New Century Financial Corporation essay
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New century financial corporation had experienced years of financial growth, in terms of stock price appreciation before facing serious accounting problems, early in the year 2007. This forced the corporation to enter in to liquidity. This forced the company to file for a bankruptcy protection, under chapter 11 of Bankruptcy protection policy. According to the expert assigned the role of carrying out investigations at New Century, the problems that faced the company caused the subprime meltdown, which caused a financial crisis in the United States of America along with other countries.
This research paper analysis looks at the performance of New Century Financial Corporation's internal accounting control systems. The paper looks at the business model and accounting practices of the New Century Financial Corporation and focuses on the role played by the management, external auditors, and audit committee in the problems that New Century Financial Corporation encountered.
Accounting control systems help business organizations to use their data and financial information in a uniform manner. Three key divisions exist within the accounting control systems, which include analysis, design, and implementation. This compliments with a system of control, which a certain organization puts in place. The internal control refers to a system that plays a key role in the accounting system. It protects businesses from abuse and fraud. The internal control system ensures accuracy of information, in terms of time and regulatory requirements. Internal control must take into account environmental control, risk assessment, control procedures, monitoring, evaluation, and communication strategies. Each area mentioned contributes to the effectiveness of the control system. When one of these key areas gets secluded, the control strategies and the control system fail to work as expected. These areas form part of the accounting control systems of the New Century Financial Corporation that caused the financial problems in the corporation (Khuzami, 17).
New Century Financial corporation decent came swiftly and dramatic. The stock price dropped and on March 2, 2007, the company decided to announce that it would not file its financial report for the year 2006. This decision made many company lenders become suspicious and refused to provide further funding for the operations of the corporations. Because of these happenings, New Century Financial Corporation decided not to accept any loan application on March 8, 2007. The New York stock exchange removed the company from its list some days after the happening. Two months later after the delisting happened New Century Financial Corporation, and its affiliates filed a bankruptcy protection. This followed a series of certain events in the corporation. KPMG LLP, a new York based independent auditing company resigned as the company's auditor (Plunkett, 97).
New century financial corporation suffered two primary business risks, which included financial difficulties and bankruptcy. As a result of the events that took place in the New Century Financial Corporation, it faced some primary business risks. First, the company faced a risk of going out of business. This could happen because the corporation risked a declaration of bankruptcy that could put it under receivership. This made the corporation apply for bankruptcy protection while it cleared its mess. Because of what happened, the investors of the New Century Financial Corporation refused to continue offering funds to the corporation for fear of losses. All these happenings would lead to the failure of the company thereby missing the customers who worked with it. Therefore, the corporation would fail for lack of funds to run its operations. The corporation required employees to work with it even in the specific time the problems became worse. However, employees would not work for the company without enough pay. Therefore, this means that the corporation would miss its employees for fear of working without adequate payment.
The corporation decided not to lend loans to customers who needed loans. This meant that customers would look for other corporations that could lend the loans. This meant that the company would run out of business because of lack of customers.
All these would cause a lot of losses in the New Century Financial Corporation. The New Century Financial Corporation may face revocation of its certificate of operation. Besides this, the corporation risks losing out on the loans that it had granted to customers. Because of the problems that the corporation faced, it may not be able to put strategies in place that could help it recover the loans it had granted to people (Padmalatha, 87).
The New Century Financial Corporation made accounting errors from its financial statements of the year 2005. New century financial corporation stated that it uncovered accounting errors from its financial statements of the year 2005, which caused an overstatement of earnings that year. The accounting errors came, in addition to those brought forward, by Irvine Company in the first nine months of the year 2006. New century financial corporation made a mistake when it announced that it would not restate results of the period because of liquidation (Rezaee and Riley, 27).
The mistakes accounted for losses on loans that it repurchased. In 2005, the company also made a mistake regarding how it valued some of interest it had earned in security. These mistakes caused in stuff overstatement of pretax income for that year. Therefore, the mistake misled investors to take action using wrong financial statements.
New century financial corporation used audit reports as its financial reporting items. The audit reports consolidated the financial statements into one thing. These did not contain any adverse disclaimer or opinion and did not qualify or take modifications for uncertainty, audit scope, or any accounting principles. For example, in the year 2006, the audit report for the financial statements had not been completed as the end of that year.
Item 304(a) (IV), which allows for, disagreement report in the company, was not followed by any means. Besides, this the corporation did not carry out any auditing itself, to ensure that the audit reports posted by KPMG carried truthful, valid, and reliable financial statement reports. The company relied on the financial reports that KPMG posted from their auditing reports. This made the company work on flouted reports. The reports indicated that the company had made more profits than the profits that the company had made. This happened especially in 2005 and 2006. The company used this erroneous report in its operations, for instance releasing loans. Before the management realized, the company had entered into a serious financial mess that threatened to enter the company in to bankruptcy. The company realized its mistakes in 2007. In March, 2007, the new century financial corporation reported that it had faced difficulty in reaching the target set as the minimal financial requirements needed by its lenders. As a result of this, it indicated that it had become subject to the federal investigation. New century financial corporation faced a serious problem because it did not have the funds to pay its creditors that demanded their money (Misaal, 45).
This became more difficult when the New York stock exchange halted new century financial corporation trading while it decided whether to list the securities of the corporation with regard to liquidity problems that the company faced. In March the same year, new century financial corporation indicated that it would no longer act as the primary mortgage loan provider for government based enterprises. The company also filed a petition to the United States bankruptcy court to retrench three thousand and two hundred people who worked for the company.
There exists certain internal accounting requirements and practices relevant to the risks and reporting items. The first involves environmental control. This refers to the management and employee attitude and behavior in carrying out the corporation operations and procedures. The goals and objectives of the management usually influence employee attitudes and behavior throughout the business. This helps in achieving certain sales and practices within the corporation. The management of the new century corporation ignored the environmental control and assumed everything to happen in the right way. The management did not show interest indicating that it had an interest in reliable financial reports. As a result of this, the company charged with the duty of carrying out auditing of the company became careless. KPMG did not carry out valid reports leading to financial overestimation by the corporation. This happened to create a ground for the downfall of the new century financial corporation. The relationship between the employer and he employee was taken for granted. The failure of environmental control encourages the achievement of what the management wants instead of adhering to internal accounting controls. This happened in the new century financial corporation (Pratt, 90).
The second accounting requirement and practice involves risk assessment. This involves the ability of a business entity to carry out analysis of its business risks, estimate the importance of the risks, and act according to the risk that may present itself. Risk analysis involves a managerial function but may include a daily analysis carried out by employees. This can happen only if the work environment incorporates risk and danger analysis on its system. New century financial incorporation ignored risk management practices. The company did not consider potential risks to prevent them from happening. The company concentrated on the returns that would come from its sales. This contributed to the failure of the company. New Century Corporation did not carry out risk assessment often.
As a result of this, the company realized its failure too late. For a long time, the company did not invest in practices that could help it know risks that could lead to its failure. Thereof, the company assumed that everything went on as it expected. However, the failure came in a sadden way when the company did not expect it. The company had not planned on mitigation measures that it could use to mitigate the risks, in case they happened. This happened because the company did not plan for risks and risk taking measures. When the company knew of its looming downfall, it could do nothing to save the situation. Lack of risk management procedures made the company loose on everything. It happened because, investors put pressure on it the same way creditors, customers and the court did. The company had to lay off its staff and close down as its only option (Lafuente, 67).
The risk management practice would have helped the company carry out analysis and know whether any risk factors existed. In so doing, the company would have noted misdoings and try to fix them. However, the company decided to put all trust to KPMG who did their auditing work in a shoddy way. Therefore, lack of risk management practice as a requirement contributed to the failure of the new century financial corporation.
The next requirement involved control procedures. These provide stated methods that help when carrying out environmental controls and risk management, monitoring, and communication of information in the internal accounting control practices and requirements. These procedures help to prevent and decrease the potential of fraud, inadequacy of poorly trained personnel and elimination of financial processing errors. The checks and balances provided by control procedures ensure that every department in the entire organization provides factual, timely, and accurate information, which the company can use. New century financial corporation ignored these control procedures and delegated all financial auditing responsibilities to a company that did not form part of the company's management. This caused financial report errors that led to the failure of the company. The new century financial corporation did not outline any financial control procedures that would bind KPMG with it in terms of accounting practice accountability (Khuzami, 3).
The last accounting requirement and practice involves monitoring of internal controls. This involves carrying out assessment procedures that help the supervisory personnel to focus on high-risk areas or the company. It helps to identify circumstances that may require change and modification, make operations up-to-date and reliable. This involves spot checks of transactions going on in the company to ensure that they comply with set procedures and policies. New Century Corporation did not show any investment on spot checks to ensure that the personnel dealing with financial matters performed correct and relevant procedures that would help the company work with correct financial reports.
Financial reporting errors
The company failed to review its financial reports, for instance, the comparison of budgeted and actual revenues and expenditure. It also failed to carry out validated comparisons of current and previous year's activities. If this could have happened, the company would not experience the financial problems it encountered.
The management of the new century corporation failed to carry out validated review of FLAIR departmental ledgers, outstanding encumbrances, high-risk accounts, evaluation of trends, supporting documentation, follow up of complaints, rumors, and allegations. These contributed to the immediate fall of the corporation. Had it invested in carrying out the above evaluations, it could realize early that its accounts had incurred mistakes, and from that, it could prevent its downfall.
Key internal accounting controls
To prevent what happened in the new century financial corporation the company should have invested in risk and mitigation measures early.
First, the corporation should have employed another group of auditors as its full time employees to work with the KPMG group. This would have provided better auditing techniques, and different results that would have shown whether the financial status of the company did well or not. Besides this, it would have ensured that KPMG does not do its audit in a shoddy way because KPMG would know that its results would undergo a check and balance to ascertain whether the results posted carried correct information. If it would become difficult to employ a group of auditors that would work permanently for the company, the new century corporation would sort the services of a different auditing firm to carry out auditing of the company concurrently with KPMG, but on an irregular basis. This would have helped the company, to know whether its financial records and financial statements reflected information. This would have helped the company because besides getting different results, the procedure would cost cheaply (Hill, 43).
Secondly, the management team in the new century financial corporation would have made sure that its financial records remained up to date always. For example, it realized very late that it had made accounting errors in 2005. The accounting errors involved overestimating and overstating the returns that the company had made that year. The same happened when a California based company known as Irvine disclosed that the new century financial corporation had made serious financial mistakes in its financial statements for the first nine months of the year 2006. Considering all these, the company took a long time to realize that its financial status went down as time moved. Therefore, the company would invest in standardized management practices. This would have helped the company to ensure that its financial records carried valid information that concerned the financial endowment of the company. In so doing, no financial overstatement would occur in the financial statements of the company. It would also ensure that the company realized errors in the financial statements early, and carry out investigations and evaluations to ascertain the truth in the financial records. The financial management practices would include constant evaluation and follow up, risk avoidance and mitigation control and environmental control.
Another accounting control that could have saved the company from failure would be the procedure for giving out loans to customers. The company gave mortgage loans to customers because of the pressure put on the employees and misguided belief that funds existed in plenty from the returns. New century would have developed a plan that would help it during loan allocation so that employees would not succumb to pressure, even when customers met all the requirements for loan allocation. This would have helped the company to manage its resources in a better way (university of California, 22).
Reasons for failure of accounting errors detection
The accounting errors went undetected for a long time even after change happened in governance of the new century corporation, in post SOX error. The first reason involves the governance itself. Although the governance, of the new century corporation changed the practices in the company did not change. The practices that the previous management used applied in the company after the new governance took over. Therefore, the erroneous practices that cause financial flout in the previous governance team made it possible for errors in the new governance to go undetected. The new governance inherited the practices that existed before.
Another reason involves the accounting errors in the financial statements. The new governance started working with the financial statements that the previous governance used. The financial statements carried wrong information about the earnings of the company in the previous years. Before the management realized the mistakes in the overstatement of the financial records, the corporation had already experienced a downfall.
The new management continued to work with KPMG, which acted as the company's auditor. KPMG had failed to note mistakes in the financial records and practices of the new century financial company. In fact, as at December 30, 2006, the new century financial corporation did not have the audit report for its financial statements from KPMG. Therefore, the errors went on unnoticed because the new governance took over the errors from the previous management and worked with a company responsible for outlining errors, which it did not (Schweikart and Doti, 462).
Even though, new governance had come to the new century financial corporation, in the post SOX error, the errors went on undetected because the new governance did not come in with anything new. Its strategies reflected those used by the previous governance, together with employees and accounting control practices. Not all these could help the company detect errors in the financial statements.
The carelessness in the management and accounting control systems department, in the new century financial corporation contributed to the failure of the company. The company did not put in place measures that could help it detect errors in its accounting systems. Because of this, the company realized its mistakes too late leading to bankruptcy and closure when it realized that it could no longer sustain the needs of its customers, investors, and creditors. If the company had taken a risk and mitigation measures early, the errors could not have affected it leading to its demise. Even with a new governance team, the company could not detect errors because of similar practices and procedures of working.