The BEIS Committee accuses the government of dragging its feet over audit reform and dismisses the profession as “automatons” incapable of drawing the most basic conclusions from a balance sheet and lacking “professional grit and integrity”.
The committee is angry that its investigation into the travel chain’s failure, with the loss of thousands of jobs, and the huge cost to the taxpayer of repatriating holiday makers left stranded overseas, has been interrupted by tomorrow’s dissolution of parliament.
It is also concerned about the disruption the General Election will cause to the progress of legislation implementing reforms to the audit market.
In a letter to business secretary Andrea Leadsom, BEIS Committee chair Rachel Reeves says that the inquiry raised a number of issues, many of which the committee has commented on before “especially in relation to corporate governance and audit reform”.
“It is frustrating therefore that the government has not acted on previous recommendations from this committee; appears not to have learned the lessons from previous high profile corporate failures; and has not brought forward the expected legislation required to transform the Financial reporting council into a more powerful regulator.”
She points out that, because of the political events going on, the committee is unable to deliver a full report on “the extent and depth of failures in corporate governance, in audit and in government support”. Nevertheless, the committee has issued its conclusions and recommendations and expects the new government to respond to its successor committee as a matter of priority in the first Queen’s Speech of the new parliament.
She blames the company’s collapse on a series of misjudgements, including the “piling up of debt, confused business plans, lack of challenge in the board room and by auditors, and aggressive accounting practices”.
Much of her ire is focused on the board and senior management, whom she accused of “buck-passing and blame-shifting” but of showing “precious little humility or reflection”, particularly over the “hefty sums” they pocketed in annual salaries and bonuses that “Thomas Cook staff will only have dreamed of earning throughout their entire careers”.
“There was 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. Huge financing costs hamstrung attempts to invest in the business. The final collapse of the business resulted in misery and uncertainty for staff and customers, and brought a significant hit to the taxpayer.”
Reeves says that the failure was compounded by “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”.
She also accuses them of dragging their feet over reform of audit, executive pay and corporate governance, measures for which “have been sitting in the government’s in-tray for months”.
As far as Thomas Cook’s aggressive accounting practices are concerned, the committee focuses on goodwill which it believes also played a significant role in the earlier collapse of Carillion.
Carillion auditors KPMG, it says, did not challenge the fact that the £1.6bn of goodwill was not impaired or treated like tangible assets. “We concluded that the inability to question this was fundamental to the misleading picture of corporate health represented in Carillion’s audited annual accounts. It represented a failure by KPMG in failing to exercise – and voice – professional scepticism towards Carillion’s aggressive accounting judgments.
“We were very disappointed to find yet another corporate collapse in which goodwill has played a major part. We heard for example, that goodwill on Thomas Cook’s balance sheet had not been written down since 2012 because its auditors, PwC and EY, had considered that its cash flows and business plans continued to justify its unchanged status.”
This is deeply worrying, the Committee says, because if this approach is backed up by accounting standards, as the firms say it was, and goodwill is being treated in a similar way across the FTSE 350, it is likely that other 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 governance process,” it adds.
Another target for criticism is the purported lack of auditor independence created by firms (predominantly the Big Four) which offer non-audit services to their audit clients. The committee highlights the fact that PwC, which audited Thomas Cook between 2008 and 2016, also earned £4m providing recruitment and remuneration advice to the business between 2007 and 2012.
It acknowledges that PwC eventually put a stop to its non-audit work for the business, although it only did so because of 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,” it comments.
“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.”
The committee concludes that reform of the sector is urgently required. The collapse of Thomas Cook, it says, is “yet another warning of the risks of letting the FRC drift on, half reformed and lacking teeth that only legislation can give it”.
The committee has also posted on its website a letter from Deloitte which outlines the services it provided to Thomas Cook’s remuneration committee between 2012 and 2017. Over the six years, the Big Four firm earned £736,750.