This essay discusses about the corporate collapses in the new millennium. In recent years the Australian corporate sector has witnessed the failure of number of corporations, including HIH Insurance, Harris Scarf, One. Tel, Ansctt Australia. This paper focuses on the financial audit of HIH insurance, which collapsed on 15th March 2001. This was the largest failure in Australian business history. Royal commission was appointed investigate re-issue of HIH Insurance collapsed with debt estimated $5. 3 billion Australian dollars (Mirshekary, S, 2005).
A brief review of the incidence of corporate failure will be provided prior to an analysis of the collapse of Health International Holding (HIH) and the involvement of its auditor, Anderson. The issue of audit independence is of basic importance in the collapse of HIH. In order to give arguments it is mandatory for all professional auditors to comply with the joint code of professional conduct conventional by the Society of Certified Practicing Accountants (CPA) Australia and the Institute of Chartered Accountants Australia (ICAA).
The collapse of the insurance giant HIH in Australia and Enron in United States has been mechanism for considerable changes in financial report auditing. Many of these changes focus on the presence and extent of the auditor independence. A major issue of the Auditor independence is the treats to independence are usually restrained and difficult to measure. Overall scenario behind the corporate collapse in Australia
In recent years, the failure of Arthur Andersen as one of the biggest auditing firm and its involvement in the issue of the unexpected collapses in Australia(HIH) and USA(Enron and WorldCom). The reasons behind the corporate collapses were regulatory failure, gross fund mismanagement, their excessive discounting, management’s self interest, price cutting strategy, lack of transparency and integrity in the corporation etc; (Tina et al. 2005). During the year 2001, six months before Enron collapse, Australia had its own round of dramatic bankruptcies.
The most famous were mobile telecommunications company One. Tel, national retailer Harris Scarfe and Insurance giant HIH. In 1995, HIH insurance merged with the large Swiss company with the name of Winterthur. During 1998, Winterthur Insurance sold its holding, at that time HIH Insurance was born and given the assurance to purchase FAI Insurance by Rodney Adler (the non-executive director of HIH). In year 1998, The directors of HIH Insurance Ltd. have purchased FAI Insurance to gain market shares and to expand the company.
Although, this was the beginning of the drop of the company. In year 2001, HIH was removed as a listed company from the Australian Stock Exchange with approximately total debt of $5. 3 billion. (Mirshekary, S, 2005) One. Tel was the Australian company has a problem of set in managerial incompetence, with a defective billing system leaving the company unable to collect all its revenue, at the same time the company eventually collapsed with A$2. 4 billion in debts and losses.
Harris Scarfe, went into voluntary liquidation following six years of inflated asset values and many other accounting irregularities (Robins, F, 2006). Auditor Independence Issues and role of Arthur Andersen in HIH Auditor’s independence is the key issue in the collapse of HIH. Independence in auditing means “the professional’s freedom from any bias in relation to an engagement” (book). Independence is one of the auditor’s most vital characteristics and is essential to the principles of integrity and objectivity.
The Code of Ethics discusses independence in the context of freedom from any interest incompatible with integrity and objectivity. Section 324CA-324CC establishes a general requirement for auditor independence (Arens et al. 2002, p. 121). According to Sexton, 2001, it is the external auditor’s role ‘to provide an independent opinion as to whether the company has prepared its financial statements, including result of its operations and cash flows, in accordance with Australian Accounting Standard and Auditing Standards’.
Both Enron and HIH had been audited by Arthur Andersen, interestingly, a Commercial research company, Institutional analysis, has pointed out that there was no independent director in the audit committee from these three collapsed companies (Buffini, 2002a). In order to improvement, it is mandatory for all professional auditors to comply with the Joint Code of Professional Conduct established by the Society of Certified Practicing Accountants (CPA) Australia and the Institute of Chartered Accountants Australia (ICAA).
Arthur Andersen has done the financial audit of HIH from 1971 until HIH’s liquidation in March 2001. During this period Arthur Andersen developed a professional relationship with HIH over a 30 year period, whom it considered to be one of its major Australian clients. There were three former partners of Arthur Andersen held positions on the HIH board of directors at the time when the HIH was going in to liquidation. One of them was received the continuing benefits from Andersen. He was made chairman and appointed to the audit committee after the retirement.
Andersen paid consultancy fees to HIH chairman (Geoffrey Cohen), which was not disclosed to the board in the general meeting. According to AUP 32, no officer of the company that is not been audited shall receive any salary or fees from the audit firm (Cooper et al. , 2006). Aftermath of the collapse, as HIH’s board appointed Dominic Fodera as its chief operating officer in May 1997 immediately after he resigned as a partner at Arthur Andersen. And the third one was appointed after the five months of his retirement.
The amendments implemented recommendations of the Ramsay report (Independence of Australian Company Auditors) and relevant recommendations of the HIH Royal Commission. As a result of CLERP 9 Act amendments, the Corporations Act now contains the following measures to promote auditors independence is a requirement that auditors make an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct, the introduction of estriction on specific employment and financial relationships between auditors and their clients, directors of audit companies and audit personnel may join an audit client as a director or in a senior management position.
The another amendments is a requirement for the compulsory rotation of auditors after a fixed number of years, An auditor should to attend the AGM (Annual General Meeting) of a listed company at which the audit report is tabled and to answer reasonable questions about the audit.
The other requirement for listed companies to disclose in their annual directors’ report that the fees paid to the auditor for each non-audit service, as well as a description of each service (CLERP 9). Sarbanes-Oxley Act (SOA) Sarbanes-Oxley means that there is likely to be a contagion effect of rule-based modifications to governance structures and systems wherever there are significant concentrations of organizations drumming directly into US public capital markets. The most importance changes in US corporate law in many decades was the passage in 2002 of the Sarbanes-Oxley Act.
These changes were listed companies must satisfy audit committee requirements, including the rule that the audit committee comprise solely independent director. The change was public companies must disclose “in plain English and on a rapid and current basis” material changes in their financial condition and other significant company news. A new public company accounting supervision board will have investigative and enforcement powers in its role as accounting profession regulator (Carlin, T, 2006).
Enron’s collapse contributed to the creation of the U.S. Sarbanes-Oxley Act (SOX), signed into law on July 30, 2002. It is considered the most significant change to federal securities laws since FDR’s new deal in the 1930s. Other countries have also adopted new corporate governance legislations. This law provides stronger penalties for fraud and requires public companies to avoid making loans to management, to report more information to the public, to maintain stronger independence from their auditors, and the most controversially, to report on and have audited, their financial internal control procedures.
However, certain provisions in the legislation are currently under review in Congress. (Robins F,2006) CLERP 9 and SOX There is a general observation that the CLERP 9 reforms are less stringent than the SOX reforms in the US. SOX Act is a direct response to economic events, where as Australia’s reform, was in the context of an ongoing reform agenda under the auspices of the CLERP. This reform agenda commenced in Australia in an auditing context as far as the 1997 report of the Ministerial Council for Corporations on auditor independence and discipline (Robins, F,2006).
In Australia(CLERP 9), the Ramsay indicate that there should be an obligatory rotation of the audit partners after a maximum period of seven years but in the USA s203 Sarbanes Oxley Act requires rotation by the lead auditor and reviewing auditor after 5 years. For non-audit services, it is said that SOX Act imposes stricter enforcements than CLERP 9 and in relation to former auditor by clients; CLERP 9 imposes stricter enforcements than the US (Chapple, L, 2007).
Sarbanes-Oxley is different from CLERP 9 due to some reasons. CLERP 9 does not require CEOs and CFOs to sign off on internal control procedures. Because these listed companies make declarations that financial reports are prepared in accordance with accounting standards and present a true and fair view. The accounts are already signed off by the board, which usually has a non-executive chairman, and corporate governance systems have to be described in annual reports (Robins, F,2006). Audit Ethics
The Code of Ethics for Professional Accountants (APES 110) includes some rules, but the Australian accounting bodies have chosen the conceptual elements of professionalism through general statements of ideal conduct. In general, a code of ethics can consists of general statement of ideal conduct or specific rules that offensive behavior. The benefit of the general statements is the prominence on positive attitudes and activities that give confidence a high level of performance and the disadvantage is the difficulty of enforcing general ideals, because there are no minimum tandards of ideal behavior.
In conducting an audit, the auditor should act in accordance with the ethical requirements of the professional auditing standard and regulation. The auditing standard and regulation are appropriate in terms of the audit engagement (ISA 200, AUS 202) while working in the best interest of public and shareholders. Effectiveness of New Developments The potential effectiveness of the enforcement provisions may be criticized in a way common to most self-regulating professions.
In terms of regulating the member’s activities, all powers of enforcement, control or revocation of membership by either the member or the professional body concern. From 1 July 2006, the ethical rules potentially have the force of law. This is the view adopted by APESB. This is because ethical requirements are referenced in the AUASB’s auditing standards (Arens et al. 2002, p. 117). Many Independence threats are difficult to identify, observe and measure; out of them the most readily observable potential threat so far identified is the joint supply of audit and APNAS.
Most of the threats arise from one of the following sources: Self-interest, self-review, advocacy, familiarity and intimidation, Self-interest means the financial interests of the auditor or relatives are involved, Self- review means an auditor evaluates a situation that is a consequence of a previous judgment or advice by the auditor or the auditor’s firm. Potential threats to auditor independence The auditor’s independence and the integrity of the audit can be enhanced through the use of audit committees, auditor rotation and non audit fees.
An audit committee is an advocacy threat which promotes a position and opinion to the point. An audit committee is a selected number of members of a company’s board of directors. Most audit committees are made up of 3 to 5 directors who ideally are not a part of company management. An audit committee is useful for the company to resolve conflicts between the auditor and management, because an audit committee decides such things as auditor nomination and the scope of the services the firm to perform. (Arens et al. 2002, p. 132) An audit rotation is a familiarity threats.
A ‘familiarity threat’ means the same senior personnel on an audit has long been recognized by the professional bodies. Auditor rotation means auditor should rotate in the company for auditing activity. According to Code of Ethics for listed Companies accord with the companies Act requirement that the lead auditor and review partner be rotated every five years. There has been considerable discussion as to whether rotation should be required only of senior audit personnel. When a new firm takes over the other firm, there are implied threats for the lower quality work instead of higher quality work.
On the other hand, the loss of the firm knowledge may encourage lower quality audits, at least in the first two years following the change of audit firms. But for the BIG 4 companies, firm rotation is not a workable option (Chapple, L, 2007). Conclusion: HIH insurance was the unexpectable collapse in the world. Its demise has focused on the audit profession and the auditor’s role in its report. Arthur Andersen was the audit firm which has three partners who were the staff of the HIH and have done audit of HIH which was the breach by the Arthur Andersen and that was the major reason behind corporate collapse of HIH.
The profession is considering the ethical implications which have arisen from the collapse, specifically the provision of the non-audit services to HIH. The future implication of disclosure of non-audit services and the fees applicable as part of this essay. Ramsay report and the HIH Royal commission make a number of recommendations to overcome perceived lack of auditor independence. Because of the present challenges in auditing there will be a higher level of control in regulatory in several locations. This essay further argued on the advantages and disadvantages of the formation of CLERP 9 proposal.
Moreover there is no guarantee that following new standards by auditors will prevent companies from collapsing. Auditor’s limitations have also been discussed in this essay.