Brydon Audit Review and FRC Update

Readers probably don’t need to be reminded of the poor reputation of auditors and accountants. The announcement yesterday from Staffline Group (STAF) reiterates the point. They note the latest analysis indicates that 2018 profits were overstated by about £4 million. The CFO, Mike Watts, has left with immediate effect.

Sir Donald Brydon has published his review of the audit market and makes recommendations for significant changes. This is what he says in a preface:

“The quality and effectiveness of audit has become an increasingly contested issue, with the result that this Review has been commissioned. Some consider that audit is good enough but the starting place of this Report is that it is not.

At a time when information is everywhere and there is no obligation on users of the internet to be truthful, it matters even more that shareholders, and others, can trust what directors are communicating. Auditors have a unique advantage in having the right to see everything that goes on in a company and to assess whether that trust is deserved”.

The recommendations encompass:

  • A redefinition of audit and its purpose;
  • The creation of a corporate auditing profession governed by principles;
  • The introduction of suspicion into the qualities of auditing;
  • The extension of the concept of auditing to areas beyond financial statements;
  • Mechanisms to encourage greater engagement of shareholders with audit and auditors;
  • A change to the language of the opinion given by auditors;
  • The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement;
  • Suggestions to inform the work of BEIS on internal controls and improve clarity on capital maintenance;
  • Greater clarity around the role of the audit committee;
  • A package of measures around fraud detection and prevention;
  • Improved auditor communication and transparency;
  • Obligations to acknowledge external signals of concern;
  • Extension of audit to new areas including Alternative Performance Measures; and
  • The increased use of technology.

Comment:

Many of the proposals may improve the information available to investors and help prevent fraud or false accounts. But they will add a substantial burden on auditors, and hence costs on companies. I can see some opposition from the latter when the details are consulted upon.

Some of the proposals will increase engagement with shareholders and the role of the Annual General Meeting so are to be welcomed.

The proposals are likely to be taken forward by the new ARGA body which will replace the Financial Reporting Council (FRC) and which was included in the Queen’s Speech today.

You can read the Brydon Report here: https://tinyurl.com/t7va5fl – 120 pages of Christmas reading to fill the days when there is no news and little to do.

The FRC have also published a revised version of their “Ethical Standard” so as to strengthen auditor independence and ban conflicts of interest. See  https://tinyurl.com/soc8hq3 – that’s another 102 pages for Christmas reading although this may be more of interest to auditors than investors.

To conclude, Donald Brydon included this poem in his report just to amuse you, and to show that the concerns about audits are not new (it dates from the 1930s):

The Accountant’s Report

We have audited the balance sheet and here is our report:

The cash is overstated, the cashier being short;

The customers’ receivables are very much past due,

If there are any good ones there are very, very few;

The inventories are out of date and practically junk,

And the method of their pricing is very largely bunk;

According to our figures the enterprise is wrecked….

But subject to these comments, the balance sheet’s correct.

 

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

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Staffline Issues, Audit Purpose and News on Patisserie

Yesterday Staffline Group (STAF) issued a statement first thing in the morning saying that the publication of results scheduled for that day would be delayed. The shares promptly dropped by about a third. Later in the day it stated that “the company can confirm that this morning concerns were brought to the attention of the board relating to invoicing and payroll practices within the Recruitment Division”. A full investigation was promised and the shares were then suspended. Is this yet another accounting scandal in an AIM company one wonders? Generally after such announcements, only bad news comes out.

Staffline is a recruitment/staffing and training business. It’s one of the largest AIM companies with revenue of nearly a billion pounds and reported profits of £71 million last year. It has been growing rapidly in recent years.

I have never held the stock although I did see a presentation by the company a couple of years ago. In general I don’t like employment businesses as they tend to follow economic cycles and the sector has few barriers to entry. I also considered the company to be at risk from regulatory and tax problems. The company also has considerable debt which is odd for this kind of business which generally have a “capital light” structure. Investors might have been concerned by the announcement on the 8th January that net debt had risen to £63 million at the 2018 year-end.

Investors will have to keep their fingers crossed for further news.

I covered in some previous blog posts the issue that audit quality is generally poor and that false accounts and outright fraud are regularly missed by audits – and it’s not just one or two firms – the whole audit industry seems to be incompetent in that regard. The Commons BEIS Committee held a meeting yesterday and one of the witnesses was David Dunckley, head of Grant Thornton, who audited the accounts of Patisserie (CAKE). He admitted that auditors did not look for fraud when auditing accounts and that there was an “expectation gap”. Committee members were not impressed.

Meanwhile Investor’s Champion revealed that Luke Johnson and Paul May, directors of Patisserie, owned a property that was leased back to a subsidiary of the company. As a related party transaction this should have been disclosed in the Patisserie accounts but was not.

The FT also disclosed that at least 30 shareholders had signed up to support a legal case with law firm Teacher Stern. But other investors are talking to other solicitors. In such cases it can be many months before the basis of a claim is clear and solicitors tend to jostle for the business of pursuing a claim in the meantime – one might call some of them “ambulance chasers”. Investors are advised not to spend money on such actions until the basis of a claim, and the ability to both finance an action and identify asset rich defendants is clear.

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

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