Accounting watchdogs find ‘serious problems’ at 40% of audits

Madison Marriage in The Financial Times


Global accounting watchdogs identified serious problems at 40 per cent of the audits they inspected last year, raising fresh concerns about the quality of work being carried out by the world’s largest accounting firms. 

According to the International Forum of Independent Audit Regulators, accounting lapses were identified at two-fifths of the 918 audits of listed public interest entities they inspected last year. 

The audit inspections focused on organisations in riskier or complex situations such as mergers or acquisitions, according to the IFIAR, whose members include 52 audit regulators around the world. 

The most common issue identified by these regulators was a failure among auditors to “assess the reasonableness of assumptions”. 

The second biggest problem was a failure among auditors to “sufficiently test the accuracy and completeness of data or reports produced by management”. 

The findings have intensified concerns about weaknesses in the auditing process, an issue that has been thrust into the spotlight over the past 12 months following a string of high profile accounting failures. 

These include the collapse of BHS and Carillion in the UK, a corruption scandal involving oil company Petrobras in Brazil, and the share price collapse of South Africa’s Steinhoff after the retail conglomerate admitted to a series of accounting irregularities last year. 

Prem Sikka, an accounting expert and emeritus professor at Essex University, said the frequency of problems identified by the IFIAR was “terrible”. 

“There are a whole range of issues and there is no simple fix. There is a huge knowledge failure in the audit industry which is not being looked at. The whole industry is ripe for reform. The question is where is the political will for this?” 

The accounting industry has faced significant reputational problems in the UK in particular. KPMG came under heavy criticism from politicians last year for giving HBOS a clean bill of health shortly before the UK bank collapsed during the financial crisis. KPMG has also been criticised for declaring Carillion a going concern last March, 10 months before the construction company went into liquidation. 

The report showed that 41 per cent of the problems identified by audit regulators last year related to independence and ethics. These included accounting firms failing to maintain their independence due to financial relationships with clients, and failing to evaluate the extent of non-audit and audit services provided to clients. 

Many firms also failed “to implement a reliable system for tracking business relationships, audit firm financial interests, and corporate family trees”, the IFIAR said. Its research was based on feedback from 33 audit regulators who inspected the work done by 120 audit firms. 

Karthik Ramanna, a professor at Oxford university’s Blavatnik School of Government, said the number of firms with issues around independence and ethics was “absurdly high”. He added that the research would reinforce concerns about a lack of competition in the audit market, which is widely viewed as being dominated by the ‘Big Four’: EY, Deloitte, KPMG and PwC. 

“The auditing industry is so concentrated, once the largest firms set the standard for poor conduct, the whole industry is dragged down,” he said. 

Brian Hunt, chairman of the IFIAR, told the FT: “We would like the firms to focus on getting better. We need them to think about how they come at this a bit differently. The firms are making progress — we would like to see it happen a bit faster.” 

Deloitte said: “We remain focused on continually improving the quality of services we provide to our clients. We look forward to continuing our constructive engagement with our audit regulators.”

PriceWaterhouseCoopers chief Kevin Nicholson denies lying over tax deals

Nicholson stands by previous testimony to MPs, as accountants are accused of mass-marketing tax avoidance schemes

• Simon Goodley
• The Guardian, Monday 8 December 2014 22.42 GMT

Nicholson again denied that the tax services sold by PwC were mass-marketed schemes. Photograph: Chris Robbins / Alamy/Alamy

The head of tax at one of the UK’s top accounting groups was accused of lying to parliament about his firm’s role in devising controversial tax deals for clients in Luxembourg.

Kevin Nicholson, PwC UK’s head of tax, who worked as an HM Revenue and Customs tax inspector in the early 1990s, was in front of the Commons public accounts committee for the second time in two years, following last month’s revelations of aggressive tax avoidance by PwC clients published by the Guardian and more than 20 other international news outlets.

In a series of fractious exchanges on Monday, the committee’s chair, the Labour MP Margaret Hodge, said: “We’ve asked you to come back to see us because we’ve reflected on the evidence that you gave us on 31 January 2013, and tried to relate that to the revelations around the Luxembourg leaks that have been in the press. I think I have a very simple question for you: did you lie when you gave evidence to us?”

Nicholson responded: “I didn’t lie and stand by what I said.”

Hodge’s anger stemmed from Nicholson’s previous evidence that PwC did not “mass market” tax products or sell tax avoidance “schemes” to clients, when set against the new evidence of 548 letters – relating to 343 companies – showing how PwC wrote to Luxembourg tax authorities to agree on how their clients structured their businesses for tax purposes.

“It’s very hard for me to understand that this is anything other than a mass-marketed tax avoidance scheme,” Hodge said. “I think there are three ways in which you lied and I think what you are doing is selling tax avoidance on an industrial scale.”

Nicholson again denied that the tax services sold by PwC were mass-marketed schemes and said that around 80 of the Luxembourg rulings related to UK companies, which were all distinct and had been disclosed to HMRC.

He said: “At the heart of the Luxembourg economy now is an economy that is based around businesses going there to finance [and] to hold investments. The tax structure, the system that they have created, facilitates that happening, along with all the other infrastructure. I’m not here to change the Lux tax regime. If you want to change the Lux tax regime, the politicians could change the Lux tax regime.”

Last month’s analyses of the way multinational companies establish businesses in Luxembourg were based on a leaked cache of hundreds of tax rulings secured by PwC Luxembourg that showed major companies – including drugs group Shire Pharmaceuticals and vacuum cleaner firm Dyson – using complex webs of internal loans and interest payments, which have greatly reduced tax bills.

The exposure of these arrangements – signed off by the grand duchy and all perfectly legal – have triggered an emergency debate in the European parliament focusing on the track record of the new European commission president, Jean-Claude Juncker, who had dominated Luxembourg politics as prime minister between 1995 and 2013. Juncker has sought to brush aside criticisms, insisting: “I am not the architect of the Luxembourg model because this model doesn’t exist.” However, Hodge added: “Since I have uncovered all this, I have questions about if Mr Juncker is fit to be the president of the European commission. I think if this had been around during the period of his appointment, it might well be a different decision.”

Appearing alongside Nicholson was Shire’s head of tax, Fearghus Carruthers, who explained how the group had two full-time employees in Luxembourg, who earn a total of €135,000 (£106,200) a year and handle intra-company loans of around $10bn (£6.4bn).

Hodge said: “It is stretching our credulity in suggesting to us that these two employees, who are also directors of umpteen other companies, are seriously the guys taking the decisions on loans totalling $10bn. Let me put this to you, Mr Carruthers, because it is a very serious matter, because if the decisions in substance aren’t taken in Luxembourg, this isn’t just avoidance; for me, it’s fraud.”

Carruthers responded: “Madam chair, I can assure you that the decision-making in respect of that Luxembourg company is made in Luxembourg.”

The executive was also repeatedly asked to explain the commercial rationale behind Shire establishing companies in Luxembourg and his answers included: “The commercial purpose is to allow us to have a treasury operation in Luxembourg which finances our activities”; and “the commercial purpose is for us to reinvest our cash appropriately and efficiently.”

When asked what Shire could do more efficiently in Luxembourg, Carruthers said: “It is not necessarily a question of comparative efficiency, we could have this lending in and lending out in all sorts of other jurisdictions. It’s just a good location.”

Well-known buyout firms such as Blackstone and Carlyle also appeared in the leaked documents, and Luxembourg investment vehicles are commonplace in such investment firms. A 2008 joint venture between private equity group Apax Partners and Guardian Media Group, which owns the Guardian, used a Luxembourg structure after it invested in the magazine and events group Emap, now called Top Right.

When the leaked documents were published, a GMG spokesman said: “We partnered with a private equity company which regularly used such structures. A Luxembourg entity was used because Apax already had that structure in place. The fact that the parent company is a Luxembourg company does not give rise to any UK corporation tax savings for GMG.”

Last year, PwC made revenues of £2.81bn, of which £714m came from its tax advisory practice. PwC Luxembourg had turnover of €276m for the year to June 2013, up more than 12% on the previous 12 months. Tax advice accounted for 29% of revenues, up from 24% two years ago. The Luxembourg partnership employs about 2,300 staff – equivalent to one in every 240 people resident in the small country. New offices for the fast-growing practice were officially opened last week at a ceremony attended by the duchy’s prime minister, Xavier Bettel.

Awkward questions for Tesco should be answered by its accountants too

Auditors are vital to the financial markets. But when they miss a catastrophe in the offing, they’re not doing their job

• 
• • Aditya Chakrabortty
  • The Guardian, Monday 29 September 2014 20.49 BST

Illustration by Daniel Pudles

So the supermarket that shoved horsemeat in its burgers now admits to sprinkling horse manure on its balance sheet. That quip has been doing the rounds since Tesco confessed last week to exaggerating its profits by £250m, and it strikes at the heart of the scandal. Just as a meat patty is manufactured, so too are a set of accounts. Neither falls from the sky, or gets slung together by a solitary bloke at twilight. They are instead a huge co-production of staff, auxiliaries and quality controllers, and they reflect the culture of the environment in which they are assembled.

Conversely, whoppers as large as the one Tesco has been caught telling won’t suddenly have popped out of the mouths of a mere handful of managers. Profits forecast for the biggest of FTSE 100 retailers will have been chalked up by advisers working to standard company practice, sweated over by executives and signed off at top levels of the company. Yet the result, according to new chief executive, Dave Lewis, is the kind of accounting he hasn’t seen during 27 years in business.

The horsemeat disgrace exposed a systemic dysfunction in capitalism: the abuse of suppliers by all-powerful supermarkets resulting in dinners that families couldn’t trust. Last week’s accounting scandal opens the door on another systemic breakdown: how one of those same giant businesses, struggling to pep up a flagging stock price, produced numbers that the business world couldn’t believe.

For understandable reasons, the press has largely spun this as the latest episode in the downfall of Tesco. Who wouldn’t tell that story? It’s simpler, starker and focuses on a high-street institution – what could be more satisfying than a tale of hubris at one Britain’s last remaining world-leading companies, especially if it allows a moist recollection of former Tesco boss Terry Leahy, one of the country’s dwindling number of business people of international repute.

But then awkward questions arise that force us to pull back the frame. The one that foxes me: where were Tesco’s auditors in all this? PwC is one of the Big Four accountancy firms who between them carry out around 90% of all audits for FTSE 350 companies. The £2.7bn-turnover partnership went over Tesco’s accounts for the 12 months to February this year, and gave the supermarket chain a clean audit in May. Just a few weeks later, on 29 August, Tesco executives issued their now infamous forecast – the one that exaggerated their likely profits by 25%.

You can imagine that in the course of a not-so-balmy summer, one of Europe’s biggest businesses suddenly went off its collective trolley and put out a confected set of figures – which, let me emphasise, were not checked over by its auditors. But consider this: back in May, PwC plainly was not entirely comfortable with the numbers it was signing off for Tesco. It went so far as to note its concern over commercial income – the fees paid by suppliers for Tesco giving their products prominence within their stores, and the income overstated in August by the supermarket chain.

On page 66 of the annual report, the auditors note that “commercial income is material to the income statement and amounts accrued at the year end are judgmental. We focused on this area because of the judgment required in accounting for the commercial income deals and the risk of manipulation of these balances.” In the polite, formulaic world of company reporting, this is a warning klaxon. And yet the auditors then went on to list the measures they’d taken to allay their concerns – and to sign off the numbers.

PwC has been Tesco’s auditor for over 30 years. For that service, Tesco paid PwC £10.4m in the last financial year – plus another £3.6m for other consultancy work. Of the 10 directors on the supermarket’s board (leaving aside the chief executive and the chief financial officer, both of whom are relatively new), two are ex-PwC: Mark Armour, a non-executive director, and Ken Hanna, chair of the company’s own audit committee.

Now imagine yourself as a senior executive at Tesco. The business has never been the same since Leahy left. The slump has dampened consumer spirits, some of the company’s foreign adventures now look ill-judged, and Aldi and Lidl are eyeing up your customers. And your remuneration partly depends on the share price – which is listing, badly. How and when to count commercial income is already one of the greyest of grey areas in accounting. Why wouldn’t you be a bit more “aggressive” in your forecasting?

To be clear, we don’t know that anything like this happened – yet it’s exactly to avoid such suspicions arising that we have auditors. This is why the government demands the vast bulk of limited companies (and hospitals and charities) have their accounts audited.

Just as with credit-rating agencies, auditing is a necessary part of the financial markets – but the auditors are paid by the very companies they are judging. Just as with S&P and Moodys, they form a small but powerful “oligopoly” – what was once the Big Eight shrank to the Big Five and, after the Andersen debacle at Enron, to the Big Four. And just as with the credit-raters, the result is often so unsatisfactory as to be useless.

All those banks that collapsed in the crisis were signed off as perfectly sound by PwC and its fellow auditors. But then, as Jeff Skilling, chief exective of Enron, said in 2004: “Show me one fucking transaction that the accountants and the attorneys didn’t sign off on.”

Nor was that a one-off lapse: in May this year, the regulators at the Financial Reporting Council noted that PwC audits, while generally of “a good standard”, were also too accepting of management fudge. As Prem Sikka, professor of accounting at the University of Essex, argues: “If some used car dealer was engaged in a fraction of the shortcomings, warnings and scams that big accountancy firms have been involved in, he would be put out of business.”

For their part, accountants are often aware of their industry’s shortcomings. For his book Accountants’ Truth: Knowledge and Ethics in the Financial World, Matthew Gill interviewed 20 young accountants at the Big Four firms. He found a bunch of men well aware of the boredom of the audit and of the shortcuts they were forced to make.

Some defended what they did. One told him: “I don’t think there’s anything unprofessional in giving views of facts directed by whoever it should be.” Another described his discomfort at working in his firm’s corporate-finance department and supporting what he described as “immoral” and “borderline corrupt” tax wheezes. But rather than voice his qualms, he simply moved department. Whistleblowing was not for him: “I would have felt I would look slightly ridiculous.”

Read that last sentence and recall that the person who blew the whistle this month on Tesco wasn’t the company’s audit committee or ethics committee – and they don’t appear to be from PwC either. As far as we know, the anonymous whistleblower worked for Tesco’s UK finance director, Carl Rogberg, and their report was at first ignored.

When last week’s scandal broke, Tesco chair Sir Richard Broadbent airily opined: “Things are always unnoticed until they are noticed.” He forgot to mention that that goes double if people are paid to turn a blind eye.