24 Oct 2014 09:32am

Tesco: an opportunity for audit

The UK’s corporate governance code, with its “comply or explain” approach, is widely heralded around the world as an example of light-touch regulation that works. Businesses operating in other countries look with envy at the lack of hard and fast regulation. Regulators in several emerging economies have attempted to mimic the approach as they build their own structures. The Code appears to work pretty well, most of the time. But what happens when it fails? No regulation can ever be expected to work all the time. As departing Tesco chairman Sir Richard Broadbent might point out, “light-touch regulation always works, until it fails”.

And Tesco, of course, is the most prominent recent example of the code failing. Its £250m over-statement of profits (this week revised upwards to £263m) occurred despite it meeting the requirements of the code.

Some observers have commented that there were no experienced retailers among its non-executive directors, but that isn’t something requested by the Code. In fairness, striking the perfect balance between independence, diversity and experience on boards is never easy, but Tesco appears to have got it spectacularly wrong. The major revamp of its board that has followed the arrival of a new CEO shows the old structure was wrong.

For the wider audit community the depressing fact is that perception is as damaging to trust and reputation as reality.

So far, so bad for light-touch self-regulation. There have already been calls for reform of the code, although it is far from clear what the new version should look like. No-one seems to be of the view that recently introduced rules on going concern will make much difference in this respect.

Tesco has been an outstanding British business success story, and yet its spectacular fall from grace has been met with few tears shed. It may have been a British success, but few took it to their hearts. Its fall hasn’t been mourned the way the long-term decline of M&S has been. It was always seen as something of a bully brand, and it now seems the bullish attitude it took to farmers was also evident inside the corporate culture.

Of course there are bigger questions to be asked of a market system that prizes continual growth above all else. Cynics will point out that a dip in performance from a UK grocer is not likely to get answers to questions that 2008’s spectacular global banking crash failed to solve. But there are also specific questions from Tesco’s collapse.

As an accounting failure, questions are being asked of the auditors. There have been criticisms of the 30-year relationship between Tesco and PwC. Added conspiratorial spice comes from the fact that two senior non-executives, including Ken Hanna the departing audit committee chairman, are ex-PwC.

There may not be much of a case for the auditor to answer. The misstatement related not to audited accounts, but an unaudited set of half-yearly forecasts. Some early indications point to questions on the numbers dating back further. Now that it has been revealed the financial trickery dates back years rather than months, things will get more difficult for PwC.

PwC’s case is bolstered by the fact that it warned in the last annual report that this issue of “commercial income” (monies received from suppliers in return for promoting products) was judgmental and presented a risk of manipulation.

The audit committee countered this with a statement that internal controls were strong enough to negate such risk. At the time of that response it may have been true. But any such controls clearly went awry when half the management and senior finance team went missing in action.

For the wider audit community the depressing fact is that perception is as damaging to trust and reputation as reality. People read the familiar charge sheet and fail to hear the defence.

This case has already raised more questions over how long a firm should act as auditor for one client. Those in favour of more frequent change claim that a new broom sweeps cleanest. The counter is that you need to know where to find the dirt, something you get with experience.

As grim as it may look for the audit profession, this is an opportunity. It should be the catalyst for discussions on the relationship between auditors, management and the audit committee.

This glimpse of the debate between Hanna, his committee and PwC begs the question, why aren’t we able to see more of these discussions, more often?

Transparency for investors as to what auditors have done and crucially what they have found, would mark a profound shift in the relationship between auditors and clients (both management and audit committees). There are risk and liability issues for the profession, but it could act as a harder brake on management. More open and expansive reporting might keep more people honest. To quote Broadbent, “things go unnoticed, until someone notices”. The question is, who can we rely on to do that noticing?

Richard Cree Richard Cree is editor-in-chief of economia


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