New Century Case

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1.1) Brief of the New Century Financial Corporation Case
Over the past two decades, nearly half of the homeowners obtained their loans through subprime mortgage lending. Subprime mortgages were becoming increasingly ordinary in daily life of business for homeowners over the past two decades. However, numerous lending institutions provided home loans to borrowers who have high credit risks and are not be able to payback the loans. New Century, which is the second largest subprime lender in the country, prospered over the last decade. However, its sudden collapse following the restatement of company’s financial statements, contributed significantly to the subsequent events that eventually lead to the plunge of global financial systems in 2008. Along with New Century, Bear Stern, Lehman Brothers and Merrill Lynch are major players, which are brought down by the subprime mortgages fiasco. This case briefly provided us the meltdown of the subprime mortgages market and how it eventually leaded to an unprecedented global financial crisis. Bob Cole, Ed Cotschall, and brad Morrice found New Century in 1995 and the companies focused on the subprime sector of the mortgage market. New Century’s subprime mortgage business experienced significant growth since its inception in 1995 due to a decreasing mortgage interest rate, the deregulation of the lending industry, and a booming housing market in California. Starting 2006, Rapidly delinquencies on the loan payment weakened New Century’s financial condition. In 2007, management informed the board and audit committee that the company had understated its loan repurchase loss reserve for three quarterly reporting periods of 2006 due to “inadvertent oversight.” On April 2, 2007, New Century filed for bankruptcy in a U.S. federal court. KPMG served New Century’s independent auditor since it inception in 1995. The federal bankruptcy examiner performed extensive investigations of New Century’s quarterly financial statements and KPMG’s audit of New Century. The federal examiner alleged that KPMG failed to perform New Century’s engagements in accordance to “professional standards.” KPMG faced charges including improperly staffed audit team and lack of independence issue. The federal examiners also charged KPMG failed to consider international control weakness and to audit the company's loan repurchase loss reserve. The default rate on loans in 2005 double that on loans in any previous years. Therefore, without an effective internal control system, New Century was not able to correctly record the increase in the loan repurchase loss reserve starting 2005 and beyond. The fact that New Century only considered recent three months repurchase-requests prior to balance sheet date resulted in a material weakness of company’s reported earning. The second factor contributed to the understatement of the loan reserve was the oversight of the “interest recapture” element with related to each reporting period. KPMG insisted that the federal examiner’s allegations was “one sided” and lack of an evidence to support. Ac accounting professor at the University of Chicago claimed that it is the risky business model resulted in New Century’s bankruptcy instead of KPMG. KPMG also face other charges in the field of subprime mortgage industry.

1.2) How this case is relevant to prior cases discussed in the class? There are several critical auditing issues addressed in this case which are relevant to prior cases discussed in class. Other important issues addressed in the case include weather auditor is able to exercise professional care and retain independent relationship with clients. The case also identifies key factors of the auditor’s responsibility of analyzing the effectiveness of a company’s internal control system over financial reporting. Similar to New Century’s case, one of the major issues in CBI Holding Company, Inc. was whether Ernst & Young was able to maintain an independent relationship with...
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