HA3032 Auditing and Assurance in Australia : Legal Liability

Business Risk Evaluation Of Hih Insurance Limited

Risk or situation of harm in business is called Business Risk. Risk in business can be happened because of the bigger complexities involved in businesses and environment in which business is establish. When there is risk in business it is said that either business may grow to unexceptionally high profit or business may have huge losses which make the closure or liquidation. Broadly four types of risks are present in any business such as risk related to Operation, Strategy, Compliance and reputation of business (Jolly, 2013).

In HIH Insurance Limited major business risk which has been identified are as follows:

• Relating to strategy- The management of the company has not done SWOT analysis before making any strategy or entering into any contract. The investment by company in highly risks shares of FAI Insurance, Marine, and Fire Insurance shows the non ascertainment of the threats in business in relation to investment.
• Relating to Operation- the Company has not considered the fact that Insurance business is very unpredictable in terms of the natural disaster insurance and safety measures for that was not taken by the company resulting in high claim payments for major hailstorm in Sydney and Typhoon in Florida in 1999. The reasons for high claim were the acquisitions of the major portions of shares of FAI Insurance.
• The major business risk is relating to fiancé decision of the company where HIH is increasing its capital along with borrowings. The company has not considered the fact of its inability to pay the return on investments by shareholders and other outside liabilities.
• HIH has not maintained the prudential margins, which a insurance company has to maintain, to safeguards them from unexceptional high claims from natural disaster. Every insurance company needs to have some buffer fund which is to be investing in long period assets to get high returns. HIH discontinued this practice in 1997 and the making reinsurance from the amount which is available for prudential margins.

Thus, insurance business complexities and misunderstanding the insurance industry by the HIH management is major reasons for having risks in HIH business (Jiangbo, 2003 and Sadgrove, 2011). 

Inherent Risk Aspect In Reporting At Financial Level

While doing audit of the financial statements, risks which are presents for auditor are called audit risks and these risks generally affect the working of an auditor and making it difficult to give an opinion of the financial matters of the company. The auditor has to assess these risks at the planning of the audit and find out the factors in the business which can create these situations of danger for auditor. One of the important audit risks for auditor is inherent risk in business which can impact the reporting of auditor and auditor has to find the risk factor which can increase or decrease the degree of inherent risk (Colbert, 2014). In case of HIH Limited, the auditor has assessed the inherent risk factor as under:

• Knowledge and Experience of Management of HIH- The major member in the board of HIH are from audit background and does not possess the required knowledge and experience of the insurance industry.  This is the main reason of wrong decisions and actions taken by the management of the company in making investment.
• Reliability of the members of the management- The HIH Board major member are related either to auditor or the company in which HIH has done major investment without considering risk in investment. The HIH Company has purchase the shares of FAI Insurance at a premium from its Non Executive Director which shows that the management is not fully honest while making decisions on behalf of HIH Company.
• Nature of HIH Business- the Insurance business in itself is very complex and has high risk. The HIH management decisions of reinvestment and reinsurance makes it even more risky and complex. The auditor should consider this fact and it is the major inherent risk factor which shows the misappropriation of funds and increases the chances of frauds and errors in the company.
• External Environment- the business external environment can also creates the situation of risk for the business and for auditor. The HIH Company is dealing in the highly risky business environment consisting fire, marine, natural disaster.

The aforesaid inherent risk factors increase the level of inherent risk for auditor while doing the audit of the HIH Company (World Bank, 2006). 

Responsibility Towards Client And Creditors

The auditor responsibility has been defined under the Australian Auditing standards where the auditor is liable towards different stakeholders of the business with his reporting about the affairs of the company. Being an independent person, the auditor has responsibility towards different users of the financial information whether internal like client, employees and external like creditors, government etc. The auditor has responsibility if he does not follows the points written and agreed in engagement letter and also not follows the proper ethical standards in making his reporting which is used by external parties in their decision making process. The auditor the company has not done productive audit of HIH Company. The auditor has not understood the implication of the business risks involved in HIH and also not reported the same fact in his reporting. He can be held liable by client and outside parties for damages which has occurred by not disclosing the correct facts in the audit report. The cases which can authenticate these facts are discussed as under:

• Stevenson Vs. Donoghue – The case held in the year 1932 in which the auditor was liable for damages to the creditor. In the given case it was said that the auditor has responsibility to report about the frauds happened in the company. The auditor has not fulfilled his duties with full professional due and care and made false reporting misleading the creditor of the company.
• Daniels Vs. AWA Limited- The case was happened in 1995 as the auditor has not fulfilled the prerequisite conditions in the engagement letter. The auditor is unable to report to the management of the company about the deficit in internal controls related to foreign transactions. Thus the court held the auditor liable towards the client stating that the auditor should maintain the professional behavior and report all the material facts whether financial or non financial to the management of the company as agreed conditions.
• Ultramares Corporation vs. Touche- The auditor ,in this case as per court, has not behave professionally and does not follow all the obligation laid on him by the engagement letter and ethical auditing standards. The courts held the auditor liable for damages made on account poor audit done by auditor (Tata, 2010).

Conditions For Careless Actions Taken By Auditor

Every auditor is required to perform ethically by following all the ethical principles and auditing standards in conduct of an audit of any client. The reporting given by auditor substantiates the fact that the auditor has framed the opinion after following all the required audit procedures. There are certain situations which confirm that the auditor has act carelessly while performing his duties and responsibilities. These conditions are as follows:

• Proper planning has not been done by auditor before starting the audit.
• Audit Program has not made as per business requirement of the client.
• Skepticism in term of professional is missing in the performance of the duties by the auditor
• Sample size has not taken appropriately by the auditor.
• Review of the work of the audit staff by audit partner as the ultimate responsible of the person who signing the report.
• Differentiate the staff for performing auditing and accounting services by audit firm.
• Not checking the effectiveness and efficiency of the internal control systems of the company
• Ignorance of material facts while making an opinion about the affairs of the client.
• Reporting is not supported by proper audit documentation (Brumfield, 2010).
  

Reasons For Appointment Of Previous Audit Team Member

The HIH Company wants to hire the previous audit team ember for doing audit because of the following reasons:

• The auditor has gained good experience in terms to understand the clients business. The auditor able ascertains all the economical and financial factors which can be considered for reporting by auditor.
• The auditor has good faith in the acts done by company’s officer and can easily judge level of the deep checking from such acts. He clearly knows that where there is chance of mistakes in the action of employees.
• The stakeholders’ believes in consistency in the opinion and reporting by an auditor. If the previous external auditors will the do the reporting stakeholders can easily rely on that assuming that auditor has done detailed analysis of the operations of the company to find whether there is any material error and frauds in the financial statements of the company.
• The previous external auditor can apply all the professional skepticism very easily as compared to new auditor who may involve in getting knowledge about the business. The time frame for doing anything less as compared to new auditor if appointed by the company.

Rewards For Engaging One Firm In Audit And No Audit Services 

To save the ethical principles like integrity and objectivity of the auditor in reporting, it is not recommended to have the audit and non audit service from one firm. AASB and Corporation Act, 2001 prohibits the company to take services from the same firm. But the companies and their management executives are interested in hiring one firm as it contains the following rewards:

• Errors and frauds can be deducted at the accounting stage and corrective actions for them can be taken by company. The auditor is able identified the preventive actions which he has to take while doing audit to reduce the impact level of frauds and errors.
• The quality and timing of reporting by auditor can be enhances. When doing other services the auditor gained the knowledge in relation to business of the client and can plan accordingly the audit procedures he has to take which in terms save time and reporting will become faster.
• The total fees of firm will be on lower side if the same performs both the services as compared to the combined fees of the different firm if both the services are performed by two entities. This reduces the expenses of the company and better margin can be left for stakeholders (Verschoor, 2012).

Breach Of Ethical Principles And Their Reasons

Ethical principles are essential standards and procedures that the auditor has to follow while performing any type of professional services. In a particular situation under consideration of HIH Company, the provisions of breach of ethical standards are identified. The reasons for the same are:

• The integrity and objectivity of the auditor is under danger when the audit and non audit functions are done by the same person. There are chances of having self interest and self review threat to the independence of the auditor.
• Faithful representation can be done by the auditor as the auditor is getting high funds from the management of company for not considering some material facts in the reporting which are misleading factors for the investors of the company.
• The audit opinion supporting is not up to mark as per the ethical standards requirements. The main reason for the same is familiar relationship between audit staff and employees of the company. Also, the company officers have undue influence on the auditor for not getting certain information and not performing some audit procedures.
• The hiding of data in disclosures are also the reasons of breach of ethical standards as there is requirements of disclosing all the things which are material and can hampered the fundamental principles of accounting in future in notes to the financial statements.
  

Ramsay Report And Clerp 9 Recommedations

The primary recommendations which are put forward by Ramsay and Corporate Law and Economic Reform 9 are as under:

• Declaration about the remuneration paid to the executives by the company by way of Remuneration report as a part of director report in the annual report of the company.
• Reporting by auditor and their publications to the stakeholders of the company should be made on the regular and continuous basis so that errors and frauds can be detected and warning can issued to stakeholders.
• Supervisions should be taken place for work done by the auditor to confirm that the work has been done after following the relevant rules and regulations.
• Extra responsibility and power has been given to shareholders for taking major decisions like appointment of key managerial person (Robinson, 2003).

References

Colbert, J.L., (2014). “Inherent risk: An investigation of auditors' judgments”. Accounting, Organizations and society, 13(2), pp.111-121.

Jiangbo X, (2003), “HIH Insurance Limited: Corporate Governance and Corporate Excesses”, Australian Financial Review, pp 05-09

Jolly A, (2013),Managing Business Risk”, Ernst and Young, pp 8-16

Pany K, (2010), “Legal Liability of CPAs”, Tata Mc Graw, 4, pp 1-30.

Robinson A, (2003), “HIH Report and CLERP 9”, Allens Arthur Robinson, pp 1-5.

Sadgrove K, (2011), “Guide to Business Risk Management”, Gover Publishing, 8^th Edition, pp 25-41.

Verschoor C, (2012), “Pros and Cons of using External Auditors for Internal Auditing and Other Services”, Q Finance, pp 1-9.

World Bank, (2006), “HIH Case Study on Corporate Governance”, The Australian Financial Review, pp 05-38.