MPs slate ‘audit automatons’ over Thomas Cook failure

The next government must bring forward legislation as soon as possible to replace the Financial Reporting Council (FRC) with the Audit, Reporting and Governance Authority (ARGA)

This is a matter of urgency to eliminate the risk of further high profile corporate failures because of the lack of audit reform, MPs are warning.

Members of the Business, Energy and Industrial Strategy (BEIS) Committee also described auditors as ‘audit automatons that are incapable of drawing the most basic of conclusions from a balance sheet, questioning what they add to the corporate reporting process’.

Due to the dissolution of parliament on 6 November, the Committee was unable to publish its final report into the collapse of Thomas Cook.

However, it has released correspondence related to its inquiry and said it recommends a new government push ahead with the required legislation to establish ARGA in the first Queen’s Speech of the new parliament as a key priority, in order to improve corporate governance.

In a letter to business secretary Andrea Leadsom, Rachel Reeves, chair of the BEIS Committee, wrote: ‘Political pressure can and does draw attention to faults and flaws, but without regulators armed with the powers and resources that they need, lasting cultural change will not happen.

‘Urgent steps need to be taken, not least the introduction of long overdue legislation to empower regulators, in order to mitigate against the worst impact of corporate failures on employees, consumers, suppliers and taxpayers.’

Leadsom is heavily criticised in the inquiry documents, which noted: ‘The failure at Thomas Cook has also been notable for the extraordinary lack of interest shown by the business department and its secretary of state in the days and weeks leading up to the collapse.’

The report points out that ‘many of the necessary measures on audit, on executive pay, and on corporate governance have been sitting in the government’s in-tray for months.

‘The CMA and BEIS Committee published proposals in April on reforming the audit market, on tackling conflicts of interest, and on improving audit quality but the government failed to bring forward the legislation necessary to drive this forward.’

Goodwill

In its conclusions on the circumstances of Thomas Cook’s collapse, the report cited ‘a lack of challenge in the boardroom as the company piled up debt and Thomas Cook management missed opportunities to reduce debt levels and give the business a viable future’.

The Committee takes aim at the treatment of goodwill, which it said it first highlighted as an issue in its earlier inquiry into the collapse of Carillion.

In evidence, the Committee heard that goodwill on Thomas Cook’s balance sheet had not been written down since 2012 because its auditors, PwC and then EY, had considered that its cash flows and business plans continued to justify its unchanged status. It did not impair significant further amounts until the final interim results were released in May 2019. At the end of September 2018, 39.4% of the assets on the balance sheet were represented by goodwill.

The report states: ‘Both PwC and EY told us that they asked the right questions and challenged Thomas Cook’s management.

‘EY said that they had followed accountancy standards and procedures in this respect. If the latter is true, and goodwill is being treated in this way across the FTSE 350, it should be cause for grave concern.

‘This would mean that more Carillion and Thomas Cook collapses are potentially already locked into the system.

‘It also presents a picture of audit automatons that are incapable of drawing the most basic of conclusions from a balance sheet, questioning what they add to the corporate reporting process.’

In addition, the report draws attention to what it calls ‘a clear conflict of interest, with insufficient measures in place to manage this conflict internally’, in PwC’s decision to provide recruitment and remuneration advice to Thomas Cook during the period in which the firm was also the external auditor.

It stated: ‘Whilst we acknowledge that PwC eventually terminated their non-audit work for Thomas Cook, we are disappointed that this only came about as a reaction to a change in the law.

‘In our view, the audit industry is not proactive; it always waits for legislation rather than demonstrating the professional grit and integrity required in order to reduce such conflicts of interest.

‘We are frustrated that the industry appears to have failed to acknowledge that it has been complicit in a string of corporate failures, including BHS and Carillion. Reform of the sector is urgently required, and we share Sir John Kingman’s disappointment that proposals were not included in the Queen’s Speech.’

BEIS inquiry annex and recommendations

Rachel Reeves letter to Andrea Leadsom

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Comments

Excellent article. Surely goodwill should have treated differently over the years.

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