The Collapse of Hih – Solvency and Audit Risk

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The Collapse of HIH – Solvency and Audit Risk Following the collapse of HIH, considerable debate, comment and speculation have arisen regarding whether and at what point HIH became insolvent. When a company is close to insolvency, the risk associated with auditing that company is considerably higher than for one that is solvent. This report investigates methods of determining insolvency, the roles of directors and auditors, and the level of audit risk associated with HIH prior to its collapse. There is general agreement that the concept of solvency relates to having the capacity to meet debts as they fall due. An insurance company is solvent if it is able to fulfil its obligations under all contracts at any time (or at least under most…show more content…
Cross guarantees exist where a subset of companies in the corporate group (the "closed group") guarantee the debts of each other. A regulatory-approved Deed of Cross Guarantee has existed in Australia since 1991. All subsidiaries party to a Deed of Cross Guarantee must make a solvency statement. HIH and its subsidiary, FAI insurance had cross guarantees in place. As a result of the cross guarantee, HIH adopted a "group enterprise perspective" when attesting to its regulatory solvency position. The company treated insurance subsidiaries as if they were part of a singular corporate group and "netted-off" related company assets and liabilities in several APRA annual returns . This contributed to the fact that the auditors did not identify that some subsidiaries were potentially insolvent. The risk that a company is insolvent is a component of audit risk, which should be taken into account by auditors. Audit risk is defined as "the risk that that the auditor will give an inappropriate audit opinion when the financial report is materially misstated". Auditors risk issuing an unqualified audit opinion on financial statements that are materially misstated or omit material transactions; therefore the procedures used in the audit must be planned according to the identified audit risk. The components of audit risk are inherent risk, control risk and detection risk. Inherent risk is the risk that the financial statements contain a material
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