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Critical analysis of Harris Scarfe with Audit Issues that lead to its failure

Name
Affiliation
Date
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Table of Contents
Executive summary.....................................................................................................................................3
Introduction:...............................................................................................................................................3
Analysis:.......................................................................................................................................................3
Audit Independence:...............................................................................................................................3
Ethical and Professional Behavior:...........................................................................................................4
Audit Quality:..........................................................................................................................................5
Recommendations:..................................................................................................................................6
Conclusion:..................................................................................................................................................6
References:..................................................................................................................................................7
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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 than 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 lacking in performance.
Introduction:
Harris-Scarfe Limited had seen the biggest corporate downfall with the 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 a 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 to not 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 are needed to act with objectivity,
integrity and unbiased observations. One of the principle 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 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 review 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 is needed 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 is needed 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
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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 in the board. Therefore, in
the case of Harris-Scarfe, there is 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 prepared 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
PriceWaterhouseCoopers from 1997 onwards. The external auditors were not involved in both
scenarios 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 they 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 of 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 considered 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). The 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
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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 for 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 of reporting suitable
facts by their financial reports of the business. However, in the instance of the 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 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 finical 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
as 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
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(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 upgraded 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 had 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 3 rd, which was then
considered as the third largest retail group of Australia. More specifically, it will look at how the
financial irregularities and indiscretions was not discovered by their auditors that had been going
on than for around six years before its collapse. The paper will specifically explore the collapse
of Harris-Scarfe in terms of the auditing framework.
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References:
Allan, G., 2006. The HIH Collapse: A costly Catalyst for Reform. Deakin Law Review, 11(2),
[Accessed 23 May 2020].
Business Review Weekly, 2001. Business Review Weekly: BRW, Volume 23, Issues 13-16.
Clarke, F., 2003. Corporate Collapse: Accounting, Regulatory and Ethical Failure. Cambridge.
Deegan, C., 2014. Financial Accounting Theory. McGraw.
Edwards, J.R. & Walker, S.P., 2009. The Routledge Companion to Accounting History.
Routledge.
ICAA, 2018. ICAA issues paper discussing the scope of the audit. [Online] Available at:
https://www.johnwiley.com.au/highered/auditing/lecturer-res/current_affairs/2003-07/2003-07-
10.pdf [Accessed 23 May 2020].
Johnson, R., 2001. 1980'S CORPORATE COLLAPSES: UNRESOLVED. [Online] Available at:
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.196.2738&rep=rep1&type=pdf
[Accessed 23 May 2020].
Jones, M.J., 2011. Creative Accounting, Fraud and International Accounting Scandals. John
Wiley.
Romney, M., 2012. Accounting Information Systems Australasian Edition. Pearson Higher
Education.
Yilmaz, O.K.a.B., 2017. Corporate Collapses in Australia: Case of Harris Scarfe. Journal of
Economics, Business and Management, 5(1).