Carillion collapse raises audit and governance questions

Carillion in trouble
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Monday’s news that construction giant Carillion has filed for liquidation has raised fundamental questions of its board, auditors and the government about how this could have happened.

One of the UK government’s biggest contractors, the Wolverhampton-based firm had amassed more than £900m worth of debt and a £587m pension deficit before its compulsory liquidation at the start of this week.

As late as March last year board members claimed the firm had “substantial liquidity with some £1.5bn of available funding”.

However, Carillion’s problems began to snowball in July when it announced it was losing money on a number of large contracts and its debts were rising. Despite this, the company continued to win government contracts, leading to criticism of Carillion’s management and the government as to why those contracts were tendered for and awarded.

In July 2017 chief executive Richard Howson left the company, and between July and November 2017 Carillion issued three profits warnings and saw its shares crash by 91%.

Crisis talks with the government ended this Sunday as Carillion failed to secure the funding required to support its rescue plan, and the company filed for compulsory liquidation on Monday morning, with accountancy firm PwC appointed as administrator.

Liquidation and creditor impact

Documents seen by the Financial Times show that Carillion had just £29m in cash when it collapsed. In a document for the company’s insolvency process Keith Cochrane, the company’s interim chief executive stated there was so little available both PwC and EY rejected requests to be taken on as administrators amid concerns they would not be paid.

A reported 30,000 small firms are owed money by the organisation, and according to a witness statement filed at the High Court by Carillion’s chief executive expected recovery for creditors in liquidation is 0.8 to 6.6 pence in the pound.

Graham Randall, partner at corporate recovery specialists Quantuma, commented that the failure of Carillion will have a “serious impact on employees and its supply chain, putting the financial future of many people and smaller businesses at risk”. 

“Carillion appears to have won HS2 and other government contracts after their financial difficulties emerged last year,” he added, “this raises significant questions over the judgment of government officials and their handling of the due diligence process that took place when these contracts were awarded.”

Carillion’s UK staff working in private sector jobs could also have their wages stopped on Wednesday unless their jobs are rescued by other firms, although the government has agreed to cover those working in the public sector.

Audit criticism

Some of the criticism has also focussed on KPMG, which has audited Carillion since 1999, with experts asking whether the Big Four firm had done an adequate job.

Prem Sikka, professor of accounting and finance at Sheffield University told AccountingWEB that KPMG has some “serious questions to answer”.

“Carillion’s accounts for the year to 31 December 2016 received a clean bill of health from KPMG on 1 March 2017,” said Sikka. “KPMG said that the company was a going concern, but barely four months later the company issued a profit warning and its chief executive was sacked.

“Overall,” continued Sikka, “there are questions about the robustness of KPMG audit. What did it examine to enable it to reach the conclusion that Carillion was a going concern for the next twelve months? How thorough and independent was that examination?

According Carillion’s latest filed accounts, the company’s biggest asset is listed as goodwill, something Sikka expressed surprise and concern.

“How on earth do you raise new finance by offering goodwill as a security? How on earth did somebody come to conclude that the business had the ability to raise enough finance to remain a going concern?

“About £1.57bn was listed as goodwill. It’s a ridiculous amount and that means there’s hardly anything you can realise into cash, especially on liquidation when the whole thing is a dead loss.”

Investigative powers

A statement from the Financial Reporting Council said the watchdog has been “actively monitoring this situation for some time in close consultation with other relevant regulatory bodies.

“We have powers to investigate the circumstances relating to the audit of Carillion as well as the actions of the relevant accounting professionals,” continued the statement, “We are obliged to follow due process and will make a further statement on this matter shortly.”

KPMG said it would “co-operate fully” with any inquiry, and said its audits had been “conducted appropriately and responsibly”.

“We recognise that it is important that regulators acting in the public interest review high profile cases,” said a spokesperson, “and will of course cooperate fully with any enquiries that the FRC or other regulatory agencies may make.”

Commenting on the failure MP Frank Field, chair of the work and pensions select committee, said: “Carillion took on mega borrowings while its pension deficit ballooned. We called over a year ago for [The Pension Regulator] to have mandatory clearance powers for corporate activities like these that put pension schemes at risk, and powers to impose truly deterrent fines that would focus boardroom minds.

“It seems we have a new case like this every week,” continued Field, “and this one is particularly disastrous, with massive job losses and 28,000 current and future pensioners at risk. I would like to ask the Government today: what more is it going to take?”

About Tom Herbert

Tom is editor at AccountingWEB, responsible for all editorial content on the site. If you have any comments or suggestions for us get in touch.

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17th Jan 2018 09:56

I bet the directors got paid OK.

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17th Jan 2018 16:30

Yes. I'd say they got the cash and everyone else can have the goodwill.

The Construction Industry is one of the worst industries I have ever worked where suppliers and sub contractors are being used to fund projects, take the blame for other's errors, subjected to retentions which are never expected to be paid by the Contractor, or at least subject to "negotiation", where goods installed on site, even if not paid for "belong" to the Main Contractor and anyone foolish enough to ask for payment is threatened with no further work being offered and/or tied up in spurious QS challenges so that payment is not likely without a "deal".

Also requires a lot of "inverted commas" it seems.

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18th Jan 2018 08:08

Another well dodgy audit by the well dodgy accountants who run the profession. I expect no action to be taken whatsoever by the ICAEW or whatever other accountancy body the dodgy auditor qualified under.

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By DMBAcc
to mr. mischief
18th Jan 2018 10:22

Bit like MTD. Big four and CCAB Bodies well up for it and screw the rest of us who will pick up extra costs with no benefits

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18th Jan 2018 11:02

My experience in Italy was that we asked a contractor to prove that the sub contractors were paid out on the previous certified work before the subsequent certified installment payment. There was concern that the subs would have recourse to the client. The government could have done that at least. If the business needed the WC from the subs to survive it is a clear issue.

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18th Jan 2018 11:17

Massive goodwill means massive overpayment for acquisitions.

The government should create a law which sees the financial appraisals(say more than £25m consideration) of all acquisitions undertaken by listed entities audited by an accounting firm other than the main auditor.

Its easy to twiddle a few variables on dcf's to create wild values, and executives do it for various reasons mostly nefarious.

We really do have to put better barriers in, these well paid governor's are often just eye candy.

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to SJH-ADVDIPMA
18th Jan 2018 11:42

"Massive goodwill means massive overpayment for acquisitions". No, it does not necessarily mean that. Goodwill is mainly there because of the primitiveness of accounting thought. Let us lo0ok at an example, a pair of shoes may sell for £50 but accountants are not used to recording the cost of the whole. they like to record costs/value of items individually. so they ask what one shoe and then the second shoe is worth. The answer may be £1 each. This formulation leads to a goodwill of £48 but there are no missing or lurking assets. In the market, assets are traded at whatever price they can fetch and buyers pay on the basis of whatever the cash flow generating potential of the collection of assets, which complement each other, may be. Accountants can't cope with that then revert to old and discredited practices. The term goodwill mystifies financial reporting and does not tell users anything about the nature of the asset/advantage used to generate cash flows. In the case of Carillion, it is doubtful that even conventional accounting logic should have enabled it to report a massive goodwill figure as it was in dire financial problems, had low margins and was technically insolvent.
https://leftfootforward.org/2018/01/carillion-was-in-dire-financial-trou...

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to premsikka
18th Jan 2018 12:37

Goodwill is there (in the case of purchased goodwill resulting from business acquisition) because the double entry needs to be completed, value of identifiable assets/obligations acquired are debited/credited to the balance sheet, what about the premium,if the directors insist through their calculations the amount paid is approximating npv of future cash flows, we allow that portion of expenditure to be shown as an asset, as theoretically thats what the cash bought, its still worth that if it were to be flipped. An annual impairment review should let it be, or instigate a write down. A common tactic ive seen in listed companies is the creation of exaggerated obligations (e.g constructive obligations such as provisions set aside to bring health and safety aspects of acquired sites up to date), this increases goodwill, the provisions are then quietly dropped (through income statement) to boost income in that year (a few yrs post acquisition when the auditors forgotten).

Looking at carrilions 2015 accounts the majority of their £1.6b goodwill "arising from business combinations" the accounts also detail acquisitions (rokstad and carrillionamey)where £78m was paid, and identifiable net assets were a paltry £16m, 20% of consideration. Sounds an awful deal and or foul play in identifying obligations.

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to SJH-ADVDIPMA
18th Jan 2018 12:52

What I am saying is that accounting logic is faulty. It harks back to the days when the embryonic accounting profession mainly did bankruptcy work and the emphasis was on looking at the worth/value of assets individually rather than collectively and how they complemented each other to generate cash flows. When Carillion bought other businesses it sought to acquire many economic advantages including government links, names, etc., which conventional accounting logic does not recognise as assets. so it is all lumped into a meaningful figure.

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to premsikka
18th Jan 2018 13:21

I think the initial recognition of goodwill on business acquisition is sound enough if the appraisal (and subsequent annual appraisal)of the assets value is sound (cannot carry more than an assets value), hence my comment that big deals need independent audit oversight. As you say, £1.6b biggest asset and a liquidated business= problem, my conclusion is paid too much and or abused the goodwill value to prop up paper profits.

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18th Jan 2018 11:23

Same old same old,, the entrenched auditors claim they worked to the best of their abilities given the information available.
firmly believe no auditors should be able to perform audits for more than 2 consecutive terms

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18th Jan 2018 12:05

Well at least the Financial Conduct Authority has got something right as they do not allow licencees to declare goodwill in compliance Balance Sheets.

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18th Jan 2018 12:27

1. The Insolvency Service should force KPMG to pay PwC for the administration costs, no costs should be borne by the tax payer.

2. Directors' pay, dividends and bonuses immediately stopped. Think that's already happened.

3. Government accept total responsibility for it's total mishandling. Contracts should never have been cemented after the 1st profit warning last summer.
The PM's response that "they" were the customer NOT the manager, clearly shows a lack of basic knowledge.

The Government are supposed to be in charge of the Public Sector. If they are so worried about cost saving, how do they explain PFI and PF2, where the taxpayers are going to have to pay out over £200 billion over the next 20 years or so.

The knock on effect in the construction industry, especially with small limited and unincorporated businesses will be massive.

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18th Jan 2018 14:08

A nice little merry go round for those at the top.

Banks lend to VC's and big companies to load companies with debt and everyone (banks, big law firm, big accountants etc) makes money at every turn.

When the music stops the small company supplier and taxpayer pick up the tab and the big boys move onto the next merry go round.

My initial estimate is PWC will make over £100 million in fees out of this as "special managers".

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By ASF
18th Jan 2018 14:20

Carillion were well known in the industry for a number of years, for having a particularly "robust" approach to contract and cash flow management. The press makes hay over their use of such things as "reverse factoring", but these types of payment schemes have been industry-wide for decades. When the clients didn't commit to things such as 30-day payment terms, the main contractors were forced to use these schemes to generate cash flow. Also, widely spread stage payments on major contracts (as opposed to monthly valuations) only make matters worse. The headline 3% margins talked of don't help, but the whole construction world (including in foreign countries) has operated with these for a long time. I worked for US companies, and this was also the norm. QS' have a phrase "Change is your friend", meaning bid low and try to turn things around by variations on the contract. Some days it worked - some days it didn't. But, when you have very little CAPEX on your own B/S (assuming the industry rents plant from its subcontractors (which many do), the ROCE can still look quite good, when early/quick payment schemes are used, and a lot of people look at that as a measure. Free Cash Flow as a % of Turnover might have been a good measure, but only if adjusted for advance payments first. It is a very delicate balancing act, and the challenge is often to have a sufficiently large and diversified portfolio of business, to help ensure that "dogs" are more than covered by the "stars". Sad to see so many suffering for this, but not entirely a surprise. Corporate governance is a key factor in this, and of course, being held to account by the NEDs/Auditors/regulators. Monday morning quarterbacking is not a solution!

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By Suntree
19th Jan 2018 10:45

Enron collapse in US, resulted in Sarbanes-Oxley act being introduced and one of the big five Arthur Andersen LLP being wiped out.

One would think UK government would follow the trait and introduce legislation preventing collapse of giants of this scale leaving little people to pick up pieces and to pay for it.
Will KPMG suffer the consequences?

Quite a few bankruptcies of small contractors will follow, but are they relevant to fat cats?

Would like to see undeniable proof there was no corruption in handing Carillion overwhelming quantity of government contracts.
Putting all the eggs into one basket springs to mind.

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By DJKL
30th Jan 2018 16:33

It is essentially the same issue as the sub prime debacle, not being able to recognise the assets and liabilities from contracts so profit measurement is a fiction and they then do not know what is profitable to undertake and what is not.

This leads long term to the acquisition of more and more c**p on the balance sheet; more accurate and timely measurement might have stopped them digging the hole to such an extent they all fell in to it.

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30th Jan 2018 16:46

Why can't the Government run these contracts itself ?

Why do they have to pay some company, run by their cronies, to be middleman ?

Someone must have enough evidence to submit an SAR ...

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By DJKL
to lionofludesch
31st Jan 2018 15:36

Two words, "Edinburgh Trams".

Now I appreciate it was not the Scottish Government running it, they merely pushed it along the track, but we have half the length of track for double what we were going to pay for the whole, Leith Walk was a shambles for years, traders on it suffered, yet trams never reached that far. Now they look like building the other bit we are eagerly anticipating more years of chaos.

This is why government/local authorities ought not to be allowed to build anything. Still, it is not much better with PFI, with a wall falling killing a pupil and a fair few schools needing to be shut (including my wife's ) whilst they worked out if the cladding was tied to the building.

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to DJKL
31st Jan 2018 15:48

It's never going to be much of a service if the trams get pushed along the tracks by the Scottish Government. You need electricity.

You confuse two issues. Competency and Cronyism.

Competence can be bad in the public or private sectors.

Cronyism is about giving companies run by your mates a lot of money. Who in their right minds would deal with Philip Green ?

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31st Jan 2018 16:31

Why can't the Government run these contracts itself ?

Because the private sector will do it better and more efficiently.

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to Knight Rider
31st Jan 2018 17:03

I'm not seeing much evidence of that.

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