements - The Lehman Brothers

Scandals

The Lehman Brothers case is an example of how misreading financial statements and
breaking key accounting principles may result in a significant scandal that has an impact on a
country's economy, like the Enron case that we reviewed last week. The entire structure of its
operations was divided into collateralized debt obligations and mortgage-backed securities that
were based on subprime mortgages, a category of mortgage loans issued to borrowers with
incomplete paperwork and consequently higher credit risk (Brueckner, Calem & Nakamura,
2012). Furthermore, Lehman Brothers' portfolio was encircled by real estate, which, when
combined with the Federal Bank's low interest rates and the mark-to-market accounting method
used by its accountants, caused assets to falsely appreciate in the company's books at a time
when more people were investing in homes regardless of their financial ability to do so. The fact
that the leverage ratio between assets and equity was close to 30% (Zingales, 2008), indicating
that the firm continued to buy assets and mark them in the fair value, which was obviously
greater than the historical value (Wiggins, Piontek & Metrick, 2014), was another factor that
contributed to the financial disarray within the company. As a result, the equity could not support
the assets financially when the real estate market began to crumble. The balance sheet was
purposefully misleading while the company reported record revenues and profits.
Lehman Brothers' actions violated the prudence convention in accounting, the historic
cost convention, and the going concern convention. It is astonishing that the dual aspect
convention may have also been broken, as the firms' leverage ratio was extremely high for an
investing firm, supporting the idea that proper recording could not be achieved. The firm, which
is an investment company, broke the prudence convention by failing to properly disclose its
losses while simultaneously obtaining funding from investors, misleading its shareholders with
an alternate balance sheet despite the depreciation of its assets. At the same time, the mark-to-
market method violated the historic cost convention while the business model presented in the
balance sheet was not viable and financial sustainable concurrently violating the going concern
convention (McLaney & Atrill, 2020).
Lehman Brothers' collapse severely impacted the global banking system and the financial
system (Johnson & Mamun, 2012). Large sums of money were lost by firms and people who
invested in Lehman Brothers and linked enterprises. Analysis of the circumstances leading to the
firm's demise and the events that followed its bankruptcy revealed flaws in the firm's risk
management implementation tactics, and the accounting standard is directing the accounting
treatments of transactions involving repurchase agreements (Azadinamin, 2013; Jeffers, 2011).
Regulators could identify fraudulent activity on the part of financial institutions if they had a
basic understanding of accounting, financial statement creation, analysis, and auditing (Schapiro,
2010). Finally, more attention should have been paid to the supervision and monitoring of the
significant financial conglomerates' operations because their collapse had a negative effect on the
wider financial system.

References

Azadinamin, A. (2013). The bankruptcy of Lehman Brothers: causes of failure &

recommendations going forward. Social Science Research, 8, 2013.
Brueckner, J. K., Calem, P. S., & Nakamura, L. I. (2012). Subprime mortgages and the housing
bubble. Journal of Urban Economics, 71(2), 230-243.
Jeffers, A. (2011). How Lehman Brothers used Repo 105 to manipulate their financial
statements. Journal of Leadership, Accountability and Ethics.
Johnson, M. A., & Mamun, A. (2012). The failure of Lehman Brothers and its impact on other
financial institutions. Applied Financial Economics, 22(5), 375-385.
McLaney, E., & Atrill, P. (2020). Accounting and Finance: An Introduction (10th ed.). Pearson
International Content. https://online.vitalsource.com/books/9781292312293
Schapiro, M. L. (2010). Lehman Brothers Examiner's Report: Congressional Testimony. DIANE
Publishing.
Wiggins, R., Piontek, T., & Metrick, A. (2014). The Lehman brothers bankruptcy a: overview.
Yale program on financial stability case study.
Zingales, L. (2008). Causes and effects of the Lehman Brothers bankruptcy. Committee on
Oversight and Government Reform US House of Representatives, 23-25.