Case Study: HIH Insurance - Auditing Theory and Practices

This report provides a comprehensive analysis of the HIH Insurance collapse, focusing on the auditing failures and irregular accounting practices that led to its downfall. The report examines the company's aggressive accounting methods, including the manipulation of asset and liability values, and the use of debt financing for overpriced acquisitions. It highlights the company's failure to adhere to solvency requirements and its attempts to conceal its true financial position. The analysis also explores the role of management's self-interest motives and the ineffective valuation of acquired companies. The report references key sources and provides insights into the financial reporting weaknesses that ultimately contributed to HIH Insurance's collapse, offering valuable lessons for auditing and financial management.

AUDITING THEORY

HIH Insurance
HIH Insurance was mainly engaged in the insurance business throughout Australia but its
business often seemed quite distinct from how an insurance business must be conducted. The
reason behind this can be attributed to the irregular accounting practices undertaken by the
company that resulted in its downfall as a whole (Mock et. al, 2013).
It can be observed from the affairs of the company that most of its business acquisitions were
overpriced and they expended more than what was the actual valuation, thereby resulting in the
depletion of its financial resources. Furthermore, the company also spent enormous resources in
various unproductive areas and at the same time, it failed to operate according to the least
solvency requirement framed by the Insurance Act 1972 and APRA (Australian Prudential
Regulation Authority). Besides, since the year 1992, the company started such aggressive
accounting practices that played a key role in exaggerating or undermining the amount of its
liabilities or assets prevalent in its financial statements. This altogether hampered the financial
strength of the company. Further, this can be proved by the fact that its aggressive accounting
practice undermined the value of its liabilities by $18 million and under reserved the same for
$41 million while the preparation of due diligence report was being facilitated by Ernst &
Young. However, the significant part of such under reserved was a prudential margin that was
rejected by the company’s CEO (Ray Williams) as a reserve for the operation of normal affairs.
In addition to this, after termination of merger betwixt CE Health International and CIC
Holdings, the company also attempted various fraudulent accounting treatments within its
financials so that various portions of the balance sheet could be efficiently distorted (Saville,
2003). Nevertheless, HIH Insurance also attempted in utilizing its pledged securities in its
quarterly financial reports to conceal their real financial position so that negative comments from
the external world can be effectively avoided. Even though this attempt was not the real reason
behind the collapse of HIH, yet this practice reflected their weaknesses and characteristics in
generating income and addressing the expectations of investors. Another inappropriate
accounting practice undertaken by HIH was that it failed to value the companies that it intended
to acquire and as a result, it paid more than what was actually needed to be paid. As the company
made several acquisitions to enhance their businesses, more financial resources were destroyed
as a whole (Hoffelder, 2012). Further, most of the company’s purchases were undertaken debt
financing that also put enormous pressure upon the company in terms of payment of interest. For
instance, the acquisition of FAI wherein Goldman Sachs valued the company for $20 million but
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HIH Insurance
its original value was $200 million. This ineffective accounting practice on the part of the
company played a key role in affecting the financial position of the company and at the same
time, it was also forced to write-off its contributions in FAI (Westfield, 2003). In addition, the
management also used the company resources for self-interest motives that were further not
charged to the accounting practices of the company.
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HIH Insurance
References
Hoffelder, K. (2012). New Audit Standard Encourages More Talking. Harvard Press.
Mock, T. J, Bedard, J, Coram, P, Davis, S, Espahbodi, R & Warne, R. (2013). The audit
reporting model: Current research synthesis and implications. Auditing: A Journal of
Practice and Theory 32, 323-351.
Saville, M. (2003). HIH : The Inside Story Of Australia's Biggest Corporate Collapse. Accessed
October 2, 2017 from http://www.smh.com.au/articles/2003/03/14/1047583693489.html
Westfield, M. (2003). HIH : The Inside Story Of Australia's Biggest Corporate Collapse.
Accessed October 2, 2017 from
http://www.smh.com.au/articles/2003/03/14/1047583693489.html
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