Yu Group Crashes, Patisserie Holdings LTIPs and Audit Quality

The latest example of defective accounts in small cap companies is Yu Group (YU.) who announced this morning that accrued income had not been recognised correctly, that trade debtors need impairing and gross margins will not be as expected. The result will be a £10 million reduction in profitability when compared with current market expectations so there will be a loss for the current financial year. The shares are down over 80% at the time of writing.

Yu Group are a utility supplier to SMEs and listed on AIM in 2016. It would seem likely that these problems go back into past years. The auditors are KPMG.

The latest announcement from Patisserie Holdings (CAKE), after a note published in the FT yesterday on directors’ share options and their exercising is a clarification of the LTIPs. It ends by saying that “The Company, as part of the on-going investigation, is seeking to understand why the grant of options relating to 2015 and 2016 have not been appropriately disclosed and accounted for in its financial statements”. So that looks like another bit of bad news as one might expect now that everyone is looking very carefully at the past reporting by this company. But this is surely another matter that should have been picked up in the last audit.

It’s not just small companies that have audit problems. BHS and Carillion are recent examples of large companies where the reported accounts were suspect. How to improve the quality of audits? One big issue in my view is the fact that audits are often priced as low as possible to get the business. Companies tender for audit services and they are likely to pick the lowest cost bid, thereby relying on regulations to ensure that the standard is acceptable. Most company directors believe their internal systems are good and their staff trustworthy, so why should they spend a lot of money on an independent review of same? Meanwhile audit firms use audits as a loss-leader to build a client relationship that enables them to obtain much more lucrative consultancy work.

One change that would improve matters would be to ban audit firms from taking on non-audit work from the same client.

Another improvement would be to have someone else than the directors appoint the auditors. It has been suggested that an independent body be set up to do that, but perhaps the best solution is to have shareholders select and appoint the auditors via a shareholder committee. Shareholders have the most interest in seeing accurate accounts published and shareholder committees have many other advantages, as has been advocated by ShareSoc of late.

Regulation only ensures adherence to high standards if the penalties for getting anything wrong are severe. But that is not the case at present. Very few cases of defective accounts ever result in the auditors being severely penalised because they have numerous possible excuses for not discovering what was wrong. The Financial Reporting Council (FRC) needs to get tougher and be less dominated by the audit profession.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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