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Inherent Risk

Discuss about the Strategic and Operational Risks.

In the current business domain, every business concentrates to gain higher competitive advantages from its initial stage, which in certain circumstances, lead them towards unfavorable or unexpected situations. This in turn might cause to excessive cash outflow, fraud, crime, vandalism, inefficiency in management among others. Apart from this, this kind of situations might also take place due to inefficient decision making process regarding marketing and production (Director Publications Ltd., 2012; ACCA, 2008).

HIH Insurance Limited has currently experienced certain issues in maintaining the business effectively. The company is an outcome of merger between CE Health International and Winterthur Insurance Company. There are certain risks factors evident in the HIH Insurance Limited that majorly caused financial downturn. This can be illustrated on the basis of the insured areas such as marine, worker’s compensation insurance, natural disasters, film finance insurance, and aviation insurance that the company offered insurance facilities to its clients, which considered to be the areas of high risk. Recently, the company faced a huge loss of around $100 million from film financing. In addition to this, the company also acquired FAI insurance and as a result, it had to remit the insurance claims of the FAI clients, affected by the devastating hailstorm in Sydney. The typhoon in Florida in 1999 also made HIH to provide a huge amount of insurance coverage to the clients that caused loss in a large scale. Apart from this, the deregulation of the industry in California made an increased in the processing of insurance claims of HIH pertaining to worker’s compensation (Gay & Simnett, 2015).

The CEO of HIH insurance has intimated about the current financial position, wherein it is observed that the company had to sale its assets to meet the obligations of the insurance claims and had to pay a large compensation to the auditors and other consulting agencies. Another business risk that was associated with HIH can be regarded as the discontinuation of the practice of prudential margins and resorted to reinsurance process. As a result the company was unable to repay the money of the insurers in the process of claim settlements (ICT, 2007).

Inherent risks mostly cause due to misstatements or misinterpretations of certain facts in the financial reports. This kind of occurrences often evident while auditing due to the absence of internal control mechanisms for risk detection (ACCA, 2009; Delaney & Whittington, 2009).

Legal Liability

The Australian Securities and Investments Commissions (ASIC) sentenced the CEO Mr. Jeffrey Lucy to jail for making alterations in the three financial transactions which amounted more than hundreds of millions. This offence was not favorable for the shareholder, as they were unable to gain knowledge about the actual financial position of HIH. In this regard, Mr. Williams, the auditor of HIH, also helped to omit the information on behalf of HIH in 1998 in which the operating profit before tax was stated as $92.4 million (Gay & Simnett, 2015; ICT, 2007).

Based on the stated facts, it is apparent that the company might face issues in generating money, which will affect the financial abilities of HIH. Apart from this, the company might also unable to maintain its goodwill in the market due to these kinds of unethical activities.Thus, it is observed that the level of inherent risks in HIH is comparatively high that can create dissatisfaction among the stakeholders and reduced the ability of the company to repay the claims to the clients at the international level.

Relevant Court Cases

Several court cases can be illustrated regarding the unethical activities evident in the company, which are also continuously neglecting the creditors and the clients. for instance, the case of Enron Scandal can be highlighted in this regard, wherein the investors lose their money and employees got terminated, as the CEO hidden the information of debts on the balance sheet. This occurrence led the company towards distraction and huge reduction in the stock prices of the company (The Accounting Degree Review, 2016). Similar situation has been evident in HIH in which the company included false information to attract customers in purchasing HIH shares. In this regard, it can therefore be affirmed that HIH failed to maintain a transparent relation with its clients, which Andersen can refer.

Apart from this, the case of waste management company, Houston that was found to misrepresent its earnings can also be illustrated along with the misrepresentation of HIH, which clearly depicts a negative relation between the creditors and clients (The Accounting Degree Review, 2016; US Securities and Exchange Commission, 2002).

The HIH insurance company was found to breach the ethical codes that led the company to become insolvent. In this regard, the CEO of the company was found guilty for misguiding the stakeholders by providing false data in the financial reports. The misinterpretation of financial data and attracting customers by providing them false information are considered to be ethical violation that have been conducted by HIH based on which the stakeholders can take appropriate measures. In addition to this, nine senior executives of FAI and HIH was also found guilty for continuously repeating such unethical activities within the setting for which the customers or other stakeholders have to face huge loss (Gay & Simnett, 2015). In these kinds of cases, the clients can take legal actions against the individual as well as the company for misinterpreting the information or misguiding them.

Hire of Members from External Audit Firms

Conditions for Negligence Action

The audit functions of HIH were maintained by Arthur Andersen from the initial stage. The relation between Andersen and HIH can be considered as the reason of hiring prior members for auditing as the company need not to concern about the unethical activities conducted previously as Andersen also supported such actions.. Thus, including prior members those have knowledge regarding the unethical actions and support the same will make the deal success and the company can continue accordingly (Rogers, 2010; Mishekary, Yaftian & Cross, 2005).

Advantages of Consulting and Audit Services

The consulting services provided suggestions or possible actions in the areas of tax, technology, marketing and other strategic dimensions through which a corporate house can enhance its profitability. The responsibilities of auditing team are to evaluate the information provided by the company regarding its business operation based on which the team obtain an in-depth understanding on the company strengths, risks factors and future potential. Thus, the team can easily provide comparatively more effective suggestions or recommendations to the company in increasing its overall performance along with higher profitability and risk assessment. Conversely, in case of including different consulting firm, the team hardly have knowledge on the strategic planning, decision making or strategic priorities of the company due to which the recommendations might not provide expected outcome in long run (Verschoor, 2014; PWC, 2012).

Concerning the scenario of HIH, it is stated that Andersen has detailed knowledge on the company’s actual position and financial condition based on which he can recommend possible measures to overcome with the financial issues. Apart from this, the auditing team can also advices HIH to manage the operations of business in reducing the amount of taxes, which on the other hand helps in the decision making process, which in turn improve the quality of audit (ACCA, 2010).

From the provided case scenario, it is apparent that HIH consistently violated the ethical standards, which needs to be eliminated from the setting to maintain the business operation standard. HIH has consistently hidden the information regarding financial report or other operation related data, which depicts the actual situation of the company. In the insurance or any other business, the stakeholders must have the knowledge on the business operation, which has also not been followed by HIH. Thus, in this context, it can be stated that HIH has failed to maintain transparency within its work process as well as communication with the stakeholders along with the customers (Verschoor, 2014; Ernst & Young, 2013; ACCA, 2010).

Ethics

Nowadays, majority of companies include several unethical activities to gain higher position in the market, which in turn put a barrier for the business domain in maintaining transparency. To mitigate this concern, certain actions can be taken on the basis of the recommendations provided in CLERP 9 and the Ramsay report (Deloitte Touche Tohmatsu, 2005).

According to the report the auditors must be independent while performing auditing process and provide the results as per the ethical considerations. In addition, the team members need to be changed in every year as per the accounting standards and focused on the necessity of greater participation by shareholders. The auditors will purely concentrate on continuous need of disclosure and charge high penalties for violation of ethics (Robinson, 2003). Apart from this, as per the recommendations of the Ramsay report, it is suggested that retired auditors or working auditors cannot maintain contacts with the client companies, as indicated in the case with HIH (John Wiley & Sons, 2016).

Conclusion:

Through the changes of the rules in auditing process, the audit firms can maintain transparency amid stakeholders and companies that will prevent to misrepresent the data that in turn affects the interest of the investors. Taking the references from the case scenario, insurance companies such as HIH will also not have to suffer for financial downturn in long run due to the changes in auditing process.

References

ACCA 2008, ‘Strategic and operational risks’, Technical, pp. 34-35

ACCA 2009, ‘Audit risk’, Technica, pp. 1-4.

ACCA 2010, Consultation on audit firms providing non-audit services to listed companies that they audit, Think Ahead, viewed 24 August 2016, <https://www.accaglobal.com/in/en/technical-activities/technical-resources-search/2010/january/audit-firms-providing-non-audit-services.html>

Daughtery, B & Dickins, D 2008, ‘The value of cooling off’, Corporate Governance, pp. 30-33

Delaney, P, R & Whittington, O, R 2009, Wiley CPA exam review 2010, auditing and attestation, John Wiley & Sons, America.

Director Publications Ltd. 2012, ‘Business risk a practical guide for board members’, A Director’s Guide, pp. 1-72.

Gay, G & Simnett, R 2015, Auditing and assurance eervices in Australia, sixth Edition, McGraw-Hill Education, Australia.

ICT 2007, ‘Diploma in compliance insurance appendices’, Diploma in Compliance, pp. 1-173.

John Wiley & Sons 2016, ‘Ramsay Report recommendations into audit independence’, Auditing, pp. 1.

Judges of the Supreme Court of Canada and Australia 2016, Supreme court judgments, Decisions, viewed 24 August 2016, <https://scc-csc.lexum.com/scc-csc/scc-csc/en/item/1511/index.do >

Morgenson, G 2005, KPMG settles with S.E.C. on Xerox audit, Business, viewed 24 August 2016, <https://www.nytimes.com/2005/04/20/business/kpmg-settles-with-sec-on-xerox-audits.html?_r=0>

Mishekary, S, Yatfian, A, M & Cross, D 2005, Australian corporate collapse: the case of HIH Insurance, Abstract, viewed 25 August 2016, from <https://link.springer.com/article/10.1057/palgrave.fsm.4770157>

Parlow, D, S 2012, ‘The prospects of a successful claim against auditors in fraud’, Uploads, pp. 1-10.

PWC 2012, ‘Point of view auditors’ scope of services’, Point of View, pp. 1-3.

The Accounting Degree Review 2016, The 10 worst corporate accounting scandals of all time, Scandals, viewed 25 August 2016, <https://www.accounting-degree.org/scandals/>

US Securities and Exchange Commission 2003, SEC charges KPMG and four KPMG partners with fraud in connection with audits of XEROX; SEC seeks injunction, disgorgement and penalties, News, viewed 24 August 2016, <https://www.sec.gov/news/press/2003-16.htm>        

Verschoor, C, C 2014, ‘Do consulting services threaten audit performance’, Ethics, pp. 12-69

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