ACC701 Accounting Financial

In recent times, there has been an increased incidence of corporate bankruptcies which has had an adverse impact on the shareholder confidence and has led to growing importance of sound corporate governance practices. The essential aspect of most of these corporate failures is that from the outside it seems as though the underlying liabilities became untenable leading to the inevitable collapse of these organisations. However, on closer examination, the key issues which relate to deficiencies in business model, management approach and weak corporate governance practices. The given report tends to present an analysis of the three corporate bankruptcies namely HIH Insurance, ABC Learning and One Tel in the wake of APES 110 Code of Ethics along with principles of corporate governance.

In recent times, one of the most relevant corporate governance practices framework has been provided by the ASX (Australian Stock Exchange). These essentially rely on the following eight corporate governance practices (ASX, nd).

• “Solid foundation for management and oversight” – The underlying roles and responsibilities of the board of directors need to be shared so as to enhance transparency and accountability.
• “Addition of value through board structuring” – The board members should have the requisite knowledge and skills besides having significant representation of non-executive directors for maintaining independence and segregation from management.
• “Promotion of decision making driven by ethics and responsibility”- The directors should promote ethical behaviour by disclosing any conflict of interest that they have and must exercise their powers with responsibility and due diligence.
• “Safeguard financial reporting integrity”- It is imperative that the independence of the internal audit committee along with the external auditor must be maintained and no such action is to be taken by directors to adversely impact the same.
• “Making disclosures in a timely way”- Any material disclosure should be made public in a prompt manner irrespective of the impact of the same on the share price and also the future of the management.
• “Respect the shareholders’ rights”- The directors must provide opportunity to the shareholders to participate in general meeting and to exhibit their right to vote besides allowing them to communicate with the company for detailed information or queries.
• “Recognition and management of risk” – Provisions in the form of risk management committees must exist so as to ensure that the underlying business risk is identified and managed through appropriate measures.
• “ Fair and responsible remuneration” – Fair remuneration must be provided to the directors and the management as decided by the remuneration committee so as to ensure that while being competitive and have reasonable benchmarks to meet for performance related pay.

Additionally, for professional accountants, code of ethics has been put in place in the form of APES 110 which focus on the following key attributes. (APESB, 2010).

Integrity – The accounting professionals must ensure that they should not engage in any dishonest conduct thereby compromising their integrity.

Objectivity – The accounting professionals must avoid situations involving conflict of interest and must be objective in their analysis and opinions.

Professional competence and due care – The professionals should have the requisite knowledge about the latest developments in the accounting field and must not engage in negligent conduct.

Confidentiality – The professionals need to preserve the confidentiality of their clients unless there are special circumstances which demand the same. 

Professional Behaviour – It is imperative that exemplary professional behaviour must be displayed by accounting professionals. 

The requisite analysis has been conducted for the three corporate failures in order to identify the real cause of bankruptcy.

Case 1 - ABC Learning

Even though the company was formed in 1987 but it became prominent only after going public. The company implemented ambitious plan in relation to expanding the business reach within a short time span. The company was able to spread operations geographical which was cheered by investors leading to share price appreciation.  However, the strategy adopted by management was not prudent since geographical reach was attained but in the process the service standards were diminished. This eventually paved way for the bankruptcy of the company (CPA, 2012).

Case 2- HIH Insurance

The company had been in existence for more than two decades but significant growth for the company started only in the last decade of the 20^th century. The company undertook a number of acquisitions with the intention of enhancing geographical reach and also product portfolio.  However, this vast portfolio of subsidiaries ended up increasing the risk of the company since it continued entering new products and geographies where significant business risk existed. But the management did not have requisite risk management practices in place and instead relied on a flawed reinsurance model. However, these practices were able to be continued owing to the nexus between the external auditor and management which led to undisclosed business liabilities till the time that no recovery was possible (Mak, Deo & Cooper, 2005).

Case 3- One Tel

It was an established telecom player at the time of bankruptcy filing. Thus, the failure of the company did not happen suddenly but was in the making for a long time. The company resorted to an ill-conceived and economically unfeasible promotion plan to garner more customers. However, the losses that the company made on account of these were hidden from the financial statements. As a result, a false picture of the business was presented to the external stakeholders while the business was in continuous losses and their quantum was increasingly which eventually led to the bankruptcy of the company (Monem, 2009).

Research

ABC Learning (Cause of Liquidation)

The company post listing announced a very ambitious expansion plan and initially rolled out the same with success leading to rise in the stock price and valuation of company. However, this management approach was flawed since geographical expansion compromised the quality of services at the centres. This led to increasing incidence of complaints from unsatisfied customers and hence the reputation of the company was dented. However, the management still did not change the aggressive geographical expansion (Arens et. al., 2013).  The sole concern was to maximise franchise partners so that maximum profits can be made thorough franchise agreement without caring about the underlying brand.  The company also made attempts to foray into new markets through the acquisition route. It is apparent that the poor financial performance of the company which eventually lead to liabilities becoming unsustainable was the result of unethical and irresponsible decision making by the management backed by poor disclosures (Kaplan, 2011).

HIH Insurance (Cause of Liquidation)

The company chose a growth path which was based on acquisition and in the process the increased business risk was ignored by the company (Mak, Deo & Cooper, 2005).  The insurance business is inherently risky and the company followed risk management practices that were not appropriate and against the practices followed by other insurers (Gay & Simnett, 2012).  Further, the foray in the new markets such as US was based on very low premiums on which the company made loss but the same were still adhered to by the company and concealed with the help of external auditors.

One of the most value destructive acquisition that the company made was that of FAI which lacked appropriate due diligence and hence the company acquired FAI at premium valuations which were not warranted. This resulted in enhanced financial liabilities for the business (Mirshekary, Yaftian & Cross, 2005).  The company also made forays in very risky spheres of insurance such as ships and aircrafts where the company made huge losses due to imprudent risk management framework. However, the management never had to change the underlying practices as the picture represented to shareholders was quite rosy and ironic to the ground reality (Mak, Deo & Cooper, 2005).

One Tel (Cause of Liquidation)

Another example of a incorrect business strategy which was made to continue though weak corporate governance measures. For customer acquisition, services were offered at very low prices but the resultant losses were not disclosed in the financial statements. Gradually, the company started giving out even more unreliable information as the internal control of the company had lapsed. The result was that the information given out was to serve the interests of the management thereby ensuring that they draw maximum compensation. The management hid these losses so as to continue their ill-fated strategy of maximising customer base and their respective compensation with least regards for the future of the company and the investors (Gilbert, Joseph & Terry, 2005).

From the description of the above companies, it is apparent that even though in the end the liabilities became huge but the process initiated a long time ago which stretched into years. The management in each of the three companies had a flawed approach towards business since the underlying risk management was improper. As a result, losses were made but the same were concealed through lack of internal controls and nexus with external auditor. The end result was the continuation of those faulty practices over the years which essentially led to the bankruptcy of each of the companies.

In each of the three companies, sound corporate governance practices would have ensured that the bankruptcies would have never occurred.  Take for instance, the case of ABC Learning where the aggressive business strategy of the company was ill-founded. The company failed to manage the underlying risks, which is a pivotal principle of the ASX corporate governance principle.  Further, despite getting complaints on front of quality, the management did not behave in a responsible and ethical manner and instead continued with the strategy even though it led to adverse impact on brand (Bhagat & Bolton, 2008).

In case of HIH Insurance, the principle of risk management hailed by ASX was not adhered leading to continuation of reinsurance based model which was quite risky. Also, the management did not show ethical and responsible decision making owing to the acquisition based strategy leading to higher risk. Further, there was violation of principle regarding disclosure as misrepresentation of financial statement was done so that the current practices can continue despite being detrimental to company and shareholders’ interest (Mirshekary, Yaftian & Cross, 2005).

In context of One Tel also, the strategy adhered by management to increase customer base while making losses was risky and unsustainable and in violation with the ASX corporate governance principles. The company never the less continued with the same aided by false disclosures so that the shareholders’ do not intervene with the affairs of the company. Eventually, the huge losses lead to bankruptcy (Brown & Caylor, 2009).

In all the above cases, it is apparent that while the immediate trigger might be the outstanding liabilities. However, the key reason for the failure of these companies was the faulty, irresponsible and unethical management whose policies were wrong and the means to sustain that were based in violation of all the key principles of ASX corporate governance. Also, there was breach of APES 110 by the various accountants and auditors involved in audit and financial statement preparation for these companies.

In order to avoid a repeat of any of the discussed corporate failures, it is essential to give due importance to the various measures introduced by various regulators to strengthen the corporate governance framework in Australia. For the listed companies, it is essential to comply with the eight principles of corporate governance which ensures that there are enough checks and balances so as to ensure that any inept practice is disclosed before taking the organisation to the brink of bankruptcy. Besides, personal liability of directors has also been enhanced though the duties of directors that have been inserted in Corporations Act 2001 along with punishments for violation of the same (Arens et. al., 2013).  It is essential that more measures in this regards are taken particularly in relation with board composition, maintenance the independence of the external auditor, board members and the various internal committees particularly the internal audit committee. Further, the liability on accounting and auditing professionals must also be enhanced in wake of their active role in the corporate bankruptcies discussed (Gay & Simnett, 2012).  Despite the improvements made, it is vital that more improvements in strengthening of corporate governance framework ought to be taken on continuous basis (Clout Chappelle & Gandhi, 2009).  

APESB (2010) APES 110 Code of Ethics for Professional Accountants, [online] Available at https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed September 10, 2018]

Arens, A., Best, P., Shailer, G. and Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia, 2^nd eds., Sydney: Pearson Australia

ASX (n.d.) Corporate Governance Principles and Recommendations, [online] Available at https://www.asx.com.au/documents/asx-compliance/final-revised-principles-complete.pdf [Accessed September 10, 2018]

Bhagat, S. and Bolton, B. (2008), ‘Corporate Governance and Firm Performance’, Journal of Corporate Finance, Vol.14, No.3, pp. 257-273.

Brown, L and Caylor, M. (2009), ‘Corporate Governance and Firm Operating Performance’, Review of Quantitative Finance and Accounting, Vol. 32, No. 2, pp. 129-144.

Clout, V, Chappelle, E and  Gandhi, N (2013), ‘The impact of auditor independence regulations on established and emerging firms’, Accounting Research Journal Vol. 26, No. 2, pp. 88-108

CPA (2012) ABC learning collapse case study., CPA Website, [online ] Available at https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-study  [Accessed September 10, 2018]

Gay, G. and  Simnett, R. (2012), Auditing and Assurance Services in Australia, 5^th eds., Sydney: McGraw-Hill Education

Gilbert, W., Joseph J. and Terry J.E (2005), ‘The Use of Control Self-Assessment by Independent Auditors’. The CPA Journal, Vol. 3,  pp. 66-92

Kaplan, R.S. (2011). ‘Accounting scholarship that advances professional knowledge and practice’. The Accounting Review, Vol. 86, No.2,  pp. 367–383.

Mak, T., Deo, H. and Cooper, K. (2005), ‘Australia’s Major Corporate Collapse: Health International Holdings (HIH) Insurance ‘May the Force Be with You’, Journal of American Academy of Business, Vol. 6, No.2, pp. 104-112.

Mirshekary, S., Yaftian, A. and Cross, D. (2005), ‘Australian Corporate Collapse: The Case of HIH Insurance’, Journal of Financial Services Marketing, Vol. 9, No.3, pp. 249-58.

Monem, R. (2009), The Life and Death of OneTel, Griffith University, [online] Available at https://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf [Accessed September 10, 2018]