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Opinion: Why don't the accounts of the FTSE 50 add up?

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16th Feb 2006
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A new report by anti-tax avoidance campaigner and AccountingWEB contributor Richard Murphy shows significant adjustments made to the accounts of the UK's top 50 companies, with the majority of companies over-declaring their current year tax liabilities to investors. Furthermore, he found that 98% of the tax accounting didn't add up. In this exclusive article for AccountingWEB he examines why.

In January a report I researched for The Tax Gap Limited and the Tax Justice Network called 'Mind the Tax Gap' was issued. It looked at various issues relating to tax in the accounts of the largest 50 companies in the FTSE over a period of five years.

When preparing that report I began to question the reliability of the data I was using. Of course one would like to think that audited accounts should be reliable. But the more I saw the more I began to have doubt about that assumption, at least when it came to tax reporting. As a result I designed two tests on the data I was collecting to check its reliability. Both tests used nothing but the data within the accounts themselves.

The first test monitored the 'prior year adjustments' that companies are required to disclose each year with regard to the current taxation charges they have declared in previous years: these are a statement of the changes made to those declared tax liabilities since the accounts were issued. It seemed obvious that the lower the rate of these adjustments the more reliable I could believe the underlying data within the accounts to be.

The second test was equally straightforward. I simply checked to see if the accounts for each company for each year added up. The addition test was a simple one. The corporation tax declared to be due at the start of the year had added to it the current tax charge for the year, from which total the tax paid as per the cash flow statement was then subtracted. It was, I thought, reasonable to expect that the resulting answer should be the tax due at the end of the year.

The results of these two tests were surprising. The absolute value of prior year adjustments with regard to current taxation for the sample companies in aggregate increased from £333 million in 2000 to £1,758 million in 2004. In addition:

  • the number of companies reporting a prior year adjustment increased over the period until it became normal to do so, with over 80% of the sample reporting adjustments in each year from 2002 onward;
  • the average value of prior year adjustments increased significantly, from £13 million in 2000 to £41 million in 2004.

By the most conservative of the measures of findings used (which excluded those companies with very high adjustments and those four companies (including, somewhat surprisingly, BP) who reported no adjustments at all), the average adjustment rate was 3% on 2000. It was 10.7% in 2004 and averaged over 7% throughout the period.

Given that most auditors normally think a misstatement of 5% is significant within a set of accounts, on average the declared current tax liabilities of the companies subject to this survey were materially wrong from 2001 onwards.

There was another surprising finding. Adjustments to reduce previously stated liabilities were five times bigger in absolute value than those to increase previously stated liabilities, and this trend was persistent. Indeed, the trend is so significant that the following companies made a prior year adjustment to reduce previously declared liabilities in every one of the five years under review:

  • Lloyds Tsb
  • Tesco
  • Unilever
  • Prudential
  • Cadbury Schweppes
  • Scottish & Southern Energy
  • Reuters Group
  • Compass

To our surprise the restatements were not consistent between auditors. On the basis of the conservative results (i.e. with the largest restatements excluded) accounts audited by PricewaterhouseCoopers had an average restatement rate of 6.7% with equivalent figures for KPMG being 7.3%, Ernst & Young 8% and Deloittes 11.5%.

The results for the second test were little better. In simple summary it had to be concluded that the accounts of the FTSE 50 do not add up when it comes to disclosure of tax information:

  • In just five sets of accounts (2.1%) does the tax account balance (BAA manage this three times, Marks & Spencer once and Associated British Foods once).
  • In only 36 out of 238 sets of accounts (15%) is the difference less than £10 million.
  • In 149 sets of accounts (62.6% of the sample) the difference is more than 5% of the current tax charge.

Explanations can be offered (such as tax paid by associates through their own cash flows), but none can explain what is happening with any certainty or confidence. Indeed, since the variances were not always negative as the associated company accounting would suggest likely this is certainly not an adequate explanation.

As with the prior year adjustments, the value of the addition errors rose markedly over the period from an increase in liabilities of £2.2 billion in 2000 to a reduction in liabilities of £3.6 billion in 2004. The adjustments were material at the 5% rate.

In 2004 the value of restatements reduced the liabilities of the 50 companies surveyed by £1.6 billion. The apparent addition errors amounted to £3.6 billion. Both acted to suggest that liabilities declared in the profit and loss account were not actually settled, although explanation as to cause is not given. The declared current tax for the year of all the companies in 2004 was £34.5 billion; the apparent error rate is therefore 15%.

This I find worrying. Of course, from a taxation point of view there is concern that reported liabilities are not paid. But the issue is bigger than that. These accounts balance. And yet material adjustments to figures required to be disclosed in the profit and loss are taking place without disclosure as to their cause being made, or with explanation as to the other side of the accounting entry being offered. The result is that it is very hard to conclude that the tax reporting of these companies is as meaningful as it might be. It is clear that considerable improvements and a much stronger commitment to transparency are needed if this problem is to be resolved.

But the concern is also with the trend data. In 2000 the prior year restatements at least were not material. Now both tests show material differences, and the trend is rapidly upwards. This begs the following questions:

  • What is happening with the quality of our corporate reporting?
  • Is this trend just restricted to tax?
  • Is it solely a response to pressure on tax avoidance, meaning credit is not claimed until tax authorities have seen a scheme?
  • Is it some measure of the fact that most schemes pass scrutiny?
  • And why, whatever else is asked, do the figures fail to add up by increasing amounts?

These are big questions which challenge the credibility of the data produced at significant expense and audited at equally significant cost by our largest companies and audit firms. At present the evidence suggests that the figures presented do not add up. That is worrying if people are to keep faith with those companies, those firms and our profession. And this need not be the case, as a control check on the Co-op Bank suggested, who displayed none of these traits.

'Do they add up?' is available from the web site of The Tax Gap Limited

Richard Murphy

Richard Murphy is director of Tax Research LLP
and The Tax Gap Limited and is senior adviser to the Tax Justice Nework

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Replies (11)

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By AnonymousUser
19th Feb 2006 11:32

21st Century Accounting?
Richard

For some considerable time towards the end of the last century it became apparent that somewhere approaching half the entries made in double entry book-keeping had no basis in reality.

Therefore it was agreed that it was just a waste of time making and allegedly auditing these entries.

So a system of single entry was devised.

By this new method, the tax is calculated---and if it was wrong, the next year you just put the new figure. Without having to check it, and make all the explanations, you save considerable time and money.

Your calculations show how it works!!!!

:-)

Jrff

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By AnonymousUser
17th Feb 2006 14:18

KPMG--The major culprit?
Richard

Thanks

I see the links are above---will try to look at them over the week-end.

Meanwhile do you feel these alleged mis-statemants are a problem with all the Big 4, or just one of them?

Rgds

Jeff

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Richard Murphy
By Richard Murphy
17th Feb 2006 14:02

Jeff - methodology
Jeff

A note on methodology was included in my previous report - Mind the Tax Gap - do you want to look at that?

A note on the number of audits each of the Big 4 does is in the report.

Richard

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By AnonymousUser
16th Feb 2006 17:24

Is it the tax, or is it the profit?
Richard

I am still attempting to understand alleged inter-company debtor "assets" on Heritage plc's Balance Sheet, which led to a susbstantial investment.

I believe that Morrisons is still trying to comprehend similar "assets" of some £771.9m on Safeways last Balance Sheet, which presumably contributed to the agreed purchase price.

Both these companaies were audited by the London Office of KPMG. Heritage plc directly by Michael Hughes, who was until recently Chairman of KPMG Audit LLP.

These "assets", presumably, would have found their way onto the Balance Sheet through profit?----forgive me, I am not an Accountnnt.

However, if the profit was not actually made, you would not want to pay tax on it----therefore an adjustment the following year?

So perhaps it is not the previous years tax liability that is being adjusted----maybe it is really the previous year's profit?

Jeff Lampert
(former Chairman of Heritage plc)

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By AnonymousUser
17th Feb 2006 13:41

Re-Statements
Richard

Thanks!

Did you do a simple comparison (Profit and Tax the same year) or did you do a more"catchall" say a total of re-statements over 5 years for each of your companies?

Also do you have any idea on how many of them are KPMG Audits.

As I recall LloydsTSB went to PWC?

Rgds

Jeff

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Richard Murphy
By Richard Murphy
16th Feb 2006 17:44

No, it's tax
Jeff

Good point - partly becasue you, like me, are questioning the credibility of the accounts.

But it is the tax that is being re-stated here. Profit restatements have to be declared elsewhere.

At least, that's what it looks like - but as the figures do not, quite literally, add up it is a little hard to be sure - so maybe you are right.

And that's the most important point. How do we know when the accounting is not up to scratch, as seems to be the case?

Richard

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By AnonymousUser
16th Feb 2006 20:32

Richard, I'd be interested to know
whether you have put any of your concerns to the companies concerned for comment, whether they have commented in response, and what (if it is possible to generalise) was the nature of those responses?

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By AnonymousUser
16th Feb 2006 19:38

Do they connect?
Richard

The list of your tax re-statements is:

Lloyds Tsb
Tesco
Unilever
Prudential
Cadbury Schweppes
Scottish & Southern Energy
Reuters Group
Compass

Do these companies also head the profit re-statements?

I believe that TSB was amongst the worst acquisitions ever made. Compare Lloyds share price post acquisition with Barclays or HSBC and TSB looks like a "poison pill".

Perhaps one that had a great deal of false profit? Maybe Morrisons/Safeways does not want to go the same way?

And TSB was audited by my old friend Michael Hughes of KPMG.

Have I read too many "conspiracy theory" books?
Is it just KPMG?

Rgds

Jeff Lampert

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Dennis Howlett
By dahowlett
17th Feb 2006 12:49

Lively discussion
We're having a lively discussion about this.

My concern is one of credibility.

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Richard Murphy
By Richard Murphy
17th Feb 2006 10:23

Asking for comments
Clint

I did not ask for comments. The reason was simple. I was reviewing reporting. The reporting should explain what is going on. It should not require additional comment. So I felt that to ask was to contravene the hypothesis I was testing.

If the companies want to comment now I'd be delighted to see what they have to say.

Likewise the Big 4 firms.

Richard

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Richard Murphy
By Richard Murphy
17th Feb 2006 10:20

Restatements
Jeff

Lloyds at least did frequent restatements of profit. The trend is not so apparent in the rest.

Richard

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