Carillion's finance directors created 'corporate time bomb'

Ticking time bomb
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The second joint report on Carillion’s disastrous collapse paints a picture of a seriously compromised finance department and a “rotten corporate culture”.

The latest report puts Carillion’s “aggressive accounting policies” under the spotlight. The details aren’t pretty. In one particular case study - Carillion’s Royal Liverpool Hospital contract - the company’s management overrode an internal peer review reporting a loss.

Management insisted on a healthy profit margin being assumed in the 2016 accounts. The difference between those two assessments was around £53m, the same loss included for the hospital contract in the July 2017 profit warning.

The report goes on to detail a slew of dubious practices: accounting for revenue for work that had not even been agreed, using its early payment facility for suppliers to conceal its drastic cash flow situation, and not accounting for it as borrowing. The only tangible cash supporting Carillion’s profits emanated from a systemic culture of late payments to its suppliers.

“Whether or not all this was within the letter of accountancy law, it was intended to deceive lenders and investors,” reads the report. “It was also entirely unsustainable: eventually, Carillion would need to get the cash in.”

Carillion’s finance directors

The dominant character in Carillion’s aggressive accounting policies was Richard Adam. Carillion’s former finance director retired in 2016. “He, more than anyone else, would have been aware of the unsustainability of the company’s approach,” the report states.

“His voluntary departure at the end of 2016 was, for him, perfectly timed. He then sold all his Carillion shares for £776,000 just before the wheels began very publicly coming off and their value plummeted. These were the actions of a man who knew exactly where the company was heading once it was no longer propped up by his accounting tricks.”

Adam’s successor Zafar Khan is portrayed in a more sympathetic light by the review, but it also adds that he should not be absolved of responsibility. “He failed to get a grip on Carillion’s aggressive accounting policies or make any progress in reducing the company’s debt.

“He signed off the 2016 accounts that presented an extraordinarily optimistic view of the company’s health, and were soon exposed as such.”

Carillion’s final finance director, Emma Mercer, was spared criticism, however. “Emma Mercer is the only Carillion director to emerge from the collapse with any credit. She demonstrated a willingness to speak the truth and challenge the status quo, fundamental qualities in a director that were not evident in any of her colleagues.

“Her individual actions should be taken into account by official investigations of the collapse of the company. We hope that her association with Carillion does not unfairly colour her future career.”

The cosy club

The Big Four have also been harshly criticised throughout the entire Carillion scandal, and this criticism has only ramped up. Each one of the Big Four firms benefited financially from Carillion’s dysfunction, either through audit work or consultancy services.  

“This is a disgraceful example of how much of our capitalism is allowed to operate, waved through by a cosy club of auditors, conflicted at every turn,” said Frank Field, chair of the Work and Pensions Committee.

Rachel Reeves, chair of the BEIS committee added, “[Carillion’s] auditors should also be in the dock for this catastrophic crash. They are guilty of failing to tackle the crisis at Carillion, failing to insist the company paint a true picture of its crippling financial problems.

“The sorry saga of Carillion is further evidence that the Big Four accountancy firms are prioritising their own profits ahead of good governance at the companies they are supposed to be putting under the microscope.

“KMPG, PwC, Deloitte and EY pocket millions of pounds for their lucrative audit work - even when they fail to warn about corporate disasters like Carillion. It is a parasitic relationship which sees the auditors prosper,  regardless of what happens to the companies, employees and investors who rely on their scrutiny.”

Reeves recommended that the Competition and Markets Authority look at the break-up of the Big Four accountancy firms to help increase competition and deal with conflicts of interest.

'No confidence in our regulators'

The Financial Reporting Council (FRC) and the Pensions Regulator (TPR) didn’t escape censure, either. FRC and TPR, the report said,  were “united in their feebleness and timidity” and too “passive and reactive” to make effective use of the powers they have.

The report said the FRC is too content with "apportioning blame once disaster has struck" rather than proactively challenging companies.

For its part, the FRC provided an update of its investigation into KPMG, Adam and Khan this morning. “Good progress with the investigation is being made by the FRC’s team of lawyers and forensic accountants,” the regulator said.

The investigation focuses on: contract accounting, reverse factoring, pensions, goodwill and going concern. “The FRC expects to review tens of thousands of documents and emails in order to establish how and why audit and accounting decisions were reached.”

About Francois Badenhorst

Francois

I'm AccountingWEB's business editor. Feel free to get in touch with comments, tips, scoops or irreverent banter. 

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By ShayaG
17th May 2018 10:53

The link to the report is broken

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to ShayaG
18th May 2018 11:05

Apologies, ShayaG. Will fix it now.

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By tedbuck
17th May 2018 11:04

The tick box culture at work - fill in the forms and allow the brain to sleep - as long as the is are dotted and the ts crossed it must be all right - mustn't it?
In a business such as Carillion surely it would be necessary to have a few audit staff ferreting about on a daily/weekly/monthly basis within the financial set up? Otherwise they are just going to be fed data which is probably largely meaningless.
The lady, Emma Mercer, who blew the gaffe, was there quite a while before she worked it out so obviously it was fairly well hidden.
I think that the whole rationale of auditing probably needs looking at from a different angle as what happens now doesn't seem to be very good at spotting this sort of situation. Carillion wasn't the first and won't be the last either.
I suppose we now have so many standards that no-one can see the wood for the trees. And if they don't work anyway what is the point of them?

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to tedbuck
17th May 2018 11:39

Hi, the standards do work its just greed / unintended consequences of bonus payments that drives senior managers, directors and external auditors to obfuscate and waive through . There is generally very little point to senior layers of management, they exist mostly to accrue maximum remuneration to themselves via smoke and mirrors, great acting and oratory. The big problem as ever is the 'police' I.e. the auditors are in on it.

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17th May 2018 11:07

What a sad and sorry tale that puts a serious blot on the accountancy profession's copybook.

There's a time-honoured phrase I would use to the approach of senior management to the financial affairs of Carillion - "cooking the books".

Dozens of small contractors - the type of people I act for - have been short-changed by the irresponsibility of Carillion management and their auditors. This is nothing short of scandalous.

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By ASF
17th May 2018 11:26

This is most definitely NOT the end of things. Many companies in the contracting side of the infrastructure/major projects world will be facing similar challenges, on a daily basis, on a wide portfolio of their respective projects. Reverse Factoring is a well-used and well-known vehicle to improve year-end balance sheets. The conflicting priorities between what project teams believe results/forecasts should show, and what the varying levels of management between them and others, all the way up to the board are constant. Let's not believe this will not happen again. It's just a case of where, when and how bad will it be. At the root of it is the conflict between companies tendering for work at very low margins, aggressive customer resistance to pay for (often) legitimate claims for scope and cost changes, and finding the margins often only get worse as the project progresses - rarely better! The desire of the markets for a continuous "improving" trend of reported results and executive pay highly geared towards that, just means the wrong behaviours are being exhibited. Well-designed and enacted LTIPs may help, but they won't solve the underlying problems of poor results. Management (from Board level down) need to enforce the rules, instead of engineering ways to bend
(or even break) them!

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17th May 2018 11:32

But.... once again, after the outraged words gather dust, what amounts to nothing will be done.

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17th May 2018 12:07

While the overall direction of the report was pretty accurate, even after allowing for the politicians' grandstanding, there a few basic errors in the accounting and financial analysis
* analysis of goodwill - there is a statement that "goodwill is the intangible assets of the business being acquired" which I don't think is not correct - it is the residual of purchase price minus all assets being acquired. So for example, acquired brands should be separately identified
* Banks do not (and should not) use current ratios or balance sheet capitalisation when there is sufficient disclosure of cash flows and a market (rather than book) value of equity. On the other hand, working capital flows should be very closely analysed.

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17th May 2018 12:12
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17th May 2018 13:29

The scandalous state of the audit trade persuaded me to change my strategy for my non-property investments. I no longer trust the accounts of any entity which is audited by the big 4 - which means most of the FTSE100 and a large chunk of the rest. I was always a value investor but that sort of strategy depends on true and fair accounting which, Polly Peck , Rolls Royce and Marconi notwithstanding, used to be more common than it is now. I now operate a trading strategy based on short term over-sold price analysis. The only accounting item I ever look at now is cash, to try and make sure the business isn't about to go bust. It's not easy to misrepresent a business's cash flow, although I confess I was fooled by Conviviality. Most people invest via managed or indexed funds which can't duck and dive like I do, and I increasingly perceive the managed funds as sitting ducks,trying to decide where to make long-term investments based on accounts which are, to a large extent, useless.

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17th May 2018 13:48

At no point should an auditor be able to provide any other services to the organisation they are auditing. To do so creates a conflict of interest that the accounting industry clearly can not cope with.

Accounting standards might try to paint a perfect world but time and again we see organisations collapse when the most recent set of audited accounts give no clue to what was going to happen.

The current auditing system is worthless to users of accounts and seems only to be a loss leader for more "lucrative" work and that can not continue.

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By JPK
to rememberscarborough
18th May 2018 09:26

You'd think that Enron had never happened.

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17th May 2018 13:49

The link that needs to be broken is that a multinational needs to have the same auditor everywhere, even where they have an Enterprise Resource Planning and the accounting of all group companies is on it. Most ERPs are SAP, installed by one of these audit firms as SAP's logo'd partner, but it should not then follow that one auditor must audit every group company. SAP itself should be the enabler that group companies can select their own auditor, and the role of the auditor at the parent level would be to supervise both the roll-up and the production of reports that meet the standards that the parent must adhere to. Since dozens of group companies will be in effect SMEs, they can select a local auditor outside the Big Four.

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By ASF
to boblyddon
17th May 2018 14:41

Dear boblyddon,

I understand what you are saying, but I am not entirely sure that will solve the underlying problem. For complex multinational groups, the issues around planning, forecasting, controlling and reporting major cross-border projects can be very complex, themselves. Then, when you try and "consolidate" the relevant business unit, company, group reporting, the mists get foggier and foggier. Sometimes, down at the local level, the big picture is often not readily visible. Similarly, my experience says that sometimes, local auditors, outside of the Big 4 may lack the international "nowse" to get a clear understanding of the commercial realities of project/contract problems. I know for our group, the group auditor places no reliance whatsoever on subsidiary co auditors, even when it is one of their own local "affiliates" (i.e. Franchisees!). So, in that case, we feel we benefit from one auditor having the "group" view. A key audit skill, for me, that they need with these big companies, is to be able to audit "the project" or "the contract", follow it all the way up the food chain to see how the figures the project team realistically believe may happen, find their way into the eventual consolidated group reporting. There are some very subjective judgements that can take place within a large project's forecasting and reporting, that can mask the reality. Indeed these "judgement calls" can continue all the way up. All of this ignores the high-level considerations of debt, goodwill, dividends, pensions, which are clearly very relevant, but have different issues and oversight challenges to projects. These major MNCs are very complex beasts, offering great scope for obfuscation!

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to ASF
17th May 2018 16:21

An SAP implementation was billed as reducing complexity, by ensuring a standardised account chart with clarity of roll-up, standardised rules, and financial processes that were broken down into many small sub-processes, each with defined triggers for inputs and outputs, and controls over both. That was one of the main sales points for ERP in the late 1990s, that it should make auditing quicker and easier within an MNC. I recall that a major Swedish/Swiss packaging group were prepared to pay implementation fees heading towards $100 million for that, but paid to the Consulting side and in a way aimed at reducing what was being paid to the Audit side of the same firm (this was pre-Enron). It does not seem to have eliminated the scope for obfuscation, though!

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By ASF
to boblyddon
17th May 2018 17:19

I worked on an SAP implementation, in the late 1990's, that probably cost more than the figure you mentioned, that promised much the same, but you had to implement it in a "plain vanilla" format (out of the box). Nobody can, and this is where the consultants make their money (along with back-filling people taken from the BAU teams to implement), and "training" users. I am not saying that the company concerned may not have benefited from the implementation (who knows, by now, they might even have saved something approaching the implementation cost!), but if anyone thinks they will do it "out-of-the-box" experience says "NO!" Obfuscation, will find a way, to plagiarise Jeff Goldblum in a well-known film, and no ERP system invented is ever likely to prevent it!

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to boblyddon
17th May 2018 18:33

I used to work as an accountant for a large construction business. The quantity surveyors and I met monthly , we discussed contract values, work not invoiced and valuation reserves. When pressure is on, jobs and bonuses on the line, reality is stretched, bow to the pressure and try and find a solution tomorrow. Its nothing to do with ERPs or accounting standards, its purely governance. If we can obtain pecuniary advantage by deception with very low risk, we will.

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17th May 2018 14:26

Bring back the birch!

The only answer is to overturn the big 4 's ability to audit listed entities, instead CIPFA must perform the audits, and there must be strong incentives to qualify audits. Give a 5 year handover to enable CIPFA to expand appropriately and big 4 to adjust.

Its an important step to protect capitalism, people will turn the board game over to reset it (at the ballot box, Corbyn), if we capitalists with brains, don't take steps ourselves.

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17th May 2018 21:33

Hi
Whilst the report and comment has highlighted the "technical way" the losses at Carillion occurred and the accounting devices used to hide the inevitable loss the real problem is much simpler - GREED!
The world - because it's not just a UK problem - has got to find a way of making it unacceptable for Directors of any Company to be paying themselves salaries / bonuses and other benefits at highly inflated eyewatering levels. If "reward" for doing a job was based on the work achieved rather than per cent of "profit" then there would not be this constant pressure to make every result "look good" and "better" than last year.
When I was in Management Accounting (for major international PLCs) I was taught to be cautious. We always estimated for the "worse case", thus were not "surprised" by the reality of the final invoice! Our management was not driven by greed in those days nor were they outsourcing everything or treating suppliers as a source of finance. Shareholders were happy, they got regular dividends and capital value increased.
Business needs to get back to a way of working with a degree of morality.
Audit firms certainly need to return to the principal of their role which is to act as "watchdogs" finding and reporting on any form of mal practice. Not colluding an and encouraging ways of avoiding tax.

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By BrianL
18th May 2018 09:50

Richard Adam is now a non-executive director and Chair of the Audit Committee of FirstGroup plc according to FirstGroup's website. See http://www.firstgroupplc.com/about-firstgroup/leadership/board-of-direct...
Clearly he knows lots about audits. This would be funny if it were not outrageous.

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By ASF
to BrianL
18th May 2018 10:37

Appalling. This feels rather like Reynard The Fox going on TV to push the publishing of his best selling cookbook of chicken recipes!!!
People who preside over such corporate failures must surely be stuck off from being a director of major companies, or even involved in the running of them, in such ways as committee members (via being a NED or even "co-opting") for periods running up to decades. Of course, the whole game is rigged, when their university buddies are in regulatory, government and accounting firm senior roles. So, the revolving door just revolves once more, and they come back, in another guise, as you have noted!

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