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Auditing Case Study for Terminology Business Risk

Question:

Discuss about the Auditing Case Study for Terminology Business Risk.

Answer:

1. (a)

The terminology business risk is considered as a probability that the business of an organization might have a decreased amount of profit than what was expected or the business of an organization might have make losses instead of making profit. It has been found that the risks of any business is commonly influenced by different factors, such as – costs of input, volume of sales, price per unit, the entire situation like competition, economic climate and many more (Smith 2015). From detailed analysis, it can be said that the risks of any business generally impacts the ability of an organization to earn an enormous amount of return. Therefore, the business risks put a negative effect on the shareholders and the investors of an organization. According to Tarr and Mack (2013), an organization might face four types of business risks. These include – operational risks, strategic risk, reputational risk and compliance risk. It has been found that operational risks generally arise in the day-to-day operations of a business, especially when the business fails to carry out its operations accurately. On the other hand, the strategic risks take place when a business is not executed as per the plan or the model of the business. Additionally, the reputational risks commonly occur when a particular business start losing its customers due to various business risks. Lastly, the compliance risks occur when the laws, policies, rules and regulations of a particular business do not comply with the standards.

The business risks that have been identified within the organization HIH Insurance are as follows:

The organization HIH Insurance mainly faced difficulty in its business operation due to the implementation of the aggressive expansive strategy. In addition to this, it has also been found that the particular firm entered into those markets that are highly competitive and are overloaded. Moreover, it has also been noted as per the case study that HIH Insurance has acquired those companies which have several issues. Therefore, all these together have resulted into strategic risks. Additionally, HIH Insurance ventured that particular market in which the firm has least knowledge regarding both the legal issues and business issues. This has leaded the firm to face the compliance risk. Moreover, it has been found that HIH Insurance faced some fundamental issues regarding under pricing and inadequate reserve and the firm offered insurance at a lower rate of premium (Sirtes et al. 2016). However, it failed to reserve capital that might provide security to the business by covering all the future debts of the firm. Furthermore, it has also been found that the management department of HIH Insurance was reckless, greedy and fraudulent, so they provided false reports. All these factors have leaded the firm to face various business risks. Thus, these stated business risks cause damage to the company’s reputation, so it can also be said that HIH Insurance also faced reputational risks. Therefore, it can be suggested that by assessing all the risks, HIH Insurance might manage its operations accurately and can also save the firm from getting collapsed (Damiani et al. 2015).

(b)

At the level of financial reporting, the inherent risk is considered as a risk through which the financial statements of a firm might be misstated materially with the aim to avoid any error. Opined to Bonner et al. (2014), the inherent risks are counted as high only if the degree of judgment is high and assessment is included. Additionally, the inherent risks are common in case of transactions which are complex. The inherent risk factors that are found within the organization HIH Insurance are as follows:

It has been found that within the organization HIH Insurance, the cash balance was overly stated. Thus, the firm represented an increased amount of working capital.

Additionally, it has also been found that the debtors of HIH Insurance were also overly stated. Thus, the working capital condition of HIH Insurance could also be enhanced.

Moreover, the creditors of HIH Insurance were understated, such that the particular firm could represent a high amount of working capital.

Lastly, it has been noted that the firm HIH Insurance has a poor financial situation. Thus, the management had a pressure to overstate the total sales volume and amount. Therefore, the management department of HIH Insurance announced that the target of the firm regarding its profitability and sales were achieved, however, in actual it was not (Adams and Borsellino 2015).

2. (a)

As per the royal commission of the HIH Insurance, due to business, auditing and accounting factors, the particular firm failed. It has been found that Arthur Anderson finished the external audit starting from 1971 till 2001 (year of collapse). As per the competent audit, hostile accounting policy was used by HIH Insurance. Thus, the auditors’ liability was counted as vital factor. Recently, as per Adams (2014), auditors are subject to various laws from common laws to case laws and contract laws.

It is very critical for an auditor to serve an effective control for saving different errors. For Pacific Acceptance Corporation ltd v Forsyth, auditor expresses an opinion about compliance of the financial reports to accounting standards (Gamertsfelder 2016). In case of Kingston cotton mill co, auditors performed their duty with care as they require skills as well as competence. In case of HIH insurance, it had huge numbers of financial statements users, thus, an auditor’s liability to the investors (external users) and creditors extended. Therefore, an attempt was made to identify the liability of auditors of HIH insurance.

For Pacific Acceptance corporation limited V Forsyth, it has been found that auditor was negligent in performing his duties as he was unsuccessful to inform about fraud and irregularities of certain loans (Drinnan and Campbell 2015). Therefore, in this case, auditor is counted liable for negligence.

For the case of Esanda Finance Corporation V Peat Marwik Hungerfords, the finance organization suffered loss as it provided loan on the basis of audited financial statements to a defendant client. Here, auditor was not liable as financial statements were not prepared for using by finance organization (Comino 2015). Thus, auditor was not held liable for the neglectful misstatement.  

As per the case of Hedley Byrne V Heller, disclaimer was efficient in Australia as they were based on the statutory obligations under the trade practice and corporations act (Ramsay 2015).  

In AWA Ltd V Daniels T/A Deloitte Haskins & Sells & Ors case, the auditor was excused from his negligence on the basis that the directors as well as the staffs of the firm were negligent.

For the case of Brown & Hatton V National Australia Bank, the directors should abide proper liability for losses that the firm suffered. This was measured as unfortunate for the directors for escaping the debt by transferring the burden of reimbursing external parties to auditors (Sisman et al. 2015).

On the basis of the above cases, an auditor is measured liable under negligence only if the parties are allowed for recuperating the losses from auditor (Adams 2013). For HIH, the ASIC investigators elevate several queries regarding auditor’s function. They cannot be counted liable to the creditors depending on the case of Esanda Finance Corporation V Peat Marwik Hungerfords.  

(b)

As per the case study, there are only four elements that can be considered as negligent. These are – proximate cause and damage, duty, cause in fact and breach of duty.

The first situation is the identification of the fact that the auditor had any type of duty regarding the plaintiff and due to this; a relationship is counted between the plaintiff and auditor in order to ascertain the duty.

The second situation is the determination of the factor that the auditor had whether failed to perform any kind of duty which he should perform. Thus, the liability of negligence occurs only when the auditor failed to perform his duty with utmost care.

The third situation is to prove that the auditor’s actions had caused a real injury. It can also be said that if the auditor had not performed any action that causes real injury to plaintiff, then the plaintiff would not suffer it.

The fourth situation is that the auditor would be liable for those damages only that he could have foreseen.

The last situation is to prove that a real damage has been caused by the negligent action of the auditor.

3.(a)

According to Merkin and Steele (2013), an organization is able to hire a member for its audit team (external) and for that there an enormous amount of reasons. These include:

An auditor has an experience regarding various financial matters of an organization.

An external auditor is familiarized with the operation, regulation and functioning of an organization.

The management department of an organization has to form a good relationship with the company’s auditor as this particular department has to work closely with the auditor.

(b)

The benefits that an organization can obtain by engaging an external auditor to the firm for the service of consulting are as follows:

It has been found that by appointing an auditor as a consultant within an organization, the management of the firm can save its total costs.

In addition to this, an auditor has valuable experience regarding his clients. Thus, an auditor is able to offer unique solutions to every problem that an organization might face.

Moreover, an auditor possesses enormous amount of valuable knowledge regarding the business of a client. Thus, an auditor is able to provide effective and efficient consultation regarding the operation and regulation of a business.

Finally, it can also be said that an auditor is familiar with any business of his client, thus, for knowing the particular entity, consumption of time can be reduced or saved.

(c)

As per the case study, it has been found that within the organization HIH insurance limited, there are various ethical issues regarding the profession of audit, which lead to the collapse of the firm. The ethics are considered as the series of principles and it has been found that most of the auditors get stuck into various complex cases which might cause several ethical dilemmas. An auditor should act as per the ethical standard and for the shareholders’ interest. Therefore, an auditor should comply with all the five ethical standards, i.e. objectivity, professional behavior, integrity, confidentiality and professional competence. It has been found that HIH insurance limited had paid a huge amount to the audit firm for both non-audit and audit services. Therefore, the firm should consider if it was an ethical matter to give such non-audit fees by taking into account the shareholders’ interest. The management department of HIH insurance limited did not increased the audit fees of Andersen, thus the amount of work on audit was also reduced. Additionally, it has been found that it used the good relationship with the company’s management in order to increase its fees and also to take up more non-audit fees. HIH insurance was allowed to follow the policies of aggressive accounting as it had close relationship with the audit firm Andersen. An auditor is responsible for providing opinion regarding an organization’s financial statements; however, here the agreement of Andersen was unethical as the auditor was in a pressurized situation.

(d)

The discussion paper CLERP 9 and the Ramsay report have provided many recommendations for enhancing the functions of audit. The key recommendations are as follows:

As per the report, it can be recommended that a realistic informed individual might not conclude regarding the dependency of the auditor.

The report also recommends that disclosure of the annual report of an organization is an essential factor. Therefore, from the audit committee a statement regarding their satisfaction about the annual report is a mandatory factor as this implies that the non-audit services will not interfere in the auditor’s independence.

It has been found that from the association of employment, a familiarity threat might arise with HIH insurance and the audit firm. Thus, it might be recommended that the engagement and review partner should rotate after 5 years. In addition to this, there should be a waiting period of 2 years for an audit partner for joining the firm as a director.

The recommendations that have been provided mainly aim to affect the audit functions positively. According to Merkin and Steele (2013), an independent professional should perform the audit as the best view related to the financial statements of the firm can be achieved. The data of the report provides enormous safeguards regarding the non-audit services which help to run the functions without hampering the auditor’s independence. These recommendations also provide safe guards regarding the employment of the audit partners. Thus, it can be said that all the recommendations will help in enhancing the audit functioning and all the changes will have positive effect on audit practice.

Reference

Adams, M. and Borsellino, G., 2015. Is there a positive link between corporate governance and board diversity? Lessons from Asia. Journal of Business Systems, Governance & Ethics, 10(1).

Adams, M.A., 2013. Leighton's character, complexities and conflicts.Keeping Good Companies, 65(11), p.676.

Adams, M.A., 2014. Faulty lines in corporate law: Issues for insurance policies. Governance Directions, 66(8), p.504.

Bonner, G., Hunt, S. and Watson-Dunne, N., 2014. Interim report into the financial system. Government News, 34(4), p.555.

Comino, V., 2015. Australia's' Company Law Watchdog': ASIC and Corporate Regulation. V Comino, Company Law Watchdog-ASIC and Corporate Regulation (Thomson Reuters, Australia 2015).

Damiani, C., Bourne, N. and Foo, M., 2015. The HIH claims support scheme. Economic Round-up, (1), p.37.

Drinnan, R. and Campbell, J., 2015. Class action risk: Now and in the future.Governance Directions, 67(9), p.537.

Gamertsfelder, L., 2016. Disclosure laws and class actions: An irresistible relationship. Governance Directions, 68(5), p.276.

Merkin, R. and Steele, J., 2013. Insurance and the Law of Obligations. Oxford University Press.

Ramsay, I., 2015. Increased Corporate Governance Powers of Shareholders and Regulators and the Role of the Corporate Regulator in Enforcing Duties Owed by Corporate Directors and Managers. European Business Law Review, 26(1), pp.49-73.

Sirtes, G., Lo Surdo, A. and White, R., 2016. Corporations law and class actions: Court recognises indirect or market-based causation in shareholder claims. LSJ: Law Society of NSW Journal, (23), p.80.

Sisman, F.A., Yozgat, U., Abunaz, E. and Ozarslan, T., 2015. IMPORTANCE OF TRANSPARENCY ON SUSTAINABLE SUCCESS ORIENTATION. Research Journal of Business and Management, 2(3), pp.366-379.

Smith, H., 2015. Australia's Company Law Watchdog: ASIC and Corporate Regulation.

Tarr, J.A. and Mack, J., 2013. Auditor obligations in an evolving legal landscape. Accounting, Auditing & Accountability Journal, 26(6), pp.1009-1026.

 

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