Critical Analysis of Harris Scarfe with Audit Issues That Lead to Its Failure
Executive summary
This paper will explore the corporate collapse of Harris-Scarfe that happened in 2001 on April 3rd, which was then considered as the third largest retail group of Australia. The paper will specifically explore the collapse of Harris-Scarfe in terms of the auditing framework. More specifically, it will look at how the financial irregularities were not exposed by their auditors that had been going on for around six years before its collapse. Initiating the paper, it is important to look at the auditing objective. The auditing objective as per ASA 200.11 is the need to ascertain rational surety that the audited financial statements and accompanying reports lack misstatements either due to fraud or error. By doing so, the auditor offers an opinion on whether the financial statements and its accompanying notes are prepared as per the financial reporting framework or not. The paper will look at the auditing functions performed on the company and its lack in performance.
Introduction:
Harris-Scarfe Limited saw the biggest corporate downfall with debts of $265 million. This corporate collapse affected the accounting and the auditing profession. The main reason for the collapse of the company has been the fraudulent records of the company and its wrong reporting to the company stakeholders. Before its collapse, the company did not seem to have any financial difficulties even though it then abruptly went to voluntary liquidation because of the problems of cash flow. The company had been falsifying its book records and representing higher than actual profits which caused it not to look for any problems. This, however, also shows that some of the parties were unable to perform their duties. This is necessarily the management team and the auditing team of the company along with the corporate governance issues. This report will look at the auditing issues.
Analysis:
Audit Independence:
As per the APES 110 section 100.5 the auditing engagement is needed to follow five fundamental principles by the audit members. Also, they need to act with objectivity, integrity, and unbiased observations. One of the principal necessities for the auditor is the auditor independence given to them by their clients. This is one of the main and key audit issues in case of Harris-Scarfe collapse. The auditing committee of Harris-Scarfe consisted of its senior management, which made the company incapable of taking any independent decisions. The audit committee of Harris-Scarfe was composed of the majority of the non-independent directors (Yilmaz, 2017). The main purpose of the audit committee is to assist the board of directors of the company in providing oversight and reviewing the financial information of the company that has to be presented to the shareholders of the company in an independent manner. In Australia, the law does not require the listed companies on the ASX to have audit committee. However, the composition of the audit committee needs to be disclosed in the annual reports. The companies in Australia however now usually have an audit committee, however, their composition is much argued.
For any corporate governance of the company to be effective, the main factors are an independent board of directors and an independent audit committee. It is argued that the audit committee needs to have three independent directors, while in the case, the majority had been non independent. Harris-Scarfe this shows that the company of Harris-Scarfe failed to comply with the best practices of auditing by compromising on the independence of the auditing committee. It is absolutely crucial for the auditing committee to have independent both in practice and appearance to have the ability to conduct open discussions with the internal and external auditors when the senior management or the non-independent directors are not available for the matters. This shows that in the case of Harris-Scarfe, the auditing committee was not inhibited by the attendance of the senior management of the company on the board. Therefore, in the case of Harris-Scarfe, there is an evident gap of independence with the attendance of the management in the audit committee. Thus, the ultimate failure of the company has been in terms of the independence of the auditors (Deegan, 2014). For putting off any misrepresentation of the financial position of the institute, it is needed that a company has an effective internal control mechanism in place. It is the duty of the management and the directors to provide effective internal control. The effectiveness of the internal control of the company financial performance is based on how much and how well the management is able to incorporate the opinions and review of the external auditors of the firm for reviewing the reports that were generated by the internal accountants of the firm. The external auditors of the firm are needed to review these reports independently in order to identify any missing loops in the financial information. The external auditors are also needed to identify if the company accountants and internal auditors fulfilled their obligations and prepare the statements as per the regulations. Accordingly, the external auditors are needed to give their opinions on what could be wrong in the statements. The company had been dependent on Ernst & Young from 1988 to 1997 while it was replaced by Price Water house Coopers from 1997 onwards. The external auditors were not involved in both scenario as the company did not involve external auditors in the review and the financial reports were therefore not reviewed for any time.
Ethical and Professional Behavior:
Ethics is one of the main components that should be upheld as these serving in the accounting profession and auditing profession. These professionals are also aware of the high level of competency, dignity, and reliability which is expected from them. However, it is often tough for the auditors to provide astounding audit opinions to the companies they are auditing and are their clients against inhibiting their earnings in an aggressive market. The company management is often responsible for hiring the audit firms and deciding on their fees which can pressure the audit firm to perform non-audit functions for them as well (Business Review Weekly, 2001). During this time, the auditors of the Australian firms of the company faced this ethical dilemma. This was the reason many also ended up closed as well. The main ethical breach arises from the Harris-Scarfe management and from the audit companies of PricewaterhouseCoopers and Ernst & Young. The act of the management by inflating the actual profits conflicted with that of the ethical behavior that was needed to be carried out. In terms of the audit firms, the court did not consider the audit firms to be guilty in the case of Harris-Scarfe collapse because the external auditor has only the responsibility to provide the assurance of the financial statements fairness and correctness which completely depends on the material and information provided by the management itself. However, this is not the case for Harris-Scarfe (ICAA, 2018). Internal control is needed to be effective to provide the control mechanisms for preventing any kind of fraud. However, the audit firms of Harris-Scarfe were unable to identify the efficiency of the internal control of the company. Therefore, in the case of Harris-Scarfe, there is obvious rupture of independence with the existence of the management in the audit committee. Thus, the ultimate failure of the company has been in terms of the independence of the auditors. They failed to comprehend that the internal control of the business of Harris-Scarfe was inadequate. This is linked with the independence of the accountant and internal auditors of the business. It was mentioned in the case of Harris-Scarfe that the accountant of Harris-Scarfe was asked to falsify the accounts by the director of the firm in 1994. This account displays that the bookkeepers of the corporation of Harris-Scarfe were unable to perform their accounting duties without independence (Clarke, 2003).
Audit Quality:
In terms of the best practices of the regularity of the meetings of the audit committees, there is not much guidance. However, it is argued that the audit committee should come across at least four times in a year or more if the situation requires (Johnson, 2001). Therefore, in the case of Harris-Scarfe, there is evident rupture of independence with the attendance of the management in the audit committee. Thus, the ultimate failure of the company has been in terms of the independence of the auditors. However, in the circumstance of Harris-Scarfe, the company audit committee did not meet four times in the last five years prior to its collapse. Even though the effectiveness of the meetings is not decisive, the lack of frequency is certainly not a worthy sign. Furthermore, the auditors of the corporation should be reliable and able to report suitable facts in their financial reports of the business. However, in the instance of Harris-Scarfe, the reporting was misleading and fraudulent for creating wrong expressions for the shareholders. This information was misleading and false and was considered as an offensive act as per the Corporation Act Sec 1309. Furthermore, as per the ASIC, the company was liable to the continuous disclosure obligation as the auditor of the company resulted in lifting the levels of the profits in the company statements. This shows that the responsibility of the auditors was not met as being fair and presenting the profitability and accounts of the company as true and inducing the company shares to be bought.
The auditors of the company also failed to develop strategic plans for the company and ratified the reports which lacked the appropriate examination hence enabling the corporation of Harris-Scarfe to expand. The company had been presenting the positive outlook for a company with large debts and bad cash flows in front of the shareholders and misled them to provide go ahead for the expansions while it had negative working capital for funding of its expansions. The collaborative effort of the directors and the management of the company resulted in fraudulent reporting of its financial potion which was then ignored by the audit committee as it was composed of major members of the senior management of the business. Therefore, the independent decision-making process of the audit committee was hampered.
Another key audit issue which the company faced in terms of its auditors was the failure of the auditors to fulfill their lawful obligation of governing the audit process and avoiding the misstatements in the financial statements to be permitted and sign up by the auditors. Furthermore, the auditors also failed to recognize and report the financial wrongdoings of the financial statements of Harris-Scarfe, which is an evident rupture of the Corporations Law. Moreover, the auditors were also unsuccessful to see the ethical obligation of providing an impartial understanding for the financial reporting of the company that was to be presented to the company board and shareholders. In 1998, Ernst & Young was replaced by PricewaterhouseCoopers as the auditor of the company. In 2000, the company received $120,000 for their audit fees and $211,284 for the non-audit services. This amount was not disclosed in terms of its explanation of the services that raised queries about the moral obligation of the audit firm providing other services to the firm as well. The companies cannot ask the audit firms to perform other functions for them as per the CPA Australia and ICAA in terms of best practices (Allan, 2006). The additional amount can be argued to be given by the Harris-Scarfe management to their auditors for providing a pre-prepared audit report which would be suitable for the senior management of the corporation of Harris-Scarfe.
The negligence that was frolicked by the company auditors stemmed in enormous losses for the owners of the firm. The audit company of the corporation Harris-Scarfe failed to encounter the quality of audit functions, of being trustworthy to expose the systematic and widespread irregularities and fraudulent accounting in the financial reports of the company. If the auditors had been capable and independent enough to display been only regular auditing capability, there is the likelihood that the deception could have been discovered in time and revealed to the board of directors who could have then able to avoid the damages and financial losses faced by the company stakeholders because of the assets value inflation and reduction in the expenses and hence expanding the profits of the company by millions of dollars for each years(Jones, 2011).
Lessons Learned & Recommendations:
There are several lessons which were learned by the corporate collapse of Harris-Scarfe that aided in changing the laws of accounting, reporting and auditing procedures for Australian companies. After such collapses, the government of Australia was concerned about the audit independent and its strength as a method of ensuring adherence to the notable practices for good governance of the companies (Romney, 2012). This new initiative by the Australian government needed the audit committees to be held accountable for tier conducted auditing process as compared to just the final audit report. This involvement needed the auditors to arrange all the needed processes for the auditing as well as the non-auditing functions that they perform for the company. As per the recommendations by the Ramsay Report, there had been suggestions on increasing the independence of the auditors for the aim of reducing the expectation gap. It is also evident that most of the recommendations which were made by the Ramsay Report was then included in the corporate law economic reform program released afterwards by the Australian government. The legislation entailed 41 provisions that are related to the superiority of the auditors, the autonomy of the auditors, the prerequisites of the financial statements reporting, liabilities of the auditors and disclosure requirements. This reform improved the responsibility, clearness and the rights of the auditors. As per this reform, the audit firms were needed to align themselves with the needed requirements settled by the CPA and ICAA for conformation for auditing and accounting procedures (Edwards & Walker, 2009). These reforms aided in reducing the level of manipulation of the auditors by the management of the companies.
Conclusion:
It is evident by the analysis of the case of collapse of Harris-Scarfe that the company had been facing auditing irregularities and issues related to auditor independence. The company audit committee lacked independence, ethical practice, and fulfillment of the legal liabilities of the auditing functions. The management had contributed to this situation and was actively aware of it. The audit committee and the board of governance did not have the level of autonomy that it needed to oversee and identify the irregularities in the auditing function. This paper explored the corporate collapse of Harris-Scarfe that happened in 2001 on April 3rd, which was then considered as the third largest retail group of Australia. More specifically, it will look at how the financial irregularities and indiscretions were not discovered by their auditors that had been going on for around six years before its collapse. The paper will specifically explore the collapse of Harris-Scarfe in terms of the auditing framework.
References:
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