Question

In regards to the Freddie Mac scandal of 2003,

What were the business risk and fraud factors?

What accounts were misrepresented and how was it done?

What auditing standards were violated?

Answer 1

A) Business Risks and Fraud factors of Freddie Mac scandal 2003 are as follows

1) Lack of attention to the staffing,skill set and resources

2) The policies were weak or non-existent

3) Deficiencies in internal controls

4) Lack of Care in responsibility to ensure safety and soundness

5) Over market exposure

B) The root of the problem Could be found in the Statement of Financial Accounting Standards (FAS) 133, which determines accounting rules when derivatives are used as hedges. The rules require companies to assign current market values to the interest-rate swaps, options, and other derivatives they hold and to reflect any changes in their value on the balance sheet. Additionally, companies can offset any gains (or losses) on an asset with a similar loss (or gain) on the derivative used as a hedge. Crucially, any changes in a derivative's value can be recognized over the life of the hedge, allowing companies to avoid the volatility that market-value accounting creates. Freddie took advantage of this loophole in hedge accounting to amortize gains and thus smooth company earnings, effectively boosting investor and lender confidence in the company.

C) Auditors have a duty to form and express an opinion as to whether the company's accounts demonstrate an accurate view of the entity's financial position. The auditor, judged that Freddie's accounts were compliant with GAAP and therefore the audit was 'unqualified'. In doing so, auditor appeared to have failed to notice the fact that Freddie kept their loan loss reserves at levels higher than that permitted by GAAP, maintaining a reserve account to cushion fluctuations in premiums and discounts resulting from mortgage prepayments. Neither did auditor realize Freddie's illegitimate reporting of the derivatives trading. The auditors, as professionals and specialists, should be responsible for realizing such material misstatement. The auditor violated, auditor's responsibility in detecting fraud through a company's internal controls