Audit and Assurance Lecture - Overview and BHS Collapse Analysis

BUS165 - Assurance BSc (Hons) in Week 1 Richard Accounting (w/c 27 Poole & Jan) Finance/FC CA The role of an Auditor  What is an audit...

BUS165 - Assurance BSc (Hons) in Week 1 Richard Accounting (w/c 27 Poole & Jan) Finance/FC CA The role of an Auditor  What is an audit An audit is a systematic and independent examination of books, accounts, statutory records, documents and vouchers of an organization to ascertain how far the financial statements as well as non- financial disclosures present a true and fair view of the concern.  Who has to have a statutory audit of their financial statements? Companies Act 2006 - all UK Turnover does not companies have to exceed £10.2m have a Balance Sheet total statutory does not exceed audit unless £5.2m they meet Number of employees the 2 out of does not exceed 50 the following 3 thresholds:  Form an independent opinion on the truth and fairness of the financial statements Statutory Confirm they have Auditor been properly prepared in Responsibiliti accordance with the Companies Act 2006 es Confirm the Directors report is consistent with the financial statements  Why is the Audit report Important? Investors, employees, the government, suppliers, customer & the general public need to be able to use the financial statements. We need to be able to rely on the information contained within the financial statements BHS Collapse in 2016  BHS Pension Scheme BHS – What Had a pension deficit of £571m following the stock went market crash in 2008 as half of the pension scheme wrong assets were invested in shares This deficit has to be cleared by larger contributions into the scheme, usually spread over 10 – 15 years  In December 2001 it sold 12 stores to Carmen Properties Limited for £105.9m. It then BHS – rented them back from the Jersey-based company for What about £12m a year (also went owned by Sir Phillip Green). wrong These rents were above market rates so hard to afford  Dividends Over a 4 year period £414m was paid in BHS – dividends (almost all going What to Sir Phillip Green and his family) went wrong That was £118m more than its pre-tax profits. The payment wiped out £147.7m of reserves held in BHS.  Current owner BHS was sold to Retail Acquisitions a year before BHS – it went into What administration. went It’s new owner, Dominic wrong Chappell, had twice between declared bankrupt, was an ex racing driver with no retail experience.  Competitive advantage Retail experts tend to agree BHS had fallen behind its BHS – competitors. The number of clothing shoppers coming What through its doors, and its share of clothing sales, on the High went Street were falling. wrong "Even to its core audience, BHS had become something of an irrelevance," Neil Saunders, chief executive of retail analysts Conlumino  PwC/senior audit partner Steve Denison signed off a clean audit report days before the collapse BHS – Why saying the business would didn’t continue as a going concern. auditors foresee the liquidation Net assets of over £3m coming? Loss of £69m would shrink in the following year to £30m as a result of a 6.7% growth in sales.  The audit had 114 hours of chargeable time, of this just 9 hours were done by a senior manager and 2 hours by the audit partner, The everyone else had less than 4 years Financial of experience. Reporting Council’s report on The audit fee was £355,000 = the audit of £2,300 per hour BHS The same audit partner charged £2.9m in the year for non audit services  Sales were not audited The Financial Reporting Large parts of cost of sales were not Council’s audited report on the audit of BHS Going concern was not audited The auditor who did most of the work didn’t even know about the sale of the company from Sir Philip Green to Dominic Chapell  It couldn’t pay wages or creditors Why did BHS go It couldn’t secure emergency funding bust? Despite more than 30 expressions of interest, it couldn’t secure a buyer for the business  PwC fined £6.5m (less than 1% of its profit) Steve Denison was fined £355,000 and Consequenc banned from es auditing for 15 years Loss of 11,000 jobs £571m pension deficit for workers  1) Audit framework and regulation Key 2) Planning and risk assessment. Syllabus 3) Internal control. areas 4) Audit evidence. 5) Review and reporting. Carillion- 2nd largest constructi on company in the UK  Employ 43,000 staff globally with around half of these in the UK Again the auditors, this time KPMG, gave the company a clean audit opinion just 3 Carillion months before the company failed. It’s financial statements and annual report were positive  Revenue = £5.2bn, up 14% year on year Carillion Operating profit before tax = £172m Financial Operating profit margin Stateme 4.95%, slightly below the nts target of 5.3% Net borrowings £218m Order book of £4.8bn  Chairman, Phillip Green says “The Group continues to have substantial liquidity with some Carillion £1.5 billion of available financial funding” statement Chief Executive, Richard Howson says “Net borrowing s remains well within the £1.5 Liquidity billion of funding available to the Group” Financial Director, Zafar Khan says “The Group has a strong funding position to support its objectives, with £1.4 billion of funding available at the year end  Carillion The Financial Director, Zafar Financial Khan said “The Directors confirm that the Company and Statements – the Group have adequate resources to continue in Going operational existence for the foreseeable future and that concern there are no material uncertainties in relation to going concern of which they are aware. For this reason, they continue to adopt the going concern basis in preparing the financial statements”  Carillion Financial The chairman, Richard Howson states “By winning high-quality Statements – contracts in our chosen sectors we continue to change our business mix and improve the Contract risk risk profile of our contract portfolio.”  Carillion Financial Statement s – Risk The annual reports states “During the year, the Group has maintained its Managem comprehensive approach to contract management and there has been no ent change in the nature of contracts being delivered by the Group”  It racked up £1.5bn of debts, the banks and government were So what unwilling to bail them went out wrong? In a short period it wrote down the value of it’s contracts by over £1bn and had a £600m pension deficit  The £350m Midland Metropolitan Hospital in Sandwell - delays due to So what the heating, lighting and ventilation systems went The £335m Royal Liverpool wrong? Hospital - Delays amid reports of cracks in the building The £745m Aberdeen bypass – Delays and fines due to polluting two of Scotland's most important salmon rivers  The unfinished £5.5 billion So what development in the centre of went Doha, readying the Qatari wrong? capital for the 2022 football World Cup - £200m dispute for unpaid work  Independent – Directors put Why did pay 1st the directors conceal Eg The Chairman, Richard these Howson, was earning £1.5m a issues? year including bonuses Former chief executive Richard Howson said he was going to Qatar at least 10 times a year to chase up the money  KPMG received £29m in audit fees How could from Carillion. the auditors have MP Peter Kyle said “these audits missed appear to be a colossal waste of these time and money, fit only to issues? provide false assurance to investors, workers and the public.” MP Peter Kyle said “I wouldn’t hire you to do an audit of the contents of my fridge.”  - The auditors were too How could willing to accept what the auditors they were being told have by management missed these issues? - They hadn’t challenged management’s overly aggressive/overly optimistic treatment of long term contacts What has happen ed to the audit team? Peter Meehan, the KPMG Carillion Audit Partner was fined £250,000 and banned from auditing for 10 years  In Sep 21 the U.K. Financial Reporting Council (FRC) on Wednesday issued a disciplinary formal complaint against KPMG for allegedly What has providing “false and happene misleading” information during inspections into the d to firm’s audit of Carillion KPMG? The outcome was concluded in July 22, KPMG were fined £14m  1) Audit framework and regulation 2) Planning and risk Key assessment. Syllabus 3) Internal control. areas 4) Audit evidence. 5) Review and reporting.  An assurance engagement is one in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about What is an the outcome of the evaluation or measurement of a subject assurance matter against criteria assignment? Key elements include: 3rd party involvement Subject matter Suitable criteria Sufficient appropriate evidence Written assurance report  Eg Buying a house What is Practitioner = Surveyor an Intended user = Buyer Responsible party = Seller Assurance Subject matter = House Assignme Suitable criteria = Buildings nt? regulations/Best practice Sufficient evidence = Physical inspection Written assurance report = Surveyors report  Limited Assurance eg Assurance assignment to review a forecast  Moderate/Low levels of assurance  Conclusion is expressed negatively “Nothing has come to our attention Levels of which causes us to believe these assumptions do not Assuranc provide a reasonable basis for…..” e Reasonable Assurance – eg Audit of the Financial statements  High but not absolute assurance  Opinion expressed positively “In our opinion the financial statements give a true and fair view Reasonab  More regulations and standards le  Procedures would be more thorough assuranc  Evidence will need to be of a higher quality ev Limited Examples of assurance engagements Assuranc 1) Audit of financial statements e 2) Review of a forecast/business plan 3) Review of internal controls 4) Fraud investigation 5) Due diligence 6) Environmental audit  A common type of assurance engagement is the audit of a company’s financial statements. External Audit In the UK, audits are governed by: 1) Companies Act 2006 2) International Standards on Auditing (ISAs).  ISA 200 Overall objectives of an independent auditor  Obtain reasonable assurance as to whether the financial statements as a whole are free from material misstatement  Express an opinion as to whether the financial statements are prepared in accordance with the financial reporting framework External  To report on the auditors findings Audit Why do we have an audit?  Shareholders are often not involved in the day to day running of the business, management therefore need to give an account of their stewardship  Directors prepare the accounts and have an incentive to manipulate the financial statements  Auditors provide an external verification  In order to comply with these requirements, the auditor must: 1) Comply with relevant ethical requirements External 2) Plan and perform the audit with professional scepticism Audit 3) Exercise professional judgement 4) Obtain audit evidence that is sufficient and appropriate on which to base their opinion  Professional scepticism An attitude that includes a questioning mind, being alert to conditions, which may indicate possible misstatement due to error or fraud, and a critical assessment of External audit evidence Audit Professional judgement The application of relevant training, knowledge and experience in making informed decisions about the courses of actions that are appropriate in the circumstances of the audit.  Benefits of an audit  Higher quality information giving investors confidence  Independent scrutiny may help management  Reduce the risk of management bias, fraud and error  Enhances the credibility of the financial statements for other stakeholders  Deficiencies in the internal control system may External be highlighted Audit Limitations of an audit  Financial statements include subjective estimates and judgement  Internal controls may be relied upon by the auditors  Representations from management are not always reliable  Evidence is not always conclusive  Do not test all transactions, only samples