Question

In Lehman Brothers' case, why should E&Y have considered the Repo 105 transactions to be material and required these to be disclosed before signing off on the audit? What E&Y should have done regarding the accounting of Repo 105 transactions?

Answer 1

• Materiality means that accountants only record events that are significant enough to justify the usefulness of the information. Only items that are significant for a given size of operation should be recorded & evaluated.
• In simple words, any transaction or event that effect the decision of investor is Material.
• On Lehman’s last balance sheet before it went bankrupt, there were US$ 50 billion worth of Repo 105 transactions. Further, Lehman’s income before it filed for bankruptcy was US$ 6 billion, which made Repo 105 transaction significant due to its volume & size.
• Also, there is accounting principle of substance over form; real substance takes precedence over legal form. Accountants must look beyond the legal form and consider the economic reality or financial substance of transactions.
• Transaction should be reported as short term financial activity rather than to show it as a sale. This should be shown as some type of collateral short term loan.
• E&Y should follow accounting principles and use their professional skepticism to highlight the transaction in their audit report in accordance with reporting standards and save the interest of investors.