Risk Assessment, Legal Liability, and Ethics

Describe about the Risk Assessment, Legal Liability, and Ethics.

1 (a): The business is surrounded by the risks such as financial risk, operational risk, and compliance risk, thus, the risk assessment becomes an inevitable exercise for the management of every company (Skoglund and Chen, 2015). In order to attain sustainable growth, it is of paramount importance for the management to continually assess the risk and take adequate measures to reduce it to the risk appetite of the organization. Further, it is also essential to get the risk assessment certified from the independent auditor. In the process of auditing, the auditor is required to assess the risk evaluating various factors such as internal control environment, nature of business, structure of management, and industry rules and regulations (Pickett, 2010).

HIH Insurance limited is operating in Australia in the insurance industry, thus, it is essential to analyze the industry norms and the state of business in the industry. There may be significant changes in the government regulatory framework that affect the insurance industry as whole. The identification of these changes in the government regulations is crucial in risk assessment for an auditor (Pickett, 2010). Further, the state of business, for example, the level of competition, demand, and prices are also crucial things to be considered in risk assessment. The increased competition in the market poses pressure on the management to perform better. Due to the increased pressure of performance, the management may temp to adopt wrong ways by involving in manipulations and window-dressing of the financial statements (Pickett, 2010).

Further, the most crucial step in the risk assessment is the evaluation of the internal control environment of the company. In this regard, the auditor needs to verify the internal policies, processes, and procedures of HIH Insurance Limited. The evaluation of the internal controls system is necessary to ensure that there exist adequate controls on each process that prevent frauds and miss-utilization of the company assets (Pickett, 2010). Further, in order to assess the risk better, the auditor is required to take a good understanding of the strengths and weaknesses of the company. For this purpose, the auditor may conduct the SWOT analysis of HIH Insurance Limited (Pickett, 2010).           

1 (b): Inherent risk is that part of the audit risk, which, in the auditor’s opinion can not be controlled or reduced by the management. However, the assessment of the inherent risk is crucial to plan the extent and timing of the verification of the internal controls (Loughran, 2010). In case of HIH Insurance Limited, there have been identified the following factors that affect the inherent risk at the financial report level:

State of industry: The insurance industry in Australia is facing stiff competition in the market. The increased competition in the industry has caused increment in the inherent risk due possibility of management circumventing the policies and procedures to meet the stakeholder requirements (Loughran, 2010).

Changes in the regulatory regime: The regulatory framework of the insurance companies has got changed recently, which increases the inherent risk.

Nature of business: The business of insurance is of such nature that it involves high risk itself. The nature of business increases the inherent risk in case of HIH Insurance Limited (Loughran, 2010).

Changes in management: Winterthur withdrawn himself from the operations, due to concern that the company may incur losses. This event increases the inherent risk (Loughran, 2010).

Legal Liability

The auditor assumes very high responsibility towards all the stakeholders such as shareholders, creditors, and finance providers (ACCA, 2009). This is due to the fact that the decision of shareholders to invest, creditors to provide material on credit, and financers to lend money is largely dependent upon the auditor’s report. In this regards, it is essential to note that if the auditor does not perform his duties as per the professional guidelines and requirements of the auditing standards, he/ she would be liable to be charged with the professional negligence (Johnstone, Gramling, and Rittenberg, 2015). In such circumstances, the auditor will not only be liable to the shareholders but he will also be liable to compensate the third parties for the damage caused to them due to negligently performing the duties.

In the current case, Andersens, the auditors of HIM Insurance Ltd, could be charged for being negligent in performing their duties. The report of the investigation conducted into the failure of HIM by the Royal Commission reveals that the primary reason for the business failure was the inadequacy of the provisions for future claims. In this regard, it is the primary duty of the auditor to verify the truth and fairness of the financial statements, which covers the verification of the provisions for the future claims as well (Gray and Manson, 2007). Thus, if the auditor is found to be negligent in verifying the genuineness of the provisions for future claims, then the charges of negligence may be proved against him. In order to take further guidance in regard to charges of negligence, following judicial cases could be referred by Andersens:

Smith v Eric S Bush (1990) 1 AC 831

In this case, it was held by the court that the independent valuer is responsible to pay the damages to the third parties only when he owed a duty of care to them (Swarb, 2016). Further, the court explained that the duty of care arises only where there exists a proximate relationship between the parties, for example, a contract between the purchaser and the valuer for valuation of the property may prove proximate relationship (Swarb, 2016). Additionally, the court held that the responsibility of the independent valuer to third party damages arise only when the valuation or the advice was negligent, the party acted upon that advice and sustained a loss. Thus, Andersens, upon the charges of negligence being proved, shall be liable to the shareholders to pay damages. However, in respect of creditors, the auditor may not be liable, due to non existence of any explicit duty to care.     

Hedley Byrne and Co Ltd v Heller and Partners (1964) AC 465

In this case also the petition of the plaintiff was dismissed by holding that in the absence of duty of care, the auditor can not be held to be liable to pay third party damages (Casebrief, 2016).

Caparo Industries plc v Dickman and others (1990) 2 AC 605

It was reiterated by the court in this also that duty to care should be established to hold the auditor liable. If the auditor is not purported to assume the duty of care towards the third party, then there is no liability of the auditor to pay the damages caused to the third party (E-Law Cases, 2016).

2 (b)

Following are the conditions, which must be present in a case of negligence to uphold the case:

There must be a clear and visible departure from the professional standards and ethical guidelines by the auditor. This implies that firstly it must be established that the auditor did not perform duties as enunciated in the auditing standards and did not acted as per ethical guidelines (Dembinski et al., 2005).

The circumstances must reveal that the normal procedures of the auditor could have found out the fact. This implies that it should be apparently clear that the auditor skipped certain procedures deliberately to hide some facts (FindLaw, 2016).

There must be a proximate relationship between the auditor and the plaintiff. In case of audit, this implies that the report of audit should belong to the party, for example, shareholders (FindLaw, 2016).

Further, the party should have actually suffered damages. This means that the fictitious cases or the probably damages can not be claimed under the charge of negligence (FindLaw, 2016).     

Ethics

3 (a)

There are various reasons for hiring the prior members of the external audit team, some of which are good for the business and some are unethical (CCH Australia Limited, 2011). Since the existing member already have extensive knowledge about business and integrity of the management, thus, it would be advantageous for the business to hire them for the future audit assignments as well. However, there may be ulterior motives also for hiring the existing members for audit, for example, the existing member may have a good bonding with the management and thus, may collude with the management to manipulate the things (Sec.gov, 2016). In the case HIH Insurance Limited, the existing members of the auditing firm are also on the board of the company, thus, here HIH would have hired them to achieve the ulterior motives.

3 (b) The advantages of having same firm providing auditing as well as consulting services are listed below:

The auditor is supposed to have knowledge of every bit of the company’s business and the internal processes. Thus, it becomes easier for the person who is performing auditing services to provide consultancy. Further, the constancy services would be better and comprehensive also in such cases (com, 2016).

Less time would be required to provide consultancy on the matters because the auditor would already be aware of certain facts based on the knowledge gained while performing auditing services (com, 2016).

Better bonding would be established between the management and the consultant because the person performing consultancy services is already known (com, 2016).

Further, the company may also secure cheaper contract for consultancy services from the firm that has already been appointed as auditor of the company (com, 2016).      

3 (c)

Although, assigning the consultancy and auditing services to the same firm is advantageous for various reasons but it may also pose violations of the ethical standards. For example, the facts that the auditor is fully aware of the internal processes and has comprehensive knowledge about the company, poses threat violations of ethical standards. This is because the auditor may engage himself in manipulating the financial statement by colluding with the management (Gramling, Johnstone, and Rittenberg, 2012). Further, the auditor’s good bond with the management also poses threat to the circumvention of the ethical standards. This is because the auditor could easily get convinced by the management to approve the false financial statements.       

3 (d)

After the collapse of HIH Insurance Limited, the Royal Commission carried out investigation into the case. Followed by this investigation, Ramsay report was prepared with a focus on auditor’s independence and prescribing recommendations for the required changes. The major reforms in the fielded of auditing were carried out based on this report, which includes promulgation of the Corporate Law and Economic Reform Program (CLERP) Act 2004 (Waldron, 2003). The major reforms in the field of auditing as prescribed in the Ramsay report and the CLERP Act are as under:

The auditing standards were given legal recognition in Australia by promulgating CLERP Act. The impact of legal backing being given to the auditing standards would be on the auditor’s responsibilities. The auditor would now be under compulsion to comply with the auditing standards and departure from standard would be illegal and punishable with rigorous fines and penalties (Waldron, 2003).

Further, the auditor’s independence was made subject to the review of the financial reporting council. Moreover, the auditors were made compulsory to give in writing a declaration for their impendence prior to their appointment as auditor in a company.

The accounting professionals and firms having financial relationship with the company were restricted from undertaking the auditing and consultancy assignments for the company (Waldron, 2003).

Further, the act provided for a cooling period of 4 years and 2 years for the auditing firms directly and indirectly involved in audit of a company. This means that the same firm could not be appointed as auditor of the company for a period of 4 years of it has been involved directly in auditing the company in the previous years (Waldron, 2003).

Further, there are other various recommendations made in the Ramday report and provided for in the CLERP Act, which are related to the removal of the auditor, remunerations fixing, and reporting by the auditor.

These recommendations and promulgations of the act were made to stop the unethical practices in the accounting and auditing. The recommendations as discussed above are expected to enhance the auditor’s independence and strengthen the regulatory regime in the field of auditing (Waldron, 2003).

Reference

Skoglund, J. and Chen, W. 2015. Financial risk management: applications in market, credit, asset and liability management and firmwide risk. John Wiley & Sons.

Pickett, K.H.S. 2010. The internal auditing handbook. John Wiley & Sons.

Loughran, M. 2010. Auditing for dummies. John Wiley & Sons.

ACCA. 2009. Professional liability of accountants and auditors. [Online]. Available at: http://www.accaglobal.com/content/dam/acca/global/PDF-members/2012/2012p/Prof_liability.pdf [Accessed on: 22 August 2016].

Swarb. 2016. SMITH V ERIC S BUSH, A FIRM ETC; HL 20 APR 1989. [Online]. Available at: http://swarb.co.uk/smith-v-eric-s-bush-a-firm-etc-hl-20-apr-1989/ [Accessed on: 22 August 2016].

Casebrief. 2016. Hedley Byrne v Heller. [Online]. Available at: http://casebrief.me/casebriefs/hedley-byrne-v-heller/ [Accessed on: 22 August 2016].

E-Law Cases. 2016. Caparo Industries pIc v Dickman [1990] 2 AC 605  House of Lords. [Online]. Available at: http://e-lawresources.co.uk/cases/Caparo-Industries-v-Dickman.php [Accessed on: 23 August 2016].

Johnstone, K., Gramling, A., and Rittenberg, L.E. 2015. Auditing: a risk based-approach to conducting a quality audit. Cengage Learning.

Gray, I. and Manson, S. 2007. The audit process: principles, practice and cases. Cengage Learning EMEA.

FindLaw. 2016. Elements of a Negligence Case. [Online]. Available at: http://injury.findlaw.com/accident-injury-law/elements-of-a-negligence-case.html [Accessed on: 23 August 2016].

Dembinski, P., Lager, C., Cornford, A., and Bonvin, J. 2005. Enron and world finance: a case study in ethics. Springer.

Sec.gov. 2016. Final Rule: Revision of the Commission’s Auditor Independence Requirements. [Online]. Available at: https://www.sec.gov/rules/final/33-7919.htm [Accessed on: 23 August 2016].

CCH Australia Limited. 2011. Australian corporations & securities legislation 2011: corporations act 2001, Asic act 2001, related regulations. CCH Australia Limited

Icaew.com. 2016. The provision of non-audit services to audit clients. [Online]. Available at: http://www.icaew.com/en/technical/ethics/auditor-independence/provision-of-non-audit-services-to-audit-clients [Accessed on: 23 August 2016].

Gramling, A.A., Johnstone, K.M., and Rittenberg, L.E. 2012. Auditing. Cengage Learning.

Waldron, B.D. 2003. CLERP (Audit Reforms & Corporate Disclosure) Bill 2003. Available at: file:///C:/Users/Abasus%20Solution/Downloads/03543-Corporate%20Governance%20Update%20-%20CLERP%209.pdf [Accessed on: 23 August 2016].

 

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