The Importance of Corporate Governance and Auditing in Preventing Liquidation

The liquidation of HIH Insurance Company was attributed to non-compliance with corporate governance and fraudulent activities by the management. The company's financial records were falsified, resulting in losses of $100 Mn to $300 Mn and the withholding of results. This led to the eventual liquidation of the company, affecting a large number of investors and stakeholders. The analysis highlights the importance of compliance with laws and principles, as well as the need for unbiased and true approaches from auditors and management.

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By student name
Professor
University
Date: 16 September 2017.
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Contents
Introduction...…………………………………………………………………………………………….......3
Case study on liquidation for the 3 given companies………………………………...........
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Conclusion.....…………………………………………………………….....…………………………………7
Recommendation.....……………………………………………………………………………………..…8
Refrences.....……………………………………………………………….......................................9
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Introduction – Liquidation & its basics
Liquidation is a process by which the company decides to shut down its operations and
sell of all its assets. There can be many reasons behind the liquidation of a company. Some
company does it on voluntary basis and some are ordered by the court to do the same on the
basis to their operations and actions. It is an end to the going concern assumption of the company
and affects all its investors and other stakeholders who are related to the company. Three are
various rules and laws that have been established to guide the overall liquidation process of the
companies. The companies need to appoint a liquidator that will look over the overall liquidation
process (Raiborn, et al., 2016). It is possible that sometimes the personal assets of the
management may be attached in case the company is not able o pay off all its dues. A company
must try to avoid liquidation as much as possible; it is an end to the existence of the company.
Liquidation is also known as the process of winding up of the company and closing all its
operations. In case the company is making loss, the directors can propose the end of the company
and can ask for the liquidation process to begin. Apart from this reason there may be many other
reasons because of which the company might get liquidated like the business has been started for
wrong reasons, or the overall working capital of the company is not appropriate, there are
chances that the overall location of the company might not be right, there might be fraudulent
financial practices, all these factors might contribute to the overall liquidation of the company.
Non-compliance with the rules and regulations and no following the ethical path can also be a
reason for the liquidation of the same. The same is explained in the analysis given below with the
help of example of few specific companies that were liquidated. (Knechel & Salterio, 2016).
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The case of liquidation with ABC learning, One Tel Phone company and HIH Insurance
ABC learning has been known for one of the best child education providing companies in
Australia in the past. It had a large number of educational primary and secondary centres across
Australia and was earning heavily and the profit margins were high. The new auditors took over
in 2000 and the company was listed on the Australian Stock exchange with the huge market
capitalization of 2.5 billion dollars in 2006. However, later on the company was found to be
involved in the number of malpractices because of ethics and governance in accounting and it
had to liquidate due to a number of issues. This occurred as it had a huge borrowing and debt and
was not able to pay in time. A large number of investors were affected and went into widespread
losses. The auditors were also held responsible for the acts of the company as they did not
highlight the same to the management and hence the company went into liquidation in 2008.
Later on in December 2009, it was taken over by Goodyear Early Learning, which currently
operates with 650 centres across Australia. (Sonu, et al., 2017).
All this happened as the company was not able to pay off its creditors and as a result, it
went into voluntary liquidation as the auditors denied signing off the audit report in the presence
of material misstatement in the financials of last few years and thus, the auditors demanded
recasting and re-preparation of the financial statements. The childcare started in early 2000s and
soon it expanded rapidly to have as many as 2300 centres across Australia making it a leader not
only inside the Australian territory but also acquiring 1% stake in the US market. It was also
involved in some of the major acquisitions and all this accounted for huge profits for the
company ranging from 15-20% in 2004 – 2005. However, all this came under the shed of
increasing debt burden on the company, which the company was never able to pay and as a result
had to undergo dramatic collapse of the share prices by more than 40% in 2007. All this resulted
not only in receivership being imposed on the company going through financial distress but S&P
also delisted the company from the stock exchange. (Fay & Negangard, 2017).
Many reasons can be attributable to the collapse of ABC learning via liquidation but
some of the major includes lack of corporate governance being followed at the organisation, lack
of ethics in business, incorrect valuation supported by non-disclosure of price sensitive
information to the stakeholders. The poor internal control and lack of review from management
showed that there was no due diligence being done by the company on the acquisition of the new
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entity and there were huge differences from the actual should be valuation to the tune of multi
million dollars. This proved that the acquisitions were never analysed based on future economic
benefits or numbers but was just a rubber and stamp activity for those charged with governance.
It did not had the investment review committee instead; it had management group approval
whose only work was redundant stamping exercise. (Jones, 2017). One of the reports also
showed up that one of the companies which was acquired was valued $ 70 Mn instead of the
actual $ 30 Mn, which is one of the example of the overvaluation of the companies and making
excessive payments.
Another company being discussed here is One tel phone company which was one of the
renowned telecommunication brands in Australia known widely for its mobile and internet
services, marketing and new information systems and famous among the youth and had a
customer base of 2 million across 8 countries. This was again caused with the issue of weak
internal financial controls and weak business ethics together with non-competitive management
who were least interested in giving the true, unbiased and fair picture of accounts to the
stakeholders. The liquidation of the company was primarily brought about by wrong flow of
information regarding the expected revenues and profits based on the past year profit figures.
The company was earning tremendously in the past 4 years from 1997 to 2000 with the rise in
sales by 127%, 40%, 57% and 100% and thus gave the sales rise estimate of 10 times compared
to the last year. However, in reality, the company could not achieve as per the expectations
inspite of huge growth in the past years. The other reason of failure to pay the debts and ending
with huge payables and liabilities in the Balance sheet was the purchase of addition spectrum
licenses which were not actually required. This also included public as well as government
funding. But in the year 2000, One tel suffered one of the major blows of all time and suffered
losses amounting to $ 291 Mn and the share prices fell to as low as $ 1. Inspite of ending with
major losses, the company continued to pay its directors Rich & Keeling handsomely with
salaries and bonus in million dollars. All these factors cumulatively accounted for negative cash
flow and increase of debt burden on the company. (Bena, et al., 2017) The company had to close
its operations, sell its assets, lay off huge number of employees and ultimately liquidate in 2001.
Corporate governance in the company was totally done away with and the financial accounts no
more reflected the true and unbiased affairs of the business on which any decision could be
taken. It was not only that the sales were shown inflated in the accounts, but the figures of
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receivables, other accruals and profits were also shown to be excessively high which missed the
view of the auditors. This was a detection risk, which could have been bought to the notice of the
management.
HIH insurance is another pivotal companies in Australia known for insurance business. It
was the 2nd largest at that time but had to liquidate courtesy a major collapse because of huge
losses being incurred by the entity. The losses were to the tune of $ 5.3 billion, which is still
being considered as one of the major corporate collapse in Australia. The major reason for
liquidation was the incorrect over inflated pricing or valuation of the taken over entity FAI along
with the aggressive accounting techniques being followed by the entity. On top of the losses
incurred, the company had paid to its chief executive office a multi million severance package
when he decided to resign the entity just an year ago when the entity was liquidated. This
affected the construction industry and housing business terribly. (Bae, 2017). The major
operations of HIH insurance included property dealing and underwriting services but the
aggressive intent of accounting coupled with wrong disclosure of facts and figures of many such
acquisitions like CE Health international where the liabilities and reserves were shown to be
understated in the financials, resulted in liquidation. Again, in this case too, the acquisitions were
made without proper due diligence and wrong information was being reported by the company
under the nose of the auditors who could identify the same at that time. All this resulted in losses
amounting to $100 Mn to $ 300 Mn and hence the results were not published. This non
compliance of corporate governance coupled with other factors led to the liquidation of HIH
insurance company. (Félix, 2017)
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Conclusion
In the given analysis, we see that there were many factors that had contributed to the
liquidation of the company. The company was not able to manage its operations properly and
that contributed to its liquidation. The management of the company, as we in the case of the
ABC Learning centre indulged in several fraudulent means by which they show that loss-making
units was making a large amount of profit. This was an unfair mean that was adopted by the
company and when the company got liquidated large number of investors and other related
parties were affected very badly. There were many other reasons as the overall accounting
processes in the company were not up to the work, even the auditors of the company helped in
falsification of the records. Because of all these strict rules have been written by the law framing
bodies to make sure that the overall liquidation process is properly monitored and the companies
do not indulge in any kind of fraudulent means that might hamper their existence and cause the
company to liquidate. From the examples of these three companies, we can see how important it
is for the company to get their accounts audited and how important it is for the auditor to
maintain an unbiased and true approach. In any, way if we see that the auditor or the
management is indulging in fraudulent practices then they can be punished and held guilty for
the same. The overall process of liquidation must be handled by the liquidator who must be very
true in their approach and maintain the appropriate code of ethics in their function. (Grenier,
2017).
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Recommendations
The companies need to understand that if they are being liquidated so many people
become unemployed and lose on their jobs and their income. The investors who had invested in
the company based on the audit reports of these companies, assuming them to be going concern
suffers huge loss because of the same. There are so many laws that the government has framed to
make sure that these parties are not affected in cases that the companies go into liquidation
(DeZoort & Harrison, 2016). The overall analysis of these three companies helps in developing
an overall understanding about the importance of compliance with the laws and the principles.
The management and the other professionals must be true to their work and must have an
unbiased approach to the company and its financial statements. This is very helpful in the end;
hence, it will help in the global development of the company and its management.
References
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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.
Bena, J., Ferraira, M., Matos, P. & Pires, P., 2017. Are foreign investors locusts? The long-term effects of
foreign institutional ownership. Journal of Financial Economics, pp. 21-35.
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.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of
insurance companies. MASTER THESIS, pp. 1-69.
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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