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Financial Accounting Of Liquidation

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Question:

Discuss about the Financial Accounting Of Liquidation Company.
 
 

Answer:

Introduction

Liquidation of a company is a process by which a company shuts down all its operations, closes its books and sells off all its assets with the help of a liquidator. The companies must appoint a liquidator as required by the law. The most important thing, that the company is running into loses and does not have enough money to pay off its debts, there may be chances that the debtors are not paying the company their dues because of which the company does not have enough funds. There are chances that the company is not able to cope up with the fierce competition and that has led to its liquidation. There can be voluntary or involuntary liquidation depending on the situation of company (Bae, 2017).

Because of all these reasons, the directors or the management of the company can opt for liquidation, but that must always be the last resort, because a lot of stakeholders are dependent on the company. In cases where the companies do not propose the liquidation they there are chances that they can get liquidated. Moreover, in case the company becomes insolvent and the director proposes for liquidation, he has to do the same as soon as possible otherwise his personal assets would also be liable for the liquidation purposes. This protects the members, directors and creditors (DeZoort & Harrison, 2016). Liquidation is also known as winding up and it proposes the official closure of a company and its books. There can be many other reasons besides the above mentioned reasons basis which the company may think of liquidation like business being started but is running for the wrong reasons, inadequate working capital of the company, the location might not be right, the financial skills may not be good enough, poor marketing or lack of planning to develop the correct business model, extreme competition in the market, etc.

 

Ethics & governance in explaining the company’s financial distress

In this given case study, we will analyze the reasons behind the liquidation of one of the top educational company in Australia, the ABC Learning company. The other companies being One tel phone company which liquidated in 2001 even after being one of the giants in Australian telecommunication business and having over 2 million clients across 8 nations. The 3rd and final company being assessed here is the HIH insurance company which was the second largest insurance company in Australia but liquidated in 2001 with loss measuring over $ 5.3 billion. This is considered to be one of the major corporate collapse in the history of Australai. There were several reasons that had led to the liquidation of the company and all the related discussion have been given below but the major reason which was found common in all these companies is the lack of internal control in the company, governance being at substandard level, strategic errors, inappropriate pricing policies, non communication and reporting of errors and frauds to the top management and window dressing. The level of audit being done for the 3 companies is also to be scrutinised here as all of them failed to point the material misstatement in the financial statements. (Grenier, 2017).

The case of liquidation with ABC learning, HIH Insurance and One Tel phone company: Major factors and whether liabilities were a major factor contributing to the liquidation

ABC Learning Company is one of the top educational companies in Australia; it has a large number of educational centers that impart primary and secondary level education to children in Australia. The company was earning huge profits as per the records and then after the new auditors took over the company. They found there were a lot of issues in the accounts of the company and that had led to its liquidation. Thus the company didn’t performs well owing to its malpractices that was not able to cover the same and that led to its liquidation. A large number of investors and stakeholders who had invested in the company were very badly affected. The auditors of the company were held responsible for their actions and were asked to justify the same. Amidst all this, it went into liquidation in the year 2008 and was bought back by Goodyear Early Learning in December 2009 which now operated in 650 centress across Asutralia (Sonu, et al., 2017).

 


The company was unable to pay to its creditors and as a result of this, auditor declined to sign the audit report for the year 2008 stating that the books of accounts are materially misstated for the last few years and needs to be revised and recasted taking into consideration the correct picture. Because of unability to pay off its creditors on time, it has to go into voluntary liquidation in 2008. The child care support company started in the early 2000s and the number of centres started to grow gradually later on becoming 2300 across the major maket and nations. It also acquired few of the big companies to expand its business and reach. It not only became the market leader in Australia but also captured 1% market in the US. It was going big and making huge profits in the year 2004 and 2005 when it had a profit percentage of 15-20%. But amidst all this, its debt portion also got on increasing and in the process the company had a huge debt burden which it was unable to pay. Its share prices fell drastically in 2007 by more than 40%.

There were many reasons for this dramatic collapse but one of them was incorrect valuation of the acquisitions done and lack of internal control and governance in the company. In place of due deligence of the companies to be acquired by ABC learning, what was going on is only rubber and stamp activity in the company without proper validation. Later the investigations by the lawyers proved that the company was not fulfilling the corporate governance and the ethics of the business and there were huge multi million differnces in the valuation of the deal. (Jones, 2017) Instead of having the investment review committee, it had a orthodox procedure of management group approval which was nothing more than a stamping activity. It also came to notice that the company had paid to one of the other companies some $ 70 Mn instead of the actual valuation which came to $ 30 Mn from the independent valuer. In this way, ABC learning increased its liability by self action of not validating the deals on the basis of the income streams and other major components. The collapse of the ABC learning through all these years was attributable to the lack of corporate governance in the company just 9 months prior to its liquidation. (Fay & Negangard, 2017).

 


In the classic case of HIH insurance company, the company collapsed owing to the incorrect and irresponsible valuation of the taken over entity FAI insurance company and its aggresice intent of accounting. Inspite of suffering huge losses in the last year, the chief executive office of HIH insurance company got millions as the severance package in view of the resignation submitted by him and year before the closure of the company.The liquidation had a worldwide impact on the construction and housing business alongwith the re-insuarnce business. Its operations mainly included underwriting services, investment financing and property dealing and it was found that the aggressive accounting strategy at the time of acquisition of CE Health International where the liabilities were understated alongwith the reserves of the company. There was no due deligence being done at the time of acquisition and wrong disclosures were being made to the public in terms of the net assets an liabilities being held by the company and auditors were paid AUD 1.7 Mn for this task. Later on when the actual figures were flashed, the losses of the company multiplied from $ 100 Mn to $ 200 Mn to $ 300 and so on and the resultrs were never published. So, all in all it was a combined effect of many other factors including poor audit quality which can be attributed to liquidation of HIH.

The third company i.e., One Tel phone company which was once a revolution among the youth for its mobile phones and internet services, marketing and information system, etc was yet another victim of the weak internal control processes and was ultimately liquidated. The major reason behind this was overstating the sales to around 10 times based on the past trends of 1997 to 2000 when the sales rose by 127%, 40%, 57% and 100% respectively. Inspite of huge growth in revenue numbers, the profits could not be aligned because One tel purchased additional spectrum licenses than required and used funds from public as well, however, in the year ended 30th June. 2000, Tel had a loss of $291 Mn and share prices fell to as low as $ 1. Besides the adverse condition of the shares at the markets, it contined to pay its directors handsomely at $ 0.56 Mn as salary and $ 6.9 Mn bonus. As a result, it went cashless and out of money unable to pay off its debts. This not only made the insolvent but forced the company to lay off around 1400 employees in 2001. The weak internal control by the directors allowed the wrong information to flow to the management and the stakeholders without proper validation. Corporate governance was totally being overridden in this case and its financial reports were no more a decpiction of the true state of affairs. Not only the sales, but the entire receiables, the EBITDA, accounts payable and the trial balance was misstated. It was a case where the accruals were shown to be tremendously high as compared to the market competitors and hence was just a form of window dressing.

 

Conclusion

We see that there are a lot of factors that leads a company into liquidation. There are many reasons that lead to this. The most important being the policies of the management which are often not in sync with the standard rules and practices. The company can liquidate in many ways, sometimes when the business is not doing any profit, the companies can go for voluntary liquidation. Sometimes the court orders when the business of the company is not fruitful or against the policies of the government. In this case the loss making units from shown to generate huge revenues, this made a false impression in the minds of the investors. They believed that the company is performing well and hence invested their money in the company. The auditors also did not perform their task with conviction and applied professional skepticism into the matter. They did what the management asked them do. This led to a lot of issues, falsification of the accounts and when the new auditors further interrogated then found that the management had indulged in malpractices. (Knechel & Salterio, 2016).

Recomendations

There are several ways by which can prevent the entire case of liquidation. For this it is important that the companies must have a proper stand and should perform all their duties with conviction. The management can also take expert advice to help them in these matters. There are several laws and policies that govern the process of liquidation. All the companies must follow the same. In cases where they require any expert help, they should take. Liquidators must be appointed to make sure that the overall process is profitable for the company. It will also help in protecting the interest of the stakeholders who are dependent on the company. Thus this entire analysis of the ABC Company will provide a basis for the other companies to understand that how important it is for the management to have their stand and how important it is for the investors of the company to make sure that they invest their money after careful considerations. These are the few wyas in which the company can avoid the liquidation and the stakeholders can get proper returns for their dues (Raiborn, et al., 2016).

 

Refrences

Bae, S., 2017. The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From Korea. Journal of Applied Business Research, 33(1), pp. 153-172.

DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud within organization. Journal of Business Ethics, pp. 1-18.

Fay, R. & Negangard, E., 2017. Manual journal entry testing : Data analytics and the risk of fraud. Journal of Accounting Education, Volume 38, pp. 37-49.

Grenier, J., 2017. Encouraging Professional Skepticism in the Industry Specialization Era. Journal of Business Ethics, 142(2), pp. 241-256.

Jones, P., 2017. Statistical Sampling and Risk Analysis in Auditing. NY: Routledge.

Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.

Raiborn, C., Butler, J. & Martin, K., 2016. The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), pp. 10-21.

Sonu, C., Ahn, H. & Choi, A., 2017. Audit fee pressure and audit risk: evidence from the financial crisis of 2008. Asia-Pacific Journal of Accounting & Economics , 24(1-2), pp. 127-144.

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