Question 1 —Business Risk and Inherent Risk Assessments

“It is difficult for an insurance company to go broke in the space of a year, let alone a few months” Sydney Morning Herald, May 19–20, 2001.

Required:

1. a)  How would you assess the business risk of HIH Insurance Limited?
2. b)  List several inherent risk factors effecting HIH at the financial report level and whether they would have contributed to an increase or decrease in the inherent risk assessment.

Question 2— Legal Liability

Sydney solicitor Bruce Dennis will be coordinating a class action for some 600 HIH shareholders against the auditors — Andersens (as the firm is now known). In addition, HIH’s liquidator, Tony McGrath of KPMG Peat Marwick is also likely to seek to recover funds for HIH creditors.

Required:

1. a)  Discuss the facts and findings of relevant court cases that Andersens should refer to in determining the likelihood of the partnership being held liable to:

1) clients
2) creditors.

1. b)  What conditions need to exist for a negligence action to be upheld?

Question 3 — Ethics

The HIH board of directors includes three former partners of the audit firm Arthur Andersen. In the past decade, Andersens has earned more than $8 million from auditing HIH books and $7 million for other services.

Required:

1. a)  Why would HIH have wanted to hire prior members of its external audit team?
2. b)  What are the advantages of having the same firm provide both the auditing and consulting services?
3. c)  Indicate whether these circumstances represent a violation of ethical standards and give reasons for your answer.
4. d)  Outline the primary recommendations for audit reform proposed by the Ramsay Report and CLERP 9. What impacts do you feel these changes will have on the practice of auditing?

                                                     SAMPLE SOLUTION

Question 1: Business Risk and Inherent Risk

1. Assessing Business For HIH Company

Business risks are the uncertainties that are futuristic in nature and affect the firm’s revenue as well as profit. These uncertainties tend to lower the profit margin that would otherwise be attained by an organization (Rees, 2015). Business risk can arise both from within an organization or form the external environment. Corporate risk is a union of both business risk and financial risk. In assessing the risks of HIH Insurance Company, it would be prudent to focus both at the internal as well external environment as explained below;

Internally Generated Risks

These are risks that arise from within the Insurance Company. According to Reel (2015), operational risks are those that emanate from the daily operations of an organization. These risks include; discontentment of the members or else the company directors. In the year 1998 for instance, Winterthur showed his discontent by selling all his shares. Discontent shareholders like him would portray the image of the company negatively leading to a reduced trust by the clients. This would reduce the profit of the company due to low revenue. Another internal risk is ineffective management policies. Purchase of FAI without following proper process is an indication on inefficiency of the management policies. Failure to adhere to due process while investing would lead to inheritance of enormous risks. Furthermore, certain undeserving liabilities would be inherited without noticing. Poor investment policies are also internal business risk.

Decision to invest in risky areas such as World Marine and General Insurance would demand a proper re-insurance policy as well as diversification. The decision of the firm to venture into these areas without a proper provision to counter the risk was not a good investment decision. This decision led to considerable losses due to occurrence of unfortunate events that in effect led to increase compensation claims by employees.