Mortgage-backed securities (MBS) produced by New Century and other major subprim

Question

Mortgage-backed securities (MBS) produced by New Century and other major subprime lenders have been a focal point of attention during the recent financial crisis. Many parties have maintained that the mark-to-market rule for investments in securities such as MBS contributed significantly to that crisis and that the rule should be modified, suspended or even eliminated. Briefly summarize that principal arguments of those parties opposed to the the mark-to-market rule. Do you believe that those arguments are legitimate? Why or why not?

Explanation / Answer

According to AU Section 342, the auditor should adopt one or a combination of the following approaches in the audit of an accounting estimate.

a. Review and test the process used by management to develop the estimate.
b. Use an independent expectation of estimate for comparison with that prepared by management.

c. Review subsequent events which confirm the estimate made.

1. Reviewing and testing the process used by management.

In many situations, the auditor assesses the reasonableness of an accounting estimate by performing procedures to test the process used by management to make the estimate. The following are procedures the auditor may consider performing when using this approach:

2. Use of an independent expectation of estimate

The auditor may make or obtain an independent expectation of estimate and compare it with the accounting estimate prepared by management. When using an independent expectation of estimate the auditor would ordinarily evaluate the data, consider the assumptions and test the calculation procedures used in its development. It may also be appropriate to compare accounting estimates so made for prior periods with actual results of those periods. Based on the auditor's understanding of the facts and circumstances, he may independently develop an expectation as to the estimate by using other key factors or alternative assumptions about those factors.

3. Review of subsequent events

Transactions and events which occur after period end, but prior to completion of the audit,
may provide audit evidence regarding an accounting estimate made by management. The
auditor's review of such transactions and events may reduce, or even remove, the need for the auditor to review and test the process used by management to develop the accounting estimate or to use an independent estimate in assessing the reasonableness of the accounting estimate.

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