The Financial Reporting Council (FRC) has highlighted widespread concerns about whether auditors are sufficiently ‘dispassionate’ when assessing a company’s financial reporting, or whether client relationships are clouding their judgment and level of challenge, during evidence to MPs at the inquiry into the collapse of Thomas Cook
Answering questions from the Business, Energy and Industrial Strategy (BEIS) committee, FRC director of enforcement, Elizabeth Barrett, denied that the media and public outcry, as well as government pressure, over the travel firm’s collapse into liquidation had promoted the regulator to open an investigation into its auditing.
Barrett said: ‘From the time of the first announcement of Thomas Cook’s problems, there needed to be sufficient information about potential issues with the audit which might merit investigating. The concerns needed to satisfy the threshold test for investigation, which they did.’
Asked by BEIS committee chair Rachel Reeves to identify those concerns, Barrett replied ‘broadly speaking, in particular issues around going concern and goodwill impairment.’
Barrett said she was hesitant to give more details about the FRC investigation into EY’s audit of the financial statements of Thomas Cook Group for the year ended 30 September 2018, as it is ongoing.
However, she told MPs that key element related to the sufficiency of the challenge auditors applied to management’s assumptions about going concern and goodwill, and the sufficiency of the audit evidence to support the work that was done.
Reeves raised the issue that while Thomas Cook had reported impairments to goodwill in 2011, there had been no further reporting on this until 2019, when £1.1bn was written down. Barrett indicated that while the FRC investigation is focused on the 2018 reporting, it is not unusual for such investigations to be widened out to other years.
MPs heard evidence that the FRC has amended the audit standards on going concern and goodwill impairment in recent times. Asked whether these changes had made an impact, David Rule, FRC executive director of supervision, said: ‘This is an area we look at in our corporate reporting reviews and in audit inspections, as these are one of the more judgmental areas, and one where we have often found issues around challenge of management.’
Committee member Antoinette Sandbach MP said: ‘Isn’t this a conflict of interest, since the auditor is effectively challenging their client about the client’s assets and goodwill and is afraid of upsetting them by suggesting they overpaid for assets?’
In response, Barrett said: ‘You have hit a very fundamental point about whether the auditor should be regarding an entity as client, or should consider their position much more as an “independent scrutiniser” on behalf of management.
‘We do have, from an enforcement perspective, cases where we find auditors have to our mind lost their objectivity in where that line between the client relationship and the separate, dispassionate independent reviewer should lie,’ she said.
Rule, who has been in post at the FRC for six weeks, said he had already been to a number of conferences for partners in audit firms, which had stressed audit quality and the need to recognise that the auditor’s client is not management but has to take into account wider interests, including shareholders.
‘I think there are at least the right noises being made but nonetheless when we look at audits and find problems these are often around challenge to management and reflect a culture of not being willing to challenge management because of conflict. Other factors are time pressure, partners not being sufficiently involved and quality control,’ he said.
MPs also asked the FRC executives about the implementation of the recommendations of the Kingman review of the regulator, many of which require government legislation to implement.
Barrett said around 34 of the 80 or so recommendations need legislation to enact, while 11 cannot be achieved in any way without such legislation.
Rule said that in some cases, the new leadership team at the FRC has indicated it plans to introduce interim measures to move towards achievement of the recommendations while waiting for the necessary legislation.
They also indicated that the FRC is likely to wait for the outcome of the Brydon review of audit, due before the end of the year, before making substantial changes in approach.
Barrett said: ‘We have an important opportunity to change the market for preparing financial statement and for changing the obligations on preparers and auditors, and in circumstances where we have an highly relevant review about reporting, we should wait for those findings.
‘It is better to get things right rather than to rush. Certainly I am very keen the recommendations in my area are introduced as soon as possible.’
MPs were also told that the two firms brought in as special managers in the liquidation of Thomas Cook – Alix Partners and KPMG – have so far been paid £11m for their services.
Dean Beale, CEO of the Insolvency Service, said: ‘The costs of the special managers is £11m to date across the two firm’s fees for the first three weeks, involving 26 liquidated companies.
‘The costs are coming down rapidly. With the cessation of the repatriation of customers and as parts of the business are sold, the work of the special managers is tailing off significantly.’
Asked by Reeves about potential costs to the taxpayer from the liquidation, Beale said it was not possible to say yet if there were debts to HMRC outstanding from any of the 26 entities involved, or whether there were other liabilities. He indicated the Official Receiver would be providing a fuller report before Christmas, but emphasised the scale of the forensic exercise which covers 30 accounting systems.