Ethical Issues in Auditing Company Encompasses

Question: Discuss about the Ethical Issues in Auditing for Company Encompasses. Answer: 1(a): Audsabumrungrat, Pornupatham and Tan (2015.) states that business risks of a company encompasses factors that are primarily within the purview of the company, however, few risks factors are uncontrollable in nature by the companies in general and industries as a whole. The assessment of business risk profile comprises of evaluating several parameters as enumerated below: Risk pertaining to the claims: The business decisions undertaken by HIH showcases that the company has invested towards coverage sectors that entails a high risk profile. The quantum of high claims arising from the large sets coverage which were perceived to have low chance of occurrence, such as natural disasters and marine calamities, later on resulted in disbursing of high claim amounts. The inclusion of FAI in the company portfolio again raised the risks pertaining to high claims as the business operations of FAI aggravated faulty decisions in providing coverage to businesses that entailed high probability of claims. Exogenous Risks: Insurance products offered by the companies that cover natural events encompassed a high amount of risk depending on the probability of occurrence (https://www.treasury.gov.au). The change of governmental policies can in term hike the level of claims made the companys clients. The exogenous risks pertaining to the company delves towards increasing the costs of the company (Hih.com.au. 2016). Since the company focused upon providing coverage from natural disasters, the frequency of occurrence of calamities such as the Florida Typhoons and Sydney hailstorms increase the losses substantially. The maritime risks such as security concerns along with adverse weather conditions resulted in high payout to clients, therefore the company has experienced heightened amount of risks pertaining to the environmental risks. Financial Risk: The company was involved in controversial insurance products resulting towards insolvency issues. The high quantum of losses resulting from high insurance claims showcases the amount of cash outflow from the company. Moreover the acquisition of FAI that was grossly overvalued to the tune if over $300 million further aggravated the solvency issues. The subsequent writing off $400 million from the books of HIH further deteriorated the solvency conditions. The shifts in company policies towards increasing the amount of insurance coverage on high risk areas such as coverage of natural calamities, coverage of maritime activities along with the level of insurance on film industry resulted towards adverse. The restricted access to management reports aggravated the amounts of wrongdoing in management operations. Post the acquisitions of FAI the company showcased losses in case of its US and UK business (Budescu,., Peecher and Solomon 2012). The overstating of the balance sheets and income st atements resulted in misrepresentation of the financial positions in turn resulting in favorable ratios in terms of efficiency activity, liquidity and solvency positions of the company. Moreover, large lists of losses from Florida Typhoons, hailstorms in Sydney along with losses from coverage of films further escalated the adverse financial position that the company is in. 1(b): It can be inferred that involvement of directors from Arthur Anderson compromised the level of integrity in terms of preparation of financial statements. The of material fact from the HIH prospectus also reiterates that degree of disclosures was insufficient and misleading for investors of the company and its different stakeholders. In terms of opinion of auditors in relation to the financial statements, their evaluations were grossly misstated due to the degree of influence the board members exerted upon the release of financial figures. Moreover, the discounting of amount earmarked for prudential margin by the company reduced the degree of buffer that insurance companies applied to safeguard against claims of natural calamities. Therefore the risks of bankruptcy increased substantially. The implementation of reinsurance policies by the company aggravated the amount of inherent risks. That contributed significantly towards the misappropriation of funds away from the company. 2a) Reviewing of the facts from previous court cases of HIH: Statements of court cases relevant to the clients: The findings of the Royal Commission stated that HIH collapsed because of its failure to mitigate the risks pertaining to the adverse factors emerging in the insurance markets around the globe. The Commission Report also stated the presence of mismanagement pertaining to the company operations. Moreover, the claim by HIH that the downfall of the company was caused by inappropriate regulatory sanctions made by Australian Prudential Regulation was dismissed by the Commissioner of the Royal Committee (Ministers.treasury.gov.au. 1996). The subsequent recommendations made on the strengthening the independence of auditors after the Royal Commission Report showcased that the comprising of auditory guidelines were present in case of HIH, thereby indicating passively Anderson of being guilty of malpractices in auditory services. The instances of receiving payments to the tune of $124,000 by the insurance agents towards the awarding insurance payments of higher amounts have been observed by the investigators. Moreover, the involvement of company officials into large scale misappropriation of funds has been showcased by the investigation reports (Ministers.treasury.gov.au. 1996). Further, insurance coverage of assets that encompassed high rates of risks were aggravated in numbers as the company officials along with the insurance agents streamlined such efforts in consideration for monetary benefit from a few of the companys clients. Statements of court cases relevant to the creditors: As can be observed from the instances with regards to Daniel Wilkie, Terry Cassidy along with other board members, the court found them guilty of suppressing material facts regarding the financial performance of the companies. Moreover, serious lapses were observed in case of limiting the independent functioning of audits. Further, the court also found by the management of sacking or removing the financial analysts hired by the company who have expressed their concerns regarding the rising levels of losses and the financial structure of the company. Moreover, the trials and the subsequent indictment of the board chairman along with the other board members showcases that the managements followed large sets of corporate malpractices. 2b) Depiction the factors pertaining to negligence actions by HIH: Lack of transparency in corporate practices: Bhattacharjee, Maletta. and Morena (2015) states that transparency in terms of depicting true and fair view of the companys financial position along with the level of transparency in operating and investing activities are prerequisites for a companys prospects. Moreover, the presence of directors with questionable background and subsequent challenges to ethical parameters has put a doubt in terms of the integrity in business practices of the company. Issues regarding corporate governance practices: The conflict of interests arising from the wrongful governance practices can be attributed for the adverse financial repercussions in an organization (Bhattacharjee, Maletta and Moreno 2015). The non alignment of the shareholders interests with that of the managers resulted in negative effect upon the levels of corporate governances measures undertaken by HIH. Moreover, the issues pertaining to the restriction upon the non executive directors by limiting their power among the board of directors led to increment towards the level of bad governance practices. Gunin-Paracini, Malsch and Paill, (2014) states that the quantum of transparency influences ethical consideration in auditing. Moreover, the rise in principle agent problems followed from corporate governance issues resulted towards higher level of agency costs as the non alignment of interests have far reaching outcomes (Audsabumrungrat. and Tan, 2015.). 3a: The inclusion of executives from the external auditor showcases a clear conflict of interests in terms both the audit firm and the company. Gunin-Paracini, Malsch and Paill (2014) states that in order to increase the level of transparency the workings and proceeding of auditors have to be devoid of any influence from the management of the audited firm. Further, as per guidelines laid down in the Corporations Act, 2001 the company auditor requires to declare in person or as an audit firm that no external sources of coercion have been inflicted upon the proceedings of the auditor. Moreover, the Act also states the auditors require declaring whether external audit has been conducted independently. The appointment of former executives of Anderson showcases that there is an underlying set up between the company and the external auditor. Point to be noted is the fact that the chairman of the board of director himself is former employee of Anderson; thereby the magnitude of fraud in auditin g the financial statements can be measured by such adverse managerial appointments. The reasons behind the inclusion of the Andersons former executives on the managerial board of HIH can be several, primary among them being enumerated below: To bring expertise into managing company policies in accordance with the accounting standards and legal framework of the market that the company deals in. In order to initiate window dressing comprising of suppressing large losses that the company incurred from covering high risk assets. To vitiate the independence of external auditors of the firm through alignment of Andersons goals of higher revenues, from audit and non audit services, with that of HIHs objective to increase its market price. To overstate the acquisition costs of FAI with the external auditor providing favorable audit reports. In order to suppress details of actual financial performance of the company through assistance from its external auditors. 3b Auditing firms usually tends to have expertise in terms of regulations and guidelines pertaining of investigating servies (Keune and Johnstone 2012). The non audit services provided by the external auditor of the firms tend to have several advantages as enumerated below: The safeguarding of revenues from high payments towards corporate taxes can be initiated with the assistance from the external auditors as the auditors have sufficient knowledge regarding tax laws and acts (Griffin, J.B., 2014). The insight into the operations of the company by the external auditor because of inspections and evaluation of company activities for preparation of audit report may in turn make the auditors well versed with the companys operations. Thereby, the auditors of the company are in a better position to provide consultation services. Exposure to operating and financing activities of the firm helps the auditors to earmark the discrepancies in different sets of corporate operations. The probability is high that the auditor is well versed with the challenges that are unique to the industry, in which the company belongs to. Moreover, the fees for consultative services from the external auditor are lesser than what is charged by other consultants. 3c: There is multiple numbers of ethical violations committed in the current case by the auditors of the firm. In this case, the fees for non audit services does not exceed the amount of auditing fees thereby not exceeding the ceiling prescribed in the taxation laws such as the Corporations Act, 2001 among others. However, the presence of former associates of Arthur Anderson, the external auditors, in the board of HIH followed by non audit fees that is close to matching the level of audit fees provides space for speculations. Investigations into the case revealed that the investors were provided audited financial statement that contained inflated levels of profits and were bereft of any fair representation of material facts. Moreover, it can also be inferred that the losses faced by HHI could have been mitigated if adequate amount of auditory control on the company were applied. Thereby, the auditors have restrained themselves from following ethical guidelines while conducting audits. 3d: Different recommendations enumerated in the Ramsay Report and CLERP 9 aims towards ensuring corporate governance practices in organization through limiting the scope of unethical auditory practices. The recommendations are depicted as follows: Ramsay report suggested that the auditor requires formally declaring that the auditor has been independent in conducting auditory services. The CLERP 9 requires that the CEOs and CFOs certify that their balance sheet and financial statements have been prepared in accordance with the relevant corporate laws. Entitlement of shareholders to submit queries relating to the audit in the annual general meeting. Compulsory attendance of auditors in annual general meetings of their companies. Compulsory disclosure of payments made to the auditors for non audit service fees. The compulsory declaration made by directors certifying that they are satisfied that non audit services does not compromise the independence of the auditor. The implementation of such recommendations is aimed towards limiting the quantum of unethical practices with regards to misrepresentation of material facts in financial statements. Moreover, the key executives are included under the aforementioned sets of recommendations in order to make them accountable for any lapses in fair representation of financial figures in financial statements and annual reports. Further, emphasis has been made towards ensuring that audit proceedings are bereft of any biasness by recommending that the declarations are made by auditors in regards to independence of auditory services. Moreover, in order to further mitigate unethical practices the non audit services provided by the auditors are checked for any influence upon the auditory proceedings. References and Bibliography: Amiram, D., Chircop, J., Landsman, W.R. and Peasnell, K.V., 2015. Mandatorily Disclosed Materiality Thresholds, their Determinants, and their Association with Earnings Multiples.Available at SSRN 2631876. Audsabumrungrat, J., Pornupatham, S. and Tan, H.T., 2015. Joint Impact of Materiality Guidance and Justification Requirement on Auditors' Planning Materiality.Behavioral Research in Accounting. Beck, M.J. and Mauldin, E.G., 2014. Who's really in charge? Audit committee versus CFO power and audit fees.The Accounting Review,89(6), pp.2057-2085. Bhattacharjee, S., Maletta, M.J. and Moreno, K.K., 2015. The Role of Account Subjectivity and Risk of Material Misstatement on Auditors' Internal Audit Reliance Judgments.Accounting Horizons,30(2), pp.225-238. Boritz, J.E. and Huo, K., 2013. The Effect of Alternative Business Model Representation Techniques on Business and Audit Risk Assessment. In Academic Accounting Association (CAAA) Annual Conference, June. Budescu, D.V., Peecher, M.E. and Solomon, I., 2012. The joint influence of the extent and nature of audit evidence, materiality thresholds, and misstatement type on achieved audit risk.Auditing: A Journal of Practice Theory,31(2), pp.19-41. Chen, T.T., Zhang, F.F. and Zhou, G.S., 2016. Secrecy Culture and Audit Opinion: Some International Evidence.Journal of International Financial Management Accounting. Foo, W., Bliss, M.A., Gul, F.A. and Lai, K., 2016. Auditors Response to Analysts Forecast Properties: Some Evidence from Audit Fee Pricing.Available at SSRN 2800904. Griffin, J.B., 2014. The effects of uncertainty and disclosure on auditors' fair value materiality decisions.Journal of Accounting Research,52(5), pp.1165-1193. Hih.com.au. (2016). HIH Insurance - Royal Commission. [online] Available at: https://www.hih.com.au/Group-HIHRoyalCommision.html [Accessed 1 Sep. 2016]. Gunin-Paracini, H., Malsch, B. and Paill, A.M., 2014. Fear and risk in the audit process.Accounting, Organizations and Society,39(4), pp.264-288. Hih.com.au. (2016). HIH Insurance - Royal Commission. [online] Available at: https://www.hih.com.au/Group-HIHRoyalCommision.html [Accessed 1 Sep. 2016]. Hines, C.S., Masli, A., Mauldin, E.G. and Peters, G.F., 2015. Board risk committees and audit pricing.Auditing: A Journal of Practice Theory,34(4), pp.59-84. Keune, M.B. and Johnstone, K.M., 2012. Materiality judgments and the resolution of detected misstatements: The role of managers, auditors, and audit committees.The Accounting Review,87(5), pp.1641-1677. Legoria, J., Melendrez, K.D. and Reynolds, J.K., 2013. Qualitative audit materiality and earnings management.Review of Accounting Studies,18(2), pp.414-442. Ministers.treasury.gov.au. (1996). Press Release - Report of the HIH Royal Commission [16/04/2003]. [online] Available at: https://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2003/020.htmpageID=003min=phcYear=2003DocType=0 [Accessed 1 Sep. 2016].. Sarens, G., Christopher, J. and Zaman, M., 2013. A study of the informal interactions between audit committees and internal auditors in Australia.Australian Accounting Review,23(4), pp.307-329. Woo, S., Rhee, C.S. and Woo, S., 2015. The Effect Of Directors And Officers Liability Insurance On Audit Effort.Journal of Applied Business Research,31(6), p.2039. Yao, D.F.T., Percy, M. and Hu, F., 2015. Fair value accounting for non-current assets and audit fees: evidence from Australian companies.Journal of Contemporary Accounting Economics,11(1), pp.31-45. Treasury.gov.au. (2016). 3. Aftermath of the HIH collapse | The Treasury. [online] Available at: https://www.treasury.gov.au/PublicationsAndMedia/Publications/2015/Economic-Roundup-Issue-1/HTML/article-3/3-Aftermath-of-the-HIH-collapse [Accessed 1 Sep. 2016].