In the latest subprime mortgage crisis, the accounting profession should take some responsibility as it appears basic principles of accounting were ignored when issuing subprime mortgage loans. A couple of these overlooked principles include unbiased opinions of auditors as well as fair value accounting. As noted by VanDenburgh and Harmelink (2008), “It is disappointing to discover that basic bad debt accounting practices were likely not adeptly practiced or audited in the subprime lending sector.” In my opinion, if generally accepted accounting practices had been followed, the subprime mortgage may not have been avoided, but the depths of its reaches could have been lessened.
One of the main accounting principles readily ignored in the mortgage crisis was that of fair value accounting. Here, the cost of property was recorded at its original sale value and then documented at a different value when the asset was transferred to another entity, thus inflating the “books” of lenders. This inflation was caused by willful neglect of the lenders to adequately evaluate the fair value of subprime loans by not taking into account underlying factors in these mortgages such as the buyers’ ability to repay the debt (Kothari & Lester, 2011). Auditors also had a hand in the subprime mortgage crisis. An example of this is the case of New Century Financial, one of the largest subprime lenders. New Century Financial exaggerated their profits and relied on these exaggerated profits to cushion them from the blow of defaulted mortgages on troubled home loans. The company responsible for auditing New Century Financial, KPMG, still proceeded with the proverbial auditor’s “stamp of approval” (‘Lender Failed’, 2008). This, in turn, gave investors who bought these subprime mortgages false confidence in the lenders. In order to avoid the financial crisis of the subprime mortgage misfortune, lenders and auditors should have worked together more diligently and also should have...
References: Kothari, S.P. & Lester, R. (2011). The role of accounting in the financial crisis: Lessons for the future. Retrieved from http://ssrn.com/abstract=1972354
VanDenburgh, W.M. & Harmelink, P.J. (2008). Accounting implications of the subprime meltdown. The peril of forgetting the fundamentals. The CPA Journal, December 1, 2008. Retrieved from http://www.uic.edu/classes/actg/actg593/Readings/Credit-Crisis-09/Accounting-Implications-of-the-Subprime-Meltdown.pdf
The New York Times. (2008, April 14). A lender failed: Did its Auditor?. The New York Times. Retrieved from http://dealbook.nytimes.com/2008/04/14/a-lender-failed-did-its-auditor/
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