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The current study has discussed about the financial reporting fraud of Australian Insurance Heath International Holdings Ltd where a series of incidents regarding negligence of the duties and intentional falsifying of the financial reports have been identified. The study made an effort to apply Positive Accounting Theory to hypothesize the actions of the accounting managers. It has also identified the accounting regulation that has been violated by the company. Based on the findings of the study recommendations have been provided to the accounting regulators of Australia.
Table of Contents
Key facts about HIH Insurance Australia’s “financial reporting accounting fraud”
Positive Accounting Theory’s (PAT’s) hypotheses predicting the practice.
Specific accounting regulations that were violated.
Valuable lessons for the accounting community from the outcomes.
Recommendations to the Australian financial reporting regulators.
Disclosure of the financial information and results to the external stakeholders and the managers of an organization can be referred to as financial reporting. The external stakeholders may include investors, customers, regulations and others. The financial reporting demonstrates how a company is performing over a period of time. The aim of the current study is to understand the key facts of HIH Insurance Australia’s ‘financial reporting accounting fraud’ and the predictors of this incident through Positive accounting theory’s hypotheses. In this context, the specific accounting regulation that has been violated will be discussed. Recommendations to the financial reporting regulators will also be provided based on the lesson from the findings of the study.
HIH was one of the largest insurance companies operating within Australia. However, in the year 2001, it has been placed to provisional liquidation. With A$5.3 billion of estimated loss, the downfall of HIH can be considered one of the largest corporate collapses in the history of Australia. However, the reason behind this collapse has been attributed to different factors among which fraudulent financial reporting has been considered one of the most significant contributing factors. In the year 1992 The CE Heath International Holdings Ltd have been found to have understated liabilities by $18 million and under reserved by $40 million. It can be stated that the most of this sum comprise of the common prudent practice of the insurance companies, prudential margin that reserved more than 20% more of the capital which was unnecessary to cover under liabilities that were expected (nytimes.com, 2020). A government appointed panel called royal commission, investigated about the case and reported that HIH has misreported the liabilities and profit in order to cover up its ineffective decisions.
Several criminal and civil charges have been raised against several significant company figures including the former chief executive of HIH Ray Williams along with the prominent direct of the company Rodney Adler. This incident became a cause of suffering of creditors and the shareholders; along with this, one million policy holders left without insurance sue to this incident. It has also been found that an internal audit has been withheld by Mr. Williams which is an illegal step. Apart from that an unlawful payment of 3.5 million AUD had also been made by Mr. Williams to Mr. Adler. The Accounting firm of Arthur Andersen has failed to ensure that the financial position is accurately depicted (upi.com, 2020). Therefore, it can be stated that the organization is highly liable for the financial reporting fraud as active monitoring of the accounting has not been followed. Along with this, the standard of the financial reporting has also not maintained by the directors of the organization.
The Positive Accounting Theory provides emphasis on the motives of the management for the choices of financial reporting, usage of economic models and statistical processing at the time there is an asymmetry in information and agency cost is present. Attempts of this theory are to predict and explain the choices of the firms in accounting that is a part of the need to minimize its cost of contracting and other capitals through the application of economic methods and techniques. There are three essential hypothesis identified by Watts and Zimmerman (1986). These hypotheses involve Bonus plan or management compensation hypothesis, debt covenant or debt/equityhypothesis and political cost hypothesis.
According to the bonus plan hypothesis, managers that are affixed to earnings adopt the methods of accounting that increases firm reported income for the current period. In simpler term, this hypothesis predicts that managers that are paid incentives or their remuneration is associated with the accounting performance for the firm are more likely to show accounting performance better through manipulation that it should be. The second one that is the debt/equity hypothesis predicts that if the firm’s debt or equity ratio higher, the managers are likely to use the methods of accounting that increases the earnings (Lewis and Tan, 2016). It can be stated that the motives of the managers in this term is to have a better performance and position of liquidity so that the debt principles and the interests can be paid off that are accumulated in the business. On the other hand, the political cost hypothesis predict that firms have the tendency to show their profit lower than actual through the use of different accounting methods so that politicians do not attend to the accounts of these firms as they will have an eye upon industries that are highly profitable.
It can be stated that the hypothesis of debt/equity will be appropriate to use here which could predict the accounting practices of HIH. As HIH has accumulated debt and liquidity position through faulty operations such as rapid expansion, complex and extensive reinsurance arrangements, under pricing, greed, reckless management and others, it was essential for the company to use the accounting methods that were effective for paying off the debts and neutralize the position of the company (Gad and Kim, 2019). The accounting managers of HIH, as a large firm have chosen the procedures that defer reporting form the current to the future. This is applicable particularly in the case of choosing the Inventory Method. It is a significant accounting choice taken under consideration by HIH managers as there was existence of long-term debt, total short-term liabilities over equity and leverage.
The reason behind failure or collapse of HIH has been investigated by the royal commission. It has been depicted in the 2003 published report of the commission that the failure can be attributed to the mismanagement and inadequate response of the firm to the pressures of international insurance market as well (aph.gov.au, 2020). However, the accounting mismanagement and fraudulent financial reporting are the cases which have caused different liabilities to the firm’s directors and administrators.
The former HIH director Adler has been accused in several charges which included the following:
The fiduciary duties bound the directors, certain officers and the secretaries under some regulations enforced by the Corporations law 2000 (legislation.gov.au, 2020). The current law under the Corporation’s Act 2001, the acts that will be considered dishonest are breaching the following duties of employees including the directors as well.
Mr. Williams paid a huge amount to Mr. Adler unlawfully which comes under the regulations of “disclosure of all remuneration and other benefits paid to directors in whatever form”. The regulations that are violated under this concern are as follows:
This organization has also failed to lodge financial information with Australian Securities and Investments Commission (ASIC) (under s 188 of Corporations Act 2001) (findlaw.com.au, 2020). Therefore, the above mentioned regulations have been violated by the organization particularly in the context of financial reporting.
Accounting standards are developed by the Australian Accounting Standards Board (AASB) that helps in developing and maintaining the financial reporting rules that are enforced on the public and large private organizations. The outcomes of the current study disclose the requirements and benefits of maintaining accounting standards which include the following:
In addition, the outcome of the study indicates that the performance of a management or entity in financial reporting is important to be monitored so that misinformation, faulty reporting and fraudulent transactions do not affect the company’s profitability and financial performance. This will additionally help in maintaining solvency of the company and the other duties related to finance. The accounting policies are required to be chosen by the managers wisely so that it does not require frequent changes. It is because frequent changes in the accounting policies may create confusion for the users of the statements.
Based on the findings of the current study several aspects of the financial regulations enforced by the Australian legislation have been identified with their implication. However, it is required to focus on some areas that require more concern and active monitoring.
In conclusion, HIH Insurance Australia’s demise has been reported to be caused due to different reasons such as fraudulent transactions, aggressive and unplanned expansion, falsifying financial reporting and others. Financial reporting falsification has been said to be conducted by the mainly the auditing entity of the organization. The director’s role in the falsification of the financial reports has also been identified which have raised awareness about the financial statement regulations of Australia. It has been identified that the debt/equity hypothesis of Positive Accounting Theory best for the intention of the accounting managers of HIH to imply such methods which lead them to face bankruptcy. On the other hand, a host of sections under the Corporations Act 2001 are applicable to the responsible entities of the organisations including director. However, the findings of the study have provided a widespread view of the necessity of maintaining accounting standards.
aph.gov.au, 2020, HIH Insurance Group collapse – Parliament of Australia (2020). Available at: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/Publications_Archive/archive/hihinsurance (Accessed: 2 June 2020)
aph.gov.au, 2020, ParlInfo - Report of the Royal Commission into HIH Insurance. Available at: https://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id:%22library/prspub/XZ896%22 (Accessed: 2 June 2020).
austrade.gov.au, 2020 Financial reporting in Australia - Austrade , Austrade.gov.au. Available at: https://www.austrade.gov.au/International/Invest/Guide-to-investing/Running-a-business/Understanding-Australian-business-regulation/Financial-reporting-in-Australia (Accessed: 3 June 2020).
Buchanan, B., Arnold, T. and Nail, L., 2003. Beware of the ides of March: The demise of HIH Insurance.
findlaw.com.au, 2020, The HIH Report and CLERP 9 (2020). Available at:https://www.findlaw.com.au/articles/1450/the-hih-report-and-clerp-9.aspx (Accessed: 2 June 2020).
Gad, M. and Kim, K., 2019. Does Institutional Ownership Exacerbate Debt-Equity Conflicts? Evidence from the Auditor Certificate of Debt Covenant Compliance. Evidence from the Auditor Certificate of Debt Covenant Compliance (January 2019).
legislation.gov.au, 2020, Corporations Law Rules 2000. Available at: https://www.legislation.gov.au/Details/F2002B00094/Controls/#:~:text=We%2C%20Judges%20of%20the%20Federal,Dated%2014%20December%201999. (Accessed: 2 June 2020).
Lewis, C.M. and Tan, Y., 2016. Debt-equity choices, R&D investment and market timing. Journal of financial economics, 119(3), pp.599-610.
nytimes.com, 2020, Insurer's Officers Broke Laws, Australian Inquiry Concludes. Available at: https://www.nytimes.com/2003/01/14/business/insurer-s-officers-broke-laws-australian-inquiry-concludes.html (Accessed: 2 June 2020).
pkf.com.au, 2020, The Concept of a Reporting and Non-Reporting Entity (2020). Available at: https://www.pkf.com.au/blog/2017/the-concept-of-a-reporting-and-non-reporting-entity/ (Accessed: 3 June 2020).
upi.com, 2020 Andersen in Aussie audit scandal. Available at: https://www.upi.com/Business_News/2002/01/30/Andersen-in-Aussie-audit-scandal/80301012407060/ (Accessed: 2 June 2020).
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