Financial Accounting For Liquidation Of Businesses

Case Analysis

Describe about the Financial Accounting for Liquidation of Businesses.

In the last decade or so, the incidence of liquidation of businesses has been on the increase and it becomes pertinent to explore the reasons that are contributing to such a trend. One of the key reasons that is often stated is with regards to increasing outstanding liabilities which the firm is not in a position to discharge and hence is declared bankrupt which eventually paves way for liquidation. However, through this research we seek to understand whether the root of the problem lies in mismanagement of liability or there is a greater problem at hand which pushes the company to the brink of liquidation. In order to dwell on this aspect, the liquidation cases of three companies namely ABC Learning, HIH Insurance and One Tel Company have been analysed.

A brief overview on the companies and the underlying failure of these is highlighted below.

ABC Learning

The company was founded in 1988 but only after entering the 21^st century did the company embark on an aggressive expansion plan as per which it opened it centres at a rapid pace and also approached new geographies. Eventually, the expansion strategy which was based on acquisitions proved to be a nemesis for the company as issue surfaced with regards to irregularity in reporting of assets. With the advent of the global financial crisis, the company’s liquidity woes were exposed which soon led to its liquidation (CPA, 2012).

HIH Insurance

The company was founded in 1968 but the actual growth phase in the history of the company took place only in the 1990’s when it expanded through the acquisition route and by the year 2000 boasted off about 200 subsidiaries. On the face of it, reports indicate that the company went into liquidation as it was not able to service its liabilities arising from insurance contracts. However, a layered investigation hint to the ongoing irregularities in reporting coupled with issues with the business model which was based on reinsurance. Also, the reckless management attitude also worsened the matters for the company which eventually pushed the company into bankruptcy (Mak, Deo & Cooper, 2005).

OneTel Phone

The company had established itself as one of the recognised players in the industry before suddenly slipping into liquidation. The prime reason for the same was the faculty business policies followed by the management in order to witness rapid growth. Besides, there were issues with regards to sound corporate governance policies and also irregularities in financial reporting with plethora of undisclosed losses. This process continued over many years leading the company into a situation where recovery was impossible (Monem, 2009).

ABC Learning

ABC Learning Failure – Actual Causes

After becoming a public listed company, the company witnessed unprecedented expansion which was captured in its surging stock price which became a favourite amongst investors as it posted stellar returns. However, despite rapid expansion with regards to geographical presence, the company was actually facing quality issues primarily due to the direct impact of shortage of staff which was waning down consumer satisfaction. In such situations, it would have been prudent on the part of the company to address these issues and ensure quality service to the clients (Arens et. al., 2013).  But the prime objective of the company’s management was achievement of scale and presence which it achieved through the acquisition route and hence in a short span of time multiplied its presence. The attempts to scale the business failed for the company as the economy was pushed into recession due to the onset of the global crisis which effectively resulted in collapse of the company (Kaplan, 2011). Besides, consumer complaints and weak trading environment, the company was also adversely impacted by charges related to inappropriate corporate governance practices.  It was reported that the company had given sponsorship and also lucrative maintenance contracts for ABC centres to an individual who happened to be the brother in law of a sitting director of the company which had an adverse impact on the shareholder’s confidence and the stock could really never emerge from these issues (CPA, 2012).

HIH Insurance Failure – Actual Causes

The prime cause for the failure of the company is the aggressive expansion strategy which the company embarked upon in the last decade of the 20^th century when the company diversified into so many product segments and geographical segments. However, the underlying risk associated with the ever-expanding portfolio was not well managed by the company which eventually led to its bankruptcy (Mak, Deo & Cooper, 2005).  The insurance business is associated with a high business risk and therefore commercial interests must be considered while deciding on how low the premiums could be offered in a market even with the intention of capturing customers (Gay & Simnett, 2012). HIH offered very low premiums during the initial days of launching their service in USA but failed to manage the resulting liabilities arising on account of underwriting of these contracts thus leading to an enhancement of the overall business risk. Further, they compounded their own follies by completing the acquisition of FAI at high valuations without debating on the same (Mirshekary, Yaftian & Cross, 2005).  In the midst of these miscalculated strategic moves, the company did not apply appropriate provisioning norms which are critical in management of underwriting risk and as a result, the overall business risk further enhanced. Advice in this regards was also offered by the advisors to the company but the company continued with a reinsurance based model which eventually led to the liabilities not being met by the company and the mounting losses leading to company’s liquidation (Mak, Deo & Cooper, 2005).

HIH Insurance

With regards to OneTel company, the main issue which led the company into liquidation is the faulty reporting procedures which the company had put in place. The executives did not verify the financial information which formed part of the key management reports and therefore prudent decision making was hampered both for internal and external stakeholders. The internal audit and control mechanisms were so weak that the various books of account could not be trusted and recording of significant entries was found missing. The root cause for the same was the lax attitude of the senior management which was more focused towards acquisition of customers and growth in subscriber base  (Gilbert, Joseph & Terry, 2005).

With regards to reporting of performance, adhoc financial policies were used for representation of financial statements which made comparison of the financial results over two years virtually impossible.  In certain periods when the business environment is robust, the company would use stringent and very conservative accrual policy thereby moderating the performance of the company. However, in case of adverse business environment an opposite policy stance would be taken so as to ensure that the results of the company look healthy.  However, the most surprising aspect is that despite these glaring deficiencies in reporting and internal control, the external auditor could still manage to issue an unqualified opinion to the company’s financial statements which hints at the poor quality audit (Monem, 2009).

With regards to ABC Learning, the management acted in an imprudent manner as they should have ideally focused on improvement of the service quality and resolving issues in relation to unavailability of staffs at the existing centres which was causing a bad name for the company. However, the company continued to aggressively focus on its ambitious expansion plan driven by acquisitions. This had adverse impact of the underlying financial strength of the business and at the time of downturn led to a crisis situation (Bhagat & Bolton, 2008).

For HIH also, the focus of the management was misplaced as in the last decade of the 20^th century, the company went on an expansion spree through acquisition mode and this did not create much value for the company and instead led to increasing risk exposure as the internal management of risk at the company was reckless and imprudent. However, the company instead of fixing up the internal issues with regards to risk management actually colluded with the auditor to hide any losses and thereby continue the malpractices forcing the company into liquidation (Mirshekary,  Yaftian & Cross, 2005).

OneTel Phone

For OneTel also, the management did not focus on the issue of improper financial reporting which should have been the prime concern considering massive irregularities at the level of recording of transactions in the books of account. This misrepresentation of the financial statements enabled through the auditor’s support allowed the company to hide the huge losses and continue unabated with incorrect expansion policies thus leading to company’s liquidation (Brown & Caylor, 2009).

The analysis of the above companies and their respective reasons for failure clearly provides ample scope for the implementation of sound corporate governance practices in the companies and providing more active role to the non-executive directors especially in the form of key internal committees such as audit and remuneration (Gay & Simnett, 2012).  Also, the auditors played a critical role in blowing the problem out of proportion by forming a quid pro quo relation with the management of the company. Hence, effective measures highlighted in Ramsay Report along with CLERP 9 need to be prudently and effectively adhered by the companies so as to safeguard the auditor independence and ensure that they are held liable (Clout Chappelle & Gandhi, 2009).  Also, the emphasis in the Corporations Act 2001 with regards to directors duty and appropriate conduct is likely to have a positive impact and would reduce the mismanagement of companies (Arens et. al., 2013).

Conclusion

The given discussion clearly indicates while the end reason for liquidation of the companies discussed was their inability to meet the liabilities but in reality the reasons laid in the faulty management policies and lack of measures to manage business risks. Further, the executives of the companies were driven by short term objectives and indulged in unfair practices to accomplish their goals while ignoring the other critical issues which required immediate attention. While a proactive role of the auditor could have protected the given companies from liquidation but the collusion of the two meant that losses kept on mounting off the books and eventually the companies had no choice but to declare themselves as bankrupt and entertain liquidation.

References

Arens, A., Best, P., Shailer, G. & Fiedler,I. 2013. Auditing, Assurance Services and Ethics in Australia, 2^nd eds., Pearson Australia, Sydney

Clout, V, Chappelle, E & Gandhi, N 2013, ‘The impact of auditor independence regulations on established and emerging firms’, Accounting Research Journal Vol. 26, No. 2, pp. 88-108

Gay, G. & Simnett, R. 2012, Auditing and Assurance Services in Australia, 5^th eds., McGraw-Hill Education, Sydney

Bhagat, S & Bolton, B 2008, ‘Corporate Governance and Firm Performance’, Journal of Corporate Finance, Vol.14, No.3, pp. 257-273.

Brown, L & Caylor, M 2009, ‘Corporate Governance and Firm Operating Performance’, Review of Quantitative Finance and Accounting, Vol. 32, No. 2, pp. 129-144.

CPA 2012.  ABC learning collapse case study., CPA Website, Available online from https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-study  (Accessed on September 12, 2016).

Gilbert, W, Joseph J & Terry JE 2005, ‘The Use of Control Self-Assessment by Independent Auditors’. The CPA Journal, Vol. 3,  pp. 66-92

Kaplan, RS, 2011. ‘Accounting scholarship that advances professional knowledge and practice’. The Accounting Review, Vol. 86, No.2,  pp. 367–383..

Mirshekary, S, Yaftian, A & Cross, D 2005, ‘Australian Corporate Collapse: The Case of HIH Insurance’, Journal of Financial Services Marketing, Vol. 9, No.3, pp. 249-58.

Mak, T, Deo, H & Cooper, K 2005, ‘Australia’s Major Corporate Collapse: Health International Holdings (HIH) Insurance ‘May the Force Be with You’, Journal of American Academy of Business, Vol. 6, No.2, pp. 104-112.

Monem, R 2009, The Life and Death of OneTel, Griffith University, Available online from https://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf (Accessed on September 12, 2016).