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MPs: Wretched state of audit sector evident in Thomas Cook collapse

Auditors have lost their objectivity and are too close to the firms they are assessing, the UK accounting regulator’s top enforcement official told MPs investigating the collapse of travel agency Thomas Cook.

23rd Oct 2019
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Elizabeth Barrett, executive counsel and director of enforcement at the Financial Reporting Council (FRC), told a committee of MPs that major auditors were failing in their duty to adequately challenge management.

Thomas Cook, the world’s oldest travel company, collapsed in September with £1.7bn of debt despite being given a clean bill of health by auditors PwC and EY.

Crossing the line

Over a two-day session, members of the government’s Business, Energy and Industrial Strategy Committee (BEIS) said the auditors had been “complicit” in the demise of the 178-year-old travel business.

MPs were told PwC and EY earned more than £23m from “non-audit” work, on top of around £32m they were paid for reviewing Thomas Cook’s books.

Hemione Hudson, PwC’s head of audit, said: “I do understand that people are concerned.” 

She said that the firm would not allow the arrangement to occur today, however, this is down to a rule change that forbids the practice occurring. BEIS committee chair Rachel Reeves said if the guidelines had not been updated then PwC would not have changed its policy, and that auditors were “waiting for legislation rather than doing the right thing”.

Wednesday’s session focused on the role of the regulator and the bookkeeping of Thomas Cook during the years it accumulated debts through a series of risky mergers, acquisitions and other deals.

Barrett said a point had been crossed as auditors were regarding audited entities as clients, and as in the case of Thomas Cook, appropriate levels of scrutiny were not being delivered.

“From an enforcement perspective, we find auditors have lost their objectivity in where that line between client relationship and separate dispassionate independent reviewer should lie,” Barrett said.

She said the regulator is scrutinising “audit assumptions” made by EY, the tour operator’s most recent auditor, as well as whether accountants adequately pushed back against management assumptions, but declined to offer detail more due to an ongoing FRC probe into EY’s role in the collapse. 

“There are questions over culture for audit firms,” said David Rule, FRC executive director of supervision. “We do find problems often around challenge of management, and it reflects a culture of not being willing to do that.”

The Insolvency Service chief executive Dean Beale revealed KPMG and consultancy firm AlixPartners, brought in to deal with the liquidation, had billed £11m in fees for three weeks of work assisting the official receiver.

On Tuesday, EY said Thomas Cook still owes it £900,000 in unpaid fees.

Regulator under fire

The role of regulators and auditors has come under closer scrutiny since the collapse of Carillion and resulted in a string of recommendations to uphold standards and strengthen trust in the audit process.

Reeves said lessons had not been learned from the Carillon debacle and reform of the audit sector was occurring “after the horse has bolted” given the downfall of Thomas Cook.

Earlier in the year, several calls were made to break up the Big Four over claims there were too many conflicts of interest, given the overlap of providing non-audit services to firms they were meant to be vetting. 

Independent MP Antoinette Sandbach said the regulator had to take its share of the blame and asked if the FRC had been sleeping on the job given Thomas Cook’s problems were evident from at least 2013 when the firm carried out a refinancing.

“We know the assets purchased by Thomas Cook were losing money. Shouldn’t alarm bells have been ringing at the FRC?” she said. “There was a flag-waving around the refinancing. What protection is there for customers, shareholders, clients? What oversight is there?”

Two reviews into the state of the audit sector have been carried out since 2018, the first led by Sir John Kingman, chairman of Legal & General, and the second by the Competition and Markets Authority.

The resultant findings have led the government to abolish the FRC and replace it with another regulator, amongst other findings. However, the reforms require multiple acts of legislation to be triggered.

“Since Kingman, we have had another collapse of a public company, and it has thrown up more questions that the regulator is looking at, but this is all after the horse has bolted, similarly to Carillion,” said Reeves. “There is a need to reform the audit sector, and looking at what has happened at Thomas Cook hopefully the government will speed this up.”

Barrett said she was keen for the recommendations to be introduced around enforcement “asap”. 

“We have an important opportunity to reshape the market for financial statements, and the obligations placed on auditors,” she said. “It would be better to get it right than rush it.”

No peace or goodwill

Two former Thomas Cook CEOs and the company's former chief financial officer were also grilled on their part in the travel agency’s downfall, with MPs laying into the trio for their refusal to accept blame for their actions.

“Everyone we’ve seen from Thomas Cook has blamed everyone apart from themselves,” said Reeves. “They never look at themselves, the decisions they’ve made, and reflected on those. It’s the volcanic ash, the hot weather in the UK, the depreciation of sterling, the debt acquired by someone else. It would be good for someone from Thomas Cook to say they wish they had made different decisions instead of passing the buck.”

MPs were told the auditors had warned Thomas Cook in a letter to management there had been “potential for manipulation” in the reporting of goodwill in the annual statements, and that these numbers were artificially inflated.

Harriet Green, who ran the company from 2012 to 2014, said there was overall goodwill of £2.6bn when she started and this had reduced slightly when she left the business. The figure had been heavily written down in 2019 by £1.1bn.

Former CFO Bill Scott said he would not use this term, but recognised the difference in approach to the issues of goodwill. He denied auditing is “a cosy club” and said there was challenge about the use of goodwill, but refused to accept the firm erroneously overstated its assets in relation to its performance.

Scott said the 2018 heatwave disrupted trading to such an extent it caused a damaging decline in profitability, undermining assumptions in the business plan. MPs pressed him on whether he had made a mistake.

“With the benefit of hindsight it appears unusual there could be that level of decline,” Scott said.

Manny Fontenla-Novoa, who ran the company from 2003 to 2011, also deflected accusations that financial management during his tenure was responsible for the firm’s troubles. 

Of the tactics employed, Stephen Kerr said Thomas Cook was “using its suppliers as a bank” by paying late and not declaring those liabilities on the balance sheet, making suppliers wait 60 to 90 days in some cases to be paid, although Fontenla-Novoa was adamant the firm abided by industry standards.

Fontenla-Novoa oversaw a huge expansion and acquisition spree, which included the ill-fated purchase of MyTravel in 2007. MPs accused him of pursuing risky deals due to the financial rewards on offer. Between 2008 and 2012, Fontenla-Novoa earned £12m, including £5m for the MyTravel deal, despite the company’s net debt having doubled and its profits wiped out.

The former CEO banged on the table repeatedly as he defended his actions, citing the 2010 Icelandic ash cloud and a struggling pound as reasons that the tour group entered “tough times”.

MPs were not impressed by the excuses given by the former bosses, however, and the trio were urged to take more responsibility as the probe continues.

“A bit more humility would help, but I feel we have missed that today in your case, Manny,” Reeves said.

Replies (16)

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Chris M
By mr. mischief
24th Oct 2019 05:56

Same old same old. Until the MPS pass laws with eye-watering fines and personal asset confiscation nothing will change in my view. Until ICAEW grows some balls and boots out these guys instead of the small fry who do stupid things - but far less consequential stupid things - nothing changes. The MPs should regulate the profession, I've been in it since the 1980s and it really is the same old tune played in the same old way for nearly 40 years.

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Replying to mr. mischief:
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By [email protected]
24th Oct 2019 11:47

So True!
It is time that Audit and other services were properly separated ie the same firm cant do both for the same client and not just the partner as it has been
Furthermore the selection of Auditors for PLC's should be taken out of their hands and assigned by the government (or a regulator on their behalf)
Or maybe we should go the whole hog and Audit of PLC's be done directly by a Gov't body.
Ath the end of the day the Auditor needs to be able to Audit impartially without a watching eye on other fees or continuing fees

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Bramble
By Chris.Mann
24th Oct 2019 09:26

"On Tuesday, EY said Thomas Cook still owes it £900,000 in unpaid fees".

Ain't that a shame?

MPs were told PwC and EY earned more than £23m from “non-audit” work, on top of around £32m they were paid for reviewing Thomas Cook’s books.

Isn't that a travesty?

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By Justin Bryant
24th Oct 2019 09:59

"Auditors have lost their objectivity.."

I disagree. There was never any to start with due to the inherent conflict of interest problem we have seen so many times now it's getting boring.

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By pauljohnston
24th Oct 2019 10:20

For me the problem is that the auditors takeon more re-numerative roles and cross subsidise audit.

These are big companies. Is it not time to have just Auditors to do just that. Then the regulator can ensure that companies are paying sufficient so that the Auditor can do the job properly.

Whilst big fines look good if I was a top executive I would not take on a difficult role. Its these people we badly need. So the Company must be forced to have a full Audit and I mean full not a quick look if certain things happen. These can be set by the regulator and could include a profit reduction of x%, increase in debt to asset ratio of etc. Letters as sent to Thomas Cook should have to be by regulation copied to the regulator.

Finally make it painful for auditors who dont do a proper job. As Mr Mischief says if a top 4 partner was suspended or kicked out the message would be loud and clear.

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By rememberscarborough
24th Oct 2019 11:09

When looking at a set of accounts does anyone bother to look at the audit report? Thought not....

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Chris M
By mr. mischief
24th Oct 2019 11:43

In my view big fines will not stop the best guys from taking the top jobs. Hopefully they will deter the arzz-licking clueless executives who have already been over-promoted from taking their conspicuous lack of talent and ability one stage further.

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By tedbuck
24th Oct 2019 11:43

It still comes back to the same place - even if the big 4 were awake how can they possibly audit a Thomas Cook if the Directors want to fudge the figures? All the recent Failures are pretty much the fault of the directors hanging on to get their salaries and bonuses and beggar the shareholders. You can try to blame the Auditors and they certainly aren't without fault but the whole audit procedure is way out of date and far too proscribed by box ticking. Whilst signs may be visible with the benefit of hindsight to make you look in the right place it isn't so easy when you are looking at an overall picture to spot the bit where someone has painted over the cracks.

As for politicians taking the profession to task - they are so totally incompetent at their own job of running the country that they would be better to get their own house in order first. I very much doubt whether many of them have actually done a real job so who on earth are they to criticise those who do?

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By N.Krishnaswamy
24th Oct 2019 11:44

As Mr. Scott says "the 2018 heatwave disrupted trading to such an extent it caused a damaging decline in profitability, undermining assumptions in the business plan." What sort of forecasting they had? Where was the Internal control to monitor and modify the budget immediately? When they cannot run the company properly , they should be made to return their remuneration excepting the amount required for subsistence level wages and denied all other benefits.
The auditors should also be asked to repay their remuneration to the company. In India, PWC was ordered by the Security Board of India to return their fees to the client for their faulty audit of US listed Satyam Computers.
Unless these strong measures are undertaken, no reform could produce the desired result.
Further when a company's turnover crosses certain limit, say,500 million, they should be ordered to be audited by three or more audit firms, not necessarily BIG 4s, jointly without any increase in the total audit fees, so that each auditor's area of audit is agreed to initially.
Valuation of goodwill may affect the presentation of the final accounts but does not affect the cash flow which is the problem for getting into insolvency.
Instead of merely certify going concern the auditors should be asked certify that the cash flow position is satisfactory to pay the debts and there are no outstanding dues to creditors of more than 90 days pending at the date of balance sheet.

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By ColA
24th Oct 2019 11:46

It’s been like this for approaching five decades.
The largest audit practices apply standard routines based on sampling and do not warrant that the underlying accounts are ‘guaranteed’ - watchdogs not bloodhounds!
Remedy - strict separation of non-audit v other services far greater than existing ‘Chinese walls’.
Based on a decade or so in practice and over four decades in private & public sector financial management.

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By Gerry Brown
24th Oct 2019 11:58

The auditors didn't destroy Thomas Cook - the management did that. The auditors should have informed the general public/investors/government what had happened and what was happening. They didn't.
What penalty should be applied for that failure? A ban on all work for the government (including local authorities and QUANGOs) for a two or three year period might concentrate the corporate minds. Will expelling a few partners make a cultural change?

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By Mr J Andrews
24th Oct 2019 12:41

A classic case of Cooking the books ?
Another example of a BIG Audit leaving a BIG stench behind. And why not if they are allowed o get away with it.
Who's next I wonder

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Replying to Mr J Andrews:
Bramble
By Chris.Mann
24th Oct 2019 14:21

Carluccio's, or Pizza Express, would fit the pattern, at the moment.

Tired outlets, confused High Street's and who'd trust the auditors to provide a "true" and fair view?

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Chris M
By mr. mischief
24th Oct 2019 15:04

We'll find out soon enough. It's only when the tide goes out that you find out who's not wearing a swimming costume. In my view 2020 will be moderately grim for our economy if we Remain or do a sensible Brexit, and a car crash if we do a No Deal.

So more company busts, and more dodgy auditors revealed. "But hey, we got away with 300 dodgy bank audits in the crash of 2008-9, so trebles all round at the ICAEW bar, please."

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By [email protected]
24th Oct 2019 16:05

There must be far more disclosure in the audit report.
That is the auditors detailed reasoning for accepting the figures in each of the headings in the balance sheet and in particular goodwill valuation, should be disclosed.
Future cash flow forecasts must be published and should only include income streams that are definite, and not proposed or hoped for at the time of the signing of the audit report.
Bonuses based on manipulating figures in the accounts should be outlawed for Directors in plc's, and a maximum fee should be established.
The professional bodies must wake up and look at whether the people they admit into membership are actually capable of carrying out plc audits. They should come clean and tell us how such people have come to be in their membership and bring such discredit on the rest of us.

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Jennifer Adams
By Jennifer Adams
27th Oct 2019 16:07

Can I ask a basic innocent question... who is their right minds would become an auditor?

I would suggest that anyone who is on the road to qualification keep well away.

Boring job anyway.

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