HIH Insurance was founded in 1968 by Ray Williams and Michael Payne. At the beginning, it was actually known as “M W Payne Underwriting Agency Pty Ltd”. It was then acquired by British company CE Heath PLC in 1971.
In May 1996, CE Heath International Holdings changed its name to HIH Winterthur. In 1999, HIH acquired the large Australian counterpart FAI Insurance, whose chief executive Rodney Adler became a director of HIH. After decades of business expansion, Winterthur Swiss finally sold its 51% share in HIH Winterthur to the public and HIH changed its name to HIH Insurance Ltd. HIH Insurance was the largest failure in Australian business history which collapsed on 15th March, 2011. HIH Insurance collapsed with debts estimated at $5.3 billion Australian dollar and resulted in the federal government announcing that a Royal Commission was required to investigate “the extent to which actions of directors, employees, auditors, actuaries and advisors contributed to HIH failure or involved undesirable corporate practices”. This essay will discuss about the auditing related matters in the case of the HIH collapse. The vital fundamental issue that leaded to the collapse of HIH Insurance is audit independence.
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The external auditors mainly were to provide independent and professional opinion on the financial statements prepared by the company’s management and also to enhance the credibility of the financial statements. The Royal Commissioner found out that the external auditor of HIH Insurance, Arthur Andersen was not independent enough and had not lived up to the hopes and expectations as an auditor based on its role and responsibilities. The evidence was that Arthur Andersen and his three partners actually held positions on the HIH board of directors. Arthur Andersen executed the ?nancial audit of HIH from 1971 till HIH’s provisional liquidation in March 2001. In the course of this period Arthur Andersen evolved a professional relationship with HIH, whom it taken into consideration to be one in every of its main Australian customers. At the time of HIH’s liquidation, however, three former Arthur Andersen partners held positions at the HIH board of directors. Geo?rey Cohen became Chairman, Dominic Fodera became the chief operating O?cer and Justin Gardener became a non-executive director. All three of those people had been widely recognized as the current partners and employees of Arthur Andersen, at the same time holding positions of big in?uence over the ?nancial a?airs of HIH.
As we can see, there were a significant evidence that there were a close personal relationship established among the external auditor and the board of directors of HIH Insurance. There are 5 key threats to auditor independence identified by the Code of Ethics for Professional Accountants. One of it is the familiarity threat which is obviously showed in HIH Insurance collapse case. It is a threat that happens when there is a close personal relationship exists among the assurance team and the client.
The assurance team might become too sensitive to the needs and the interests of the clients and therefore lose their objectivity and professional scepticism. In respects of these matters, Arthur Andersen might have lacked independence which then leaded to a significant impact to HIH Insurance and became one of the major issue that caused the company to collapse.Besides, the investigation of Royal Commission also stated that another auditing issue that arose from the collapse of HIH insurance is about the audit committee of the company. The effectiveness of audit committee can bring a significant influence to the company as well. Ineffectiveness of the audit committee was a flawed side in the corporate governance practices of HIH insurance which was disclosed in the Royal Commission’s report. Audit committee is a subcommittee of board of directors in a company, with specific responsibilities relating to supervise the independent audit function. In many modern companies, audit committee is a complete element of the corporate governance. Audit committees can support the Board of Directors to satisfy about the independence of company, stating by CPA Australia and the Institute of Chartered Accountants in Australia (2004).
Having most of non-executive directors has been common for the audit committee in recent times, enabling the committee to handle matters with a fair mode and non-conflicts of interest. According to HIH Royal Commission, Geoffrey Cohen who is the chairman of the audit committee and also the chairman of HIH did not filly read the presentations of auditors. He attended the great majority of the audit committee meetings, accompanied with other senior management.
“That no occasion on which the auditors met with the members of the audit committee in the absence of management were not disclosed in the evidence”, claimed by Mr White who is counsel to the Royal Commission. This implies that the management of HIH Insurance not acted opposite than usual practice. At the same time, the impartiality of the audit committee is in question.
Next, there are also some ethical issues involved in the audit profession that generated from the collapse of HIH Insurance. Ethics refer to a series of moral values or principles. Professional auditors can get stuck in many complex circumstances that produced by ethical dilemmas.
Ethical dilemmas exist when people is in the face of circumstances which have requirement of decisions about the most suitable behaviour whereas when the available choices require a trade-off ideals or interest (Arens et al, 2010). Auditors must comply with ethical standards whereas acting in the best interests of shareholders. Five ethical principles applying to auditors were identified by the Framework for Assurance Engagements, that is objectivity, integrity, confidentiality, professional behaviour, and professional competence as well as due cares (Arens et al, 2010). Arthur Andersen was paid $5.
1 million in audit fees and $2.8 million in non-audit fees from HIH Insurance during the period of 1997 to 2000 (Johnson, 2004). Also Andersen earned $5.097 million in terms of auditing the financial statements of HIH Insurance and $2.824 million from offering HIH Insurance with non-audit services during the last three financial years of HIH Insurance. Whether the supply of such non-audit services was ethical towards Andersen with having best interests of shareholders should be considered.
As already mentioned above, “Since HIH management were reluctant to increase the amount of audit fees paid to Arthur Andersen, Arthur Andersen sought to reduce the amount of work performed on the HIH audit…” were stated in comments of Mr Martin (Peursem et al., 2007). This may means a cosy relationship was utilised by Arthur Andersen to know that increasing supply of non-audit services can recoup the loss of assurance fees. The supply of non-audit services by Andersen must also be taken the ethical dilemma of having a duty of care to third parties in consideration. A former accountant at HIH Insurance, Jeffrey Simpson stated that the close connection between HIH Insurance and Arthur Andersen enabled HIH Insurance utilization of aggressive accounting policies. He also expressed that Arthur Andersen consent to the application of these policies in further statements (Mirshekary et al.
, 2004). In regard to consider Andersen’s duty of care to give an opinion to shareholders that the statements present a true and fair view, the agreement of Andersen is unethical in question and the auditor’s integrity in pressure situations.