Tesco Faces Fresh Accounting Investigation
U.K.’s Financial Reporting Council Launches Probe
Tesco disclosed earlier this year that it had overstated its first-half profit forecast. REUTERS
IAN WALKER And COSTAS PARIS
Updated Dec. 22, 2014 8:34 a.m. ET
LONDON—The U.K.’s Financial Reporting Council on Monday said it has launched an investigation into Tesco PLC’s accounts for fiscal 2012, 2013 and 2014, following the recent accounting scandal at the supermarket chain.The FRC said it was investigating the parties involved in the preparation, approval and audit of Tesco’s financial statements for the years in question, as well as their conduct in relation to accounting practices that led to a £263 million ($410.75 million) overstatement of the company’s first-half profit forecast.
The FRC, which regulates corporate governance and reporting in the U.K., had previously said it was monitoring the situation.
The FRC’s Financial Reporting Review Panel can require a company to restate its financial statements. The FRC also has the power to discipline accountants for misconduct.
Tesco first flagged issues with its accounts in September, suspending four senior executives and calling in outside auditors and legal counsel to investigate the overstatement of its forecast first-half profit. The issue resulted in the company issuing its third profit warning in as many months.
The company, which vies with Carrefour SA for the title of world’s second-largest retailer behind Wal-Mart Stores Inc., has since suspended more executives and issued yetanother profit warning earlier this month. Although Tesco remains the U.K.’s largest retailer by sales, its market share has been declining for years amid intense competition from aggressive discounters and high-end grocers.
PricewaterhouseCoopers, Tesco’s longtime accounting firm and conducting the external audit, said it would work with the FRC. A person with knowledge of the matter said the FRC would be looking into both Tesco’s accounting practices over the three years and the PwC audit. The person said that the FRC investigation was to be expected as it has been tracking the Tesco issue since September and “there is a clear public interest into this matter.”
“We take our responsibilities very seriously and remain committed to delivering work to the highest professional standards. We will cooperate fully with the FRC in its enquiries,” PwC said in a statement.
In October, the retailer said the accounting practices that led to the error had also occurred in prior periods.
The accounting practices in question involved the early booking of commercial income—or promotional money, discounts and rebates from suppliers—and delayed booking of costs, according to the company. Tesco, which has done a preliminary investigation into its U.K. food business, said it hasn’t ruled out illegal activity but would wait until the results of the investigation are known.
The U.K. Serious Fraud Office has also opened a criminal investigation into Tesco’s accounting practices.
Another person involved in the matter said the SFO was also looking to interview some of Tesco’s main suppliers.
“Since the Tesco issue involves promotions by its suppliers, the SFO wants to see whether the Tesco account on promotions is in line with what the suppliers understood or agreed,” the person added, without elaborating.
Diageo PLC, the world’s largest alcoholic drinks company, and Unilever PLC, the world’s second-largest maker of consumer goods after Procter & Gamble Co. , weren’t immediately available for comment.
An SFO spokeswoman said the investigation into Tesco’s accounts is continuing, without elaborating.
Tesco shares were down 1.5% to 184 pence in early afternoon London trading. The shares have rebounded from a 15-year intraday low of 155 pence reached Dec. 9, the day of the company’s most recent profit warning.
Dec 22, 2014
PWC Gets Unseasonal Greetings for Tesco and Barclays Roles
Pricewaterhouse Coopers just got the gift no one wants for Christmas: It’s been slapped with not one but two probes by the Financial Reporting Council, its regulator, over work for two longtime audit clients, Tesco TSCO.LN -2.37% PLC and Barclays PLC.BARC.LN +1.11%
In probes announced Monday, the regulator said it would investigate three years’ worth of Tesco’s accounts after the retailer issued a string of profit warnings this year and the Serious Fraud Office opened a criminal investigation into its accounting.
That’s just for starters. The FRC, which sets standards and oversees the U.K.’s accountants, is also probing PWC over its role in reporting to the Financial Conduct Authority on how Barclays complied with rules on segregating client assetsbetween 2007 and 2011. Barclays eventually ended up in hot water over the issue: The FCA’s fined it £37.7 million ($58.8 million) in September for failing to safeguard client assets in its investment bank when it contracted with external custodians.
The FCA’s notice to Barclays that month found the bank, among other failings, hadn’t adequately squared reconciliations on around £16.5 billion in client assets held with sub-custodians between November 2007 and January 2012. That meant the bank failed to submit an accurate valuation of those assets to the FCA for 2010. Monthly reports to the FCA, required from October 2011, provided inaccurate asset valuations and pricing errors. PWC, or former incarnations of the firm, has been Barclays’s auditor since 1896. Barclays declined to comment.
The accounting firm’s set to lose the Barclays account within the next couple of years, after the bank said it would put the audit out to tender for 2016 and won’t invite PWC to submit a bid amid moves by EU regulators to shake up accounting relationships.
PwC in a statement covering both the Tesco and Barclays probes said: “We take our responsibilities very seriously and remain committed to delivering work to the highest professional standards. We will cooperate fully with the FRC in its enquiries.”
December 22, 2014 12:20 pm
UK accountancy watchdog hits PwC with two separate probes
Harriet Agnew, City Correspondent
The UK accountancy watchdog announced two separate investigations into PwC on Monday, related to its audit clients Tesco and Barclays, adding to pressure on the big four accountancy firm, which was accused this month by MPs of “selling tax avoidance on an industrial scale”.
The Financial Reporting Council confirmed that it was investigating the preparation, approval and PwC’s audit of Tesco’s financial statements for the retailer’s past three financial years. Tesco was plunged into turmoil after it said in September it had overstated its first-half profits by £250m, a month later adding that the overstatement was in fact £263m.
The FRC investigation also centres on the run-up to Tesco’s interim results – which are not audited – for the 26 weeks ending August 23 2014. It comes almost two months after the UK’s Serious Fraud Office launched a criminal investigation into the retailer’s alleged accounting irregularities.
At the heart of the accounting issue for Tesco, which has been audited by PwC since 1983, is the way that it recognises commercial income. These are payments made for hitting a certain level of sales, or to support promotions. In Tesco’s 2014 annual report, PwC highlighted the recognition of commercial income as an area of focus “because of the judgment required in accounting for the commercial income deals and the risk of manipulation of these balances”.
The accounting errors at Tesco has resulted in the suspension of eight senior managers, known as the Cheshunt Eight after the location of Tesco’s head office north of London. Its board of non-executive directors has been shaken up and the retailer is looking for a new chairman, following the announcement that Sir Richard Broadbent will leave.
Tesco said: “We note the Financial Reporting Council is launching an investigation into individuals and a member firm in relation to the preparation, approval and audit of our accounts for the last three years. We will provide support to the FRC’s investigation.”
Also on Monday, the FRC launched a probe into PwC and another of its audit clients, Barclays. It is looking at PwC’s reporting to the Financial Services Authority on the bank’s compliance between 2007 and 2011 with the then UK regulator’s rules on client asset segregation. Barclays declined to comment.
The FRC said its decision to investigate PwC followed the final notice serviced on Barclays by the Financial Conduct Authority in September when the FSA’s successor fined the UK lender £37.7m – a record for this type of misconduct – for failing to keep appropriate records on about £16.5bn of clients’ money that its investment bank placed with third-party custodians between 2007 and 2012.
PwC said: “We take our responsibilities very seriously and remain committed to delivering work to the highest professional standards. We will co-operate fully with the FRC in its enquiries.”
The two investigations add to mounting pressure on PwC, whose tax division is under increasing political scrutiny. At a parliamentary hearing this month, MPs on the public accounts committee denounced PwC for devising financing structures that allowed companies to secure very low tax rates in Luxembourg. It was sparked by the leak of hundreds of Luxembourg tax rulings, which lift the lid on controversial tax practices in the corporate world.
Tesco crisis: watchdog opens fresh investigation into auditor’s role in historic accounts
Accounting watchdog launches new investigation into the role of Tesco auditor PwC which stretches back almost four years
By John Ficenec
10:37AM GMT 22 Dec 2014
The Financial Reporting Council (FRC) has announced a new inquiry into Tesco’s accounts for the years 2012, 2013 and 2014.
The FRC said it would be scrutinising the role of Tesco’s internal accounting team and auditor PwC “in relation to the preparation, approval and audit of the financial statements of Tesco.”
The watchdog monitors the conduct of UK accountants and actuaries.
Tesco has been rocked by an accounting scandal this year after the company wrote off £263m in profits following an investigation, having intially said it had mis-stated its half-year profit guidance by £250m.
Tesco revealed in September that it had discovered a black hole in its profits, throwing the company into the biggest crisis in its history. The hole was linked to Tesco’s commercial income, which is made up of payments and rebates from suppliers.
The Serious Fraud Office is expected to interview staff at some of the biggest companies in the UK such as Diageo and Unilever who worked on deals with Tesco and scrutinise the paperwork associated with its supplier agreements.
The move by the SFO, likely to occur early in the new year, highlights the scope and scale of its investigation into Britain’s biggest retailer.
PwC said in a statement: “We take our responsibilities very seriously and remain committed to delivering work to the highest professional standards. We will cooperate fully with the FRC in its enquiries.”
The FRC has the ability to hit those found guilty of wrongdoing with unlimited fines, sanctions or suspend the membership and withdraw the license which audit firms require to carry out their work.
Shareholders are furious at what they see as a failure of governance at Tesco, and Sir Richard Broadbent has stood down as chairman. He insisted that had not been “pushed” and that he was choosing to leave because it was the “right thing to” and demonstrated “accountability” .
Sir Richard, who defended his governance of the company, said: “On behalf of the board, to demonstrate to the world that principles exist, I choose to go. You can’t really say that nobody is carrying the can.”
Tesco’s Financial Nightmare Is Even Worse Than Anyone Thought
It’s been a rough year for British supermarket Tesco.
In September, the company had to restate its profits after realising that it overestimated them by more than £250 million over a series of years. Shortly after, Tesco chairman Richard Broadbent quit. And just last week, the firm had to issue another profit warning, while S&P suggested that the firm’s credit rating might be cut to junk levels.
But on Thursday, JPMorgan released a damaging note that shows things are even worse at the world’s second-largest retailer than originally thought.
Rental costs for Tesco have exploded in recent years and “will likely increase further”
JP Morgan is “unable to explain” the gap between Companies House earnings before tax and Tesco’s reported trading profit. This runs to over £150 million, no small change. JP Morgan asked Tesco why this might be, but they didn’t provide details.
Tesco’s results are being hit by lower supplier rebates (which Tesco is given for high sales or additional promotion of suppliers’ products.
There’s going to be pain for Tesco, with lower prices and store closures.
Tesco’s net rental costs have exploded from £158 million in 2006-7 to £989 million in 2013-14.That’s a 525% jump! The costs come off the back of more city-centre Tesco Express stores and surging operating leases for the rest of the business. These expenses are not included on the balance sheet, but they’re a growing headache for the company.
JP Morgan, Tesco AccountsTesco’s rental costs have exploded over the last 8 years.
But it gets worse: £174 million in earnings is still unaccounted for. That number stems from a estimated gap of £319 million between earnings published by Tesco UK Group and those published by individual parts of the group, like Tesco Property, Tesco Stores, and Tesco Distribution.
That gap ran to £69 million in 2008, but that’s the largest it has ever been — before now. It was £3 million last year.
A difference of £145 million is explained by the admitted profit overstatement that crashed Tesco’s share price in October. That overstatement ran to £263 million in total, but the rest happened in the current (2014-15) financial year.
Blinkbox is the only Tesco subsidiary yet to report its results, and it’s expected to post a loss and make the gap even wider.
Here’s the breakdown:
JP Morgan Cazenove
That’s really just the start of Tesco’s problems. JP Morgan doesn’t really see an upside for the company’s whopping size:
It is often argued that Tesco is a Buy because ‘it has to be a long term winner due to its scale advantage’. However, we believe that scale alone does not guarantee success; it is the effective use of it for the benefit of the customer that supports success. The world of retail is full of large companies that have failed. Execution and skills are the factors that lead to success much more than scale, in our view. But in any case, the benefit of scale has already been enjoyed by Tesco (it is in the numbers), it is not an incremental benefit. In fact, we can conclude that scale has become an incremental headwind for Tesco as the benefits of scale unwind. After years squeezing suppliers very effectively through volume rebates, as sales fall, these rebates unwind, becoming a headwind.
Those “volume rebates” are the payments Tesco and the UK’s other major retailers have been reaping from major suppliers for selling large numbers of their products, and promoting them in prominent position. That’s fine while you’re top dog. As cost-cutters like Aldi and Lidl grow and grow, suppliers are unlikely to be so deferential to Tesco.
In short, the UK’s biggest retailer’s rental costs are surging, it still may not be through the worst of its embarrassing profit restatements, and there’s no sunlight on the horizon. As Mike van Dulken at Accendo Markets put it in a pithy research note: “Every little hurts”.
December 9, 2014 9:02 am
Tesco: big shop of horrors
Jonathan GuthrieAuthor alerts
Profit warning imparts a frisson and tale of wickedness punished
Tesco has begun to resemble a retail chamber of horrors more than a supermarket chain. “Enter, my pretties!” intones chief executive Dave Lewis, fixing terrified shareholders with a glinting eye. “Let me unveil to you the vileness that lurks beneath the surface of the UK’s best-loved grocer!”
Within the dungeon at Cheshunt, investors may behold guillotined full-year profits guidance, a crew of gibbering accounting irregularities and a freak show of weird diversifications.
Given the popularity of Sweeney Todd as an exhibit at wax museums, you have to wonder what Tesco suppliers put in the meat pies. Pressure on food manufacturers to cut costs has backfired on the grocer, though. A rebalancing of a grossly unequal relationship is one reason Tesco says its full-year trading profit to February will not exceed £1.4bn. This compares with guidance of £2.4bn-£2.5bn in August, a City consensus of £1.8bn-£2.2bn, and a figure of £3.3bn for 2013-2014.
Mr Lewis cut the dividend by three-quarters to 1.16p at the interim stage. He has little choice but to cut or pass the final dividend, too. This stood at 10.13p last year — when dividends costing £1.2bn already looked unsustainable against free cash flow of £455m, according to S&P CIQ.
The would-be troubleshooter favours disposals over a rights issue to bolster the balance sheet. The difficulty is that the quicker you sell, the less you get. Corporate follies, such as the café chain Harris + Hoole, have little value anyway. Units that might lure decent bids include the Dunhumby analytics group and overseas store chains.
Chambers of horrors are supposed to impart both a frisson and object lessons in wickedness punished. A price war and higher staff costs are partly to blame for Tesco’s horrible profits warning. But the moral of the tale is that squeezing ever-larger promotional payments from suppliers was unfair and unsustainable. The realisation by the group that it had overestimated these amounts triggered a £250m cut in first-half profits guidance in September. An attempted shift to a more equitable relationship has prompted an even bigger cut in full-year forecasts. As you sow, so shall you reap.
Scene: a Wetherspoons pub. A regular staggers to the bar.
Drinker: A pint of your finest, foaming Heineken, Landlord!
Publican: No can do, Squire
D: Changing the barrel?
P. We’re boycotting Heineken. They won’t supply a new pub in Ireland because we planned to discount beer there like we do in the UK.
D: Bloomin’ Belgians! Coming over here with their segmented price strategies!
P: They’re Dutch. Chairman Tim Martin is offended because they asked the chief executive for a personal guarantee. As if he was running a single boozer, not a 926-pub chain.
D: Blinding bloke, Timbo.
P: You’ve both got mullets, I notice.
D: S’right. Business at the front, party at the back.
P: Less party for you punters and less business for Wetherspoons and Heineken with bar towels hanging over 926 beer pumps across the UK.
D: That’s not the Dunkirk spirit! Gimme a Stella. They don’t flex prices.
P: They do. And don’t you think you’ve had enough?
D: (shocked) A Wetherspoons barman never said that to me before.
P: Fair point. Gassy lager coming up.
D: Stella was “reassuringly expensive”. Heineken “refreshed the parts other beers cannot reach”.
P: Good job they no longer use that slogan. These days Heineken reaches fewer parts than anything else.
The marshmallow test gauges the ability of a child to trade off instant gratification — one marshmallow now — for a bigger sugary reward later. Regulators are conducting a similar behavioural experiment with bankers and their pay, by extending vesting and clawback periods. Rating agency Moody’s has backed the move, saying it benefits bondholders.
The theory in contention is whether a bonus that is deferred for seven years and exposed to clawback for a decade retains all its power to incentivise.
Regulators such as Mark Carney of the Bank of England and Bill Dudley of the New York Fed could be fuelling banker pay rises. After all, banking is founded on the principle that the longer capital is locked up, the higher the compensatory return.
One Wall Street investment banking boss expects to start paying staff partly in bonds that are wiped out by misconduct fines as early as next year. The move was proposed by Mr Dudley and endorsed by Mr Carney.
That plan seems unduly harsh. A middle course would be for the deferred bonuses of staff at troubled banks to convert into some kind of consolation prize. A bag of marshmallows, maybe?
December 8, 2014 12:46 pm
Watchdog warns retailers over supplier payments
Claer BarrettAuthor alerts
Retailers must provide much more clarity about the extent and nature of payments they receive from their suppliers in their audited accounts, the UK’s Financial Reporting Council has warned amid growing political scrutiny of the sector.
The accountancy watchdog said it expected to see “high-quality disclosure” of complex supplier arrangements in forthcoming annual and interim reports, warning that this would be a particular “area of focus” in 2015.
Companies needed to provide “more detail than at present” about supplier payments to help investors evaluate a company’s performance “where such amounts are, or could become, material,” the FRC said in a statement to the market on Monday.
The FRC is still considering whether to launch a formal investigation into Tesco’s £263m profit overstatement, which the retailer blamed on a miscalculation of the way it recognised income from suppliers. The overstatement is currently being probed by the Serious Fraud Office.
The regulator said that payments including listing fees, cash contributions, discounts and volume rebates had become “regular features of supplier contracts in a number of industries, including retail” but stressed that its warning was not aimed at Tesco or Premier Foods.
“This is a general cross-sector issue rather than being about the retail sector or a particular company,” said an FRC spokesman, adding that the announcement had been planned before the recent backlash from Premier’s suppliers. The watchdog has previously censured Rolls-Royce for how it booked fees from risk-sharing partnerships with its suppliers.
Richard Fleck, chairman of the FRC’s financial reporting review panel, said there was “no single standard within IFRS” to address accounting disclosures for supplier payments.
“Complex supplier arrangements such as fees and discounts may have a significant impact on the reported margins and other results of a company and on investors’ views of its performance,” he said.
“It is essential that investors are able to understand the basis and extent of judgment and estimation involved and the potential uncertainties affecting the accounts and future prospects. Today’s announcement is a reminder to boards of retail companies in particular of what they should consider and encourages them to review their reporting in this area as many have already announced.”
Although the FRC has not launched a full review, as it did with the auditing of banks’ accounts which concluded last week, it could still start investigations into company accountants or auditors that it believed were breaking the rules, or not acting in the “ethical spirit” of their professions. If it did and a tribunal found in its favour, the watchdog has the power to impose fines, costs and exclude professionals from practising for a period of years, an FRC spokesman said.