Auditing Case Analysis: HIH and Harris Scarfe Collapse

This report sheds light on the concept of significant problems that are faced by two companies named HIH and Harris Scarfe in Australia due to failure of auditing. It highlights the role of auditors and their responsibilities in that collapse. The major issue was related to the independence of auditors in those cases. This study has also described the impact of those incidents on legal frameworks as well as auditing standards.

AUDITING CASE ANALYSIS
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Executive summary
The audit process is basically designed in order to stop as well as disclose aimed and successful
security contravention. The basic business strategy of HIH was to attain a significant market
share position in the insurance industry of Australia. Harris Scarfe attained a significant position
in the market by supplying a wide range of household, agriculture as well as hardware materials.
There were significant changes in legislative structure took place after the failure of HIH
insurance company and Harris Scarfe. This report sheds light on the concept of significant
problems that are faced by two companies named HIH and Harris Scarfe in Australia due to
failure of auditing. In this context, this study has highlighted the role of auditors and their
responsibilities in that collapse. The major issue was related to the independence of auditors in
those cases. This study has also described the impact of those incidents on legal frameworks as
well as auditing standards.
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Table of Contents
Introduction and Background of two companies.............................................................................4
Auditor of companies...................................................................................................................4
Audit procedures contribution for the collapse of HIH insurance...............................................5
Audit procedures contribution for the collapse of Harris Scarfe.................................................5
Discussion on independence of auditor.......................................................................................6
Improvement in auditing standards and principles......................................................................8
Recommendation.........................................................................................................................9
Conclusion.......................................................................................................................................9
Reference list.................................................................................................................................10
Appendix :Auditor’s role in collapse of HIH Insurance................................................................12
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Introduction and Background of two companies
The audit process is basically designed in order to stop as well as disclose aimed and successful
security contravention. This report sheds light on the concept of significant problems that are
faced by two companies named HIH and Harris Scarfe in Australia due to failure of auditing.
Along with that, it also provides analysis of the process of auditing and the roles of auditors in
that collapse. This study is also aiming to highlight the change in auditing standards as a result of
that collapse.
HIH insurance company was founded in the year of 1968, and the company’s business activity
included the repayment of workers insurance in the Victorian market that became a very
effective business activity. The basic business strategy of HIH was to attain a significant market
share position in the insurance industry of Australia. As a result of this strategy after five years,
HIH took FAI insurance for $300 million (hih.com.au, 2019).
Harris Scarfe was established in the year 1850 and attained a significant position in the market
by supplying a wide range of household, agriculture as well as hardware materials. After that,
Harris Scarfe was focused on supplying department store activities by denying all other
processes. However, this company also experienced severe collapse with a total amount of $265
million (bloomberg.com, 2019).
Auditor of companies
The audit committee of Harris Scarfe was significant process innate in having proper corporate
governance as well as the independent and strong board of directors. As audit committees are
generally composed of three to five directors, therefore, the audit committee of the respective
company was consist of JM Patten independent director, AJ Trescowthick the executive
chairman and lastly, A Hodgson was a chief financial officer (abc.net.au, 2019). This company
held an audit committee for three long years, 31st July 1998, 1999 and in the year of 2000
(abc.net.au, 2019).
Arthur Anderson was the auditor for HIH Insurance for a long period. They were working from
1971 to 2001 (treasury.gov.au, 2019). They were engaged with the auditing of this company till
its demise. Alan Davies was the chief auditor for HIH Insurance from 1996 (treasury.gov.au,
2019). Before Davies, Dominic Fodera was playing that role.
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Audit procedures contributed to the collapse of HIH insurance
HIH was one of the large organizations in the Insurance industry of Australia. Failure of this
organization has been marked as a major event in terms of financial performance in the country.
This event also argues the role of auditors in such failure of a company. Auditor plays an
important role in the demise of the company. The company failed to recognize its fraud, which
became one of the biggest reasons for collapsing. Lorenz (2017, p.123), has given his view in
this matter that the strategy of the company was no fitting with the progress and the business
factors also was added uneconomical or costly corporate extravagance and acquisitions. Under
the section of 336 of the Corporations Act 2001, Auditing Standard ASQC 1: Leadership
Responsibilities for Quality within the firm act and Auditing Standard ASA 240:The Auditor's
Responsibilities Relating to Fraud in an Audit of a Financial Report were violated because the
management strategy was failed to lead the employees of the corporation (treasury.gov.au,
2019). The Royal Commission’s investigation has given their report on this matter where they
have clearly shown the faults of the auditors and the corporation. Inadequate provisions were
included in the audit procedures which were made for improper claims and insurance claims on
various policies. The audit committee of HIH insurance failed to calculate the upcoming risk.
Djordjevic and Đukić (2016, p.301), has stated that for adapting the aggressive accounting
processes, there was very low audit practice which led the company to its collapse. Even the
company did not trace out the management frauds presence within the company. Based on the
views of Djordjevic and Đukić (2016), it can be stated that a requirement for the judicious
margin is significant for the continuing processes of an insurance company. Most of the
difficulties of HIH can be related to for not creating enough subsidiaries and aggressive
acquisition strategy. Tyasari et al. (2017, p.01005), has opined that audit practice was weak, and
the calculation of the company’s expenditure was inappropriate. According to Grenier, Pomeroy
and Stern (2015), even in the planning process, was also false. Risk assessment is one of the vital
jobs in the audit process as the auditors determined the plan and structure of the audit. In the time
of liquidation, it had seemed of a growing personal close partnership between the parties, which
became a threat to auditors’ independence in their works.
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Audit procedures contributed to the collapse of Harris Scarfe
Being a departmental store in Australia, the collapse of Harris Scarfe have shown that auditing
and accounting professions can be far better for the profitability of the company. Ogiriki and
Oyadonghan (2017, p.34), have commented in this context that in order to discuss the roles of
auditors for the collapse of the company, the reason behind this is important to notice. There
were some faults in the procedures of the auditors and mismanagement in the company which
led the company to its downfall. Under the section of 336 of the Corporations Act 2001,
Auditing Standard ASA 240:The Auditor's Responsibilities Relating to Fraud in an Audit of a
Financial Report and Auditing Standard ASA 250 Consideration of Laws and Regulations in an
Audit of a Financial Report law were violated in the case of this Harris Scarfe company
(treasury.gov.au, 2019). There was a clash between the responsibilities of external auditors and
management. Besides this, the accounting professionals were not free enough to perform their
duties well. The auditor independence and the audit committee were not effective, and the board
of directors failed to create and implement better policies and rules for preventing frauds.
LeBaron et al. (2017, p.965), has stated that inflating the profits, the acts of the management
submitted the fraudulent financial report. The declarations of the management were responsible
for false records. The auditors of the company failed to find out the irregularities in accounting
systems in Harris Scarfe, which led the company to its collapse.
Figure 1: Different auditing standard violated
(Source: As influenced by LeBaron et al. 2017, p.965)
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Auditing Standard ASA 250
Auditing Standard ASA 240
Auditing Standard ASQC 1

Discussion on the independence of the auditor
Andersen’s relationship with the client was hardly admirable, and at the time of diffusion, three
partners of Andersen executed the financial audit process in the company. Professional
Statement F1 is applied to all Chartered Accountants in Australia and HIH also applied this
statement in their company. However, the Royal Commission of HIH stated that strong
relationship evolved between parties, and this strong relationship could be a warning of
independence of particular auditor or the team. APES 110 Code of Ethics for Professional
Accountant states that an auditor needs to remain independent from the entity it audits (As
influenced by the views of Tepalagul and Lin, 2015). As influenced by the views of Church et al.
(2014), reduction of independence among auditors and board of director specifies that HIH may
not be in their priority list. Therefore, Andersens failed to give enough working papers as well as
to collect significant evidence in order to support their quality of audit.
Certain confirmation also states that Anderson’s independence was not present when it came to
strong bonding between HIH’s board of director and team members of Anderson’s. Therefore it
is suggested that Arthur Anderson was committed to both audit and non audit process to HIH,
but ethical constraints also help to make sure that independence of the auditor is declined.
A significant responsibility of the board of director of Harris Scarfe was to maintain a healthy
environment where issue related to fraud can minimize with effective policies. Board of director
of this company consisted of Trescowthick and his brother Mark, Oakley, Mattingly as well as
Curtis and Patten. A strong relationship between members of the board certainly affected the
independence of the auditor, as well as a strong relationship of Trescowthick with his brother,
also affected the independence of the board of director. Auditing Standard ASA 220 Quality
Control for an Audit illustrates to provide all the present financial information as well as past
historical information of the company (Based on the views of Tepalagul and Lin, 2015). As a
result of this, Trescowthick was quite unsuccessful in applying better policies in order to prevent
certain fraud issues.
It is also stated that management of Harris Scarfe was not at all responsible in monitoring and
controlling the company’s record book, which also reflects that record book of the company was
not maintained intentionally by management. The insufficiency of internal audit is another issue
of failing to prevent frauds. Department of internal control of the audit committee must be
independent in performing an audit of a company. Section 307 of the Corporation Act states
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that significant information and explanation is necessary to give to the auditor for the purpose of
conducting an audit (treasury.gov.au, 2019). This section also states that the organization needs
to keep records registered by the Corporations Act. Along with that, ethical dilemmas have been
identified where the auditors have been paid by the company for non-audit work. This argues the
unbiasedness of auditor. Standard of auditor’s independence permits auditors for such practices
which put a question mark (abc.net.au, 2019). In terms of legal liability, auditor’s statement of
Harris Scarfe described that they had been unable to determine the financial irregularities.
Improvement in auditing standards and principles
HIH case
There were significant changes in legislative structure took place after the failure of HIH
insurance company. Improvement was implemented for authorizing APRA in order to make
provident standards for general insurance. As a result of this, the faster and pliable process was
applicable for prudential governance for easily contributing to market growth. Royal
Commission also suggested that the significant development of APRA provided an effective
approach to the general insurers. As per the views of Knechel and Salterio (2016) in terms of
Auditing Standards, auditor’s independence has been considered based on which standards have
been developed. Another significant improvement was there in Tort law, which certainly helped
to attain the goal of enhancing convenient and economic liability of public insurance. After the
severe failure of HIH government improvised medical scheme by providing financial help to the
medical insurance provider as well as clinical practitioner’s (treasury.gov.au, 2019).
Royal Commission also introduced a financial scheme in order to provide support to the public
having insurance at the time of failure of companies. Research has also stated that this particular
scheme also stabilized guarantee scheme and costs. The government also included many
commercial contracts in order to control the offshore insurance, as well as non compulsory
mutual funds, are to be regulated only as a contract under the Insurance Act (treasury.gov.au,
2019).
Harris Scarfe
Due to certain collapses in Australia, different types of developments, as well as improvisation,
arose both from the committee of the company and official individuals. CLERP 9 was basically
introduced in order to reflect certain severe failures in Australia (bloomberg.com, 2019). Along
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with that several recommendations regarding the independence of auditor was incorporated in
Corporation Act. However, auditing standard of Australia is quite similar to the IFAC’s
International audit as well as Assurance Standard Board (As opined by the views of Ogiriki
2017). But the government also enhanced the independence of auditors for the strong corporate
environment along with that; it also illustrates that member of the audit committee must be
effectively involved in the full audit process and not just in the final outcome. As a result of this,
it can mitigate certain issues regarding auditor’s independence as well as provide good advice to
all investors. As a result of this collapse, CPA Australia has accepted CFC F1 in order to ensure
the independence of the auditors.
Recommendation
The auditor needs to maintain its independence, which has a certain impact on maintaining the
relationship between client and auditor. Certain independence law regarding auditors
independence includes Divisions 3, 4 and 5 of Part 2M as well as s307C of the act related to
Corporation. Certain areas are also present of which auditor needs to get aware such as conflict
arising in a certain situation as well as shifting of auditors for unlisted companies. In some cases,
the shifting of the auditor is authorized by ASIC. Apart from this, the auditor needs to give a
written document regarding the conflict situation to ASIC and illustrate the situation, whether it
is still present or not. It is also required to ensure that the auditors will not perform any non-
auditing work as receiving payment for such activities are responsible for the ethical dilemma.
Conclusion
Thus it can be concluded that in minimizing fraud related issues, it is necessary for an auditor to
remain independent and maintain ethics in the workplace. Along with that, any conflict situation
needs to be written in ASIC, and it has to be properly illustrated. Important changes in the
legislative framework can reduce fraud cases. Apart from it,a committee of audit needs to be
fully engaged in the audit process rather than to overview only the outcome of the process.
Independence and ethical practice of auditors are major factors to determine the efficiency of the
financial statement of an organization.
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Reference list
abc.net.au (2019), Independence and Auditing: When Companies Collapse., Available At:
https://www.abc.net.au/radionational/programs/backgroundbriefing/independence-and-auditing-
when-companies-collapse/3480960 [Accessed On: 18/5/2019]
Arya, A. and Glover, J., (2014). Auditor independence revisited. Journal of accounting, auditing
& finance, 29(2), pp.188-198.
bloomberg.com (2019), Company Overview of Harris Scarfe Australia Pty Ltd., Available At:
https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=874995 [Accessed
On: 18/5/2019]
Church, B.K., Jenkins, J.G., McCracken, S.A., Roush, P.B. and Stanley, J.D., (2014). Auditor
independence in fact: Research, regulatory, and practice implications drawn from experimental
and archival research. Accounting Horizons, 29(1), pp.217-238.
Djordjevic, M. and Đukić, T., 2016. Contribution of internal audit in the fight against
fraud. Facta Universitatis, Series: Economics and Organization, pp.297-309.
Grenier, J.H., Pomeroy, B. and Stern, M.T., (2015) The effects of accounting standard precision,
auditor task expertise, and judgment frameworks on audit firm litigation
exposure. Contemporary Accounting Research, 32(1), pp.336-357.
hih.com.au (2019), HIH Insurance, Background, Available At:
https://www.hih.com.au/background [Accessed On: 18/5/2019]
Knechel, W.R. and Salterio, S.E., (2016). Auditing: Assurance and risk. Routledge: Abingdon
LeBaron, G., Lister, J. and Dauvergne, P., 2017. Governing global supply chain sustainability
through the ethical audit regime. Globalizations, 14(6), pp.958-975.
Lorenz, G., 2017. The implementation of social capital features in social auditing procedures to
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Confidence in Audit Reports. International Journal of Innovative Finance and Economics
Research, 5(4), pp.23-39.
Tepalagul, N. and Lin, L., (2015). Auditor independence and audit quality: A literature
review. Journal of Accounting, Auditing & Finance, 30(1), pp.101-121.
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treasury.gov.au (2019), The rise and fall of HIH Insurance Group, Available At:
https://treasury.gov.au/publication/economic-roundup-issue-1-2015/economic-roundup-issue-1/
the-hih-claims-support-scheme/2-the-rise-and-fall-of-hih-insurance-group [Accessed On:
18/5/2019]
treasury.gov.au (2019). 3. Aftermath of the HIH collapse, Available at:
https://treasury.gov.au/publication/economic-roundup-issue-1-2015/economic-roundup-issue-1/
the-hih-claims-support-scheme/3-aftermath-of-the-hih-collapse [accessed on: 18/5/19]
Tyasari, I., Yusof, N.Z.M. and Bahador, K.M.K., 2017. Audit quality in ASEAN region: some
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Appendix :Auditor’s role in collapse of HIH Insurance
(Source: https://prezi.com/yxcqepncj-zm/the-collapse-of-hih-insurance/)
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