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The HIH Insurance


Posted on Aug 2017



The HIH collapse raised several issues with regard to Auditor Independence

Introduction

            HIH Insurance was first listed on the Australian Stock Exchange in 1992 under the category of insurance firms. In the 1990s the company achieved tremendous growth due to its expansion strategy of acquiring various insurance companies with the aim of increasing its make shares in the Australian insurance industry. As a result, the firm acquired firms, such as CIC Insurance Limited in 1995, FAI Insurances Limited in 1998 and Colonial Mutual and General Insurance Limited in 1997. However, due to poor auditing practices, whereby, the management of the company interfered with the work of the auditors, the company eventually collapsed in 2001, with debts amounting to $5.3 billion. It is one of the largest corporate collapses in the modern day Australia. The collapse of HIH Insurance is to a big extent associated with matters to do with auditors independence and has been studied as an important case study on the importance of auditors independence in enhancing corporate governance around the globe. (Bottomley 2007). The main purpose of this report is to analyze audit issues that arose during the collapse of HIH and discuss the relevance of the Sarbanes-Oxley Act to Australian auditors.

Audit Issues during the Collapse of HIH Insurance

            The collapse of HIH insurance was caused to a greater extent due to some auditing issued. One of the major audit issues that contributed to the collapse of HIH insurance is the lack of auditors' independence. According to Monem (2011), the HIH auditors lacked independence they needed to give a right and independent opinion concerning the financial health of the firm. Anderson the company responsible for undertaking an audit of the HIH Insurance before its collapses were directly related to some of the directors of the company. Hence, in this case, the auditors lacked independence of issuing any report that would be against the will of their client. For example, an investigation into the collapse of HIH indicated that Anderson as an auditor was paying remuneration to Geoffrey Cohen one of the senior executives in the company.  This compromised the capability of the outside auditor in having autonomy in giving a valid opinion concerning the financial health of the company leading to its eventual collapse due to the errors of the auditors. Chapple and Koh (2007) indicate that for external auditors to be independent, they are not supposed to be related in any way with one of the directors for purposes of avoiding conflict of interest. However, in the case of HIH, they were related, and this created a conflict of interest resulting to auditors lacking the independence they needed to undertake the work of giving valid and accurate opinion concerning the financial health of the firm.

            The second issue related to the audit issues was auditors releasing final reports without sufficient evidence. The auditors of HIH did not have adequate evidence to carry out proper auditing investigation due to the failure of the firm management to provide sufficient evidence so that they could carry out an audit of the company financial reports and accounts (O'Donnell 2016).  An auditor is supposed to release audit report after having sufficient evidence to ascertain the financial position of the firm is indicated in the financial accounts is true. However, when it comes to the case of HIH the auditors they made an error as they released financial reports without sufficient evidence to support the true financial position of the firm as indicated in its financial reports. Consequently, it was difficult to use the opinion of the auditors in trying to save the company from collapse as they would give a clean bill of health to the financial accounts of the firm without any evidence to support the position (Jones 2011).

            Moreover, the investigations carried out on the causes of collapse of HIH revealed that some of the financial reports could have been adjusted by the management with the help of auditors, and this compromised the external auditors' independence resulting in issuance of financial reports that were on an accurate reflection of the actual financial position of the firm. It is unethical for the auditor to release an audit report; the auditing ethics and principles require an auditor to have sufficient evidence before releasing final audit opinion. The financial reports of the company appeared to have been changed, whereby, some of the items were overpriced and others underpriced with the aim of concealing the financial rot. Thus, the auditor had a responsibility of asking evidence concerning all company's transactions before releasing any audit report, for purposes of ascertaining the financial health of the company (Leung et al. 2009). However, the auditor engaged in unethical practices of releasing audit reports without any supporting evidence. Therefore, Anderson auditing firm which had been contracted to audit the company contributed to its collapse due to concealing vital information that would have been used to save the firm. This clearly indicates that it is important for the auditors to have sufficient evidence before releasing final auditor opinions for purposes of ensuring that they gave accurate and dependable opinions to the shareholders.

            Furthermore, the audit issues during the collapse of the company was that of external auditors providing various services to the company and this close relationship impacted on the ability to make an independent and informed decision.  The independence of the external auditors for the company was compromised in the case of HIH due to the close relationship between the various services offered by the contracted auditor (Mirshekary, Yaftian and Cross 2005). The auditor was responsible for giving legal services to the firm, and this compromised the ability to give an independent opinion that was contrary to the will of the senior management due to fear of losing out other businesses deals in the company. When an auditor is providing other services to the firm part of from auditing services it is difficult for the said auditor to provide accurate opinions regarding the actual financial health of the firm. This shows the importance of ensuring that an auditor does not maintain a close relationship with the firm intended to be audited for purposes of enhancing the integrity. The close relationship between the auditor and the firm made it difficult for the Anderson auditing firm to give an accurate opinion that compromised the quality of the other services it offered to the firm, such as legal advice or acquisition analysis services.

The Sarbanes-Oxley Act

            The Sarbanes-Oxley Act was developed in 2002 for purposes of protecting investors by enhancing the reliability and accuracy of various company disclosures made by the law as well as for other uses. Some giant companies had collapsed due to poor corporate governance practices, especially unethical practices of manipulation of financial reports to suit certain narratives. For example, company directors would manipulate financial reports to show the firm was performing well with the aim of getting higher salaries and compensations regarding bonuses, while in reality, the performance of the firm was bad. One of the areas that Sarbanes-Oxley Act tried to address is about auditing of firm's financial reports. The Act aimed at enhancing the preparation of accurate and reliable financial reports that could send the right signal to the investors concerning the financial health of the firm. The Sarbanes-Oxley Act provided some governance principles that should be followed when it comes to corporate management. The Sarbanes-Oxley Act is relevant when it comes to the Australian auditors as it provides some provisions and recommendations that can enhance the work of auditors, especially in the area of independence and ethics (Reiter and Williams 2013).

 One of the ways in which Sarbanes-Oxley Act is relevant to Australian auditors is about the concept of ways in which they can enhance their independence. This law outlines various measures that auditors and firms should take with an objective of enhancing the independence they need to give accurate and reliable audit opinion concerning the performance of an organization they are auditing (Reiter, and Williams 2013). One of the major reasons why auditors in the past have failed to perform their auditing duties effectively is due to engaging in various activities that undermine their work or ability to make an impartial judgment and these issues are adequately addressed by the Sarbanes-Oxley Act. One of the areas addressed by Sarbanes-Oxley Act is about the provision of non-auditing services. The Act requires auditors not to provide certain non-auditing services, such as bookkeeping services, appraisals, information system designing and implementation and others. In the case of HIH, the independence of the auditors was impacted negatively by engaging in the provision of various non-auditing services, making it difficult to provide external audit opinions that would compromise the ability to provide other non-auditing services to the organization. Therefore, the Australian auditors should follow the provision of the Sarbanes-Oxley Act in the areas of non-engaging in auditing of firms which they offer other non-auditing services that might compromise their ability to give reliable and accurate opinion concerning financial health of a company (Almer, Philbrick and Rupley 2014).

 On the other hand, the Sarbanes-Oxley Act requires auditors not to accept undertaking an external audit of a firm which one of the directors or senior managers had in the past being their employee (Chapple and Koh 2007). The main goal of this provision is to prevent conflict of interest between the shareholder's welfare and the need to protect the welfare of a certain senior manager. The move helps in improving the independence of the auditors by ensuring they are impartial and fair when giving a final opinion concerning the financial standing of a firm. Hence, the Australian auditors should consider adhering to this principle of auditing provided by Sarbanes-Oxley Act about selection of the auditor and firm to audit, so as to easily maintain high levels of integrity and ethics in the auditing process. They should avoid taking up auditing roles in a firm where they known possible conflicts regarding interest exist, as this might negatively compromise the quality of opinion they provide regarding the financial statements and reports of a firm.

            Additionally, the Sarbanes-Oxley Act is relevant when it comes to dealing with an issue of auditors' rotation. This Act requires firms to select different audits in various financial cycles with an objective of enhancing the objectivity and independence of the auditors (Almer, Philbrick and Rupley, 2014). Auditors who audit a firm more than two times end up being compromised by senior managers, with the aim of retaining the auditing rights in the future. Therefore, the auditors’ independence is adversely affected as they cannot provide an accurate opinion concerning all issues in the financial reports of a firm, be it negative or positive. Thus, they become of unethical managers by being used to hide financial accounts manipulation or practices that might result in the collapse of a firm. For example, this audit issue of lack of rotation for the auditors resulted in the external auditors of HIH being negatively compromised giving opinions concerning the financial position of the firm without adequate evidence. It is vital for the Australian auditors to consider the practice of auditing rotation with an objective of ensuring that auditors' independence and integrity is maintained at all times (Leung et al. 2009). The act of rotation would help in avoiding auditors being compromised by senior managers so as to give false reports in the future. The move will be instrumental in enhancing the quality of audits provided by auditors within the Australian auditing industry.

            Lastly, the Sarbanes-Oxley Act is relevant to Australian auditors as it touches on the issue to do with auditing quality. It outlines several measures that can be used by firms in conjunction with auditors to enhance the quality of audit reports. It recommends that firm should establish audit committee which is supposed to be responsible for dealing with all audit reports, instead of the information being presented to the management. This move would ensure that auditing reports are not manipulated, thereby; ensuring auditors provide high-quality work that is a true reflection of the financial position of a firm (Du Plessis, Hargovan and Bagaric 2010). Also, the external auditors are supposed to present any new information they gather concerning the firm financial reports to the audit committee. The Australian auditors should embrace the practice of auditing committee as the basis for improving the quality of reports they present to firm owners based on the investigations carried out on firm financial statements.

Conclusion

The case of HIH shows that auditor's independence is paramount in enhancing the quality of audits and ensuring that auditing ethics are adhered to during the process of investigating financial statements of a company and writing of final audit reports. HIH collapsed to a greater extent due to lack of independence on parts of its external auditors. For purposes of enhancing auditors independence in the Australian economy, it would be vital for auditors to observe the provision of Sarbanes-Oxley Act that deals with accounting and auditing practices within a firm (Chapple and Koh 2007). The Acts provisions are critical in building an auditing sector that is independent of any form of manipulation by the senior managers. In conclusion, all efforts should be directed towards building independence of the auditors so that they can provide reliable and accurate information related to financial health of a firm at all times.