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PwC and EY questioned over Thomas Cook going concern status

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MPs have severely criticised senior audit professionals from PwC and EY over their level of challenge to management’s going concern statements as part of an investigation into the collapse of Thomas Cook, as well as highlighting strong objections to the provision of non-audit services to audit clients, says Accountancy Daily.

Both firms faced questions from the Business, Energy and Industrial Strategy (BEIS) Select Committee about their auditing of the travel firm, with one MP suggesting the presentation of the company’s financial position ‘defied common sense’ given the risks its business faced.

Hemione Hudson, PwC’s head of audit, told the committee that PwC had highlighted in considerable detail its challenges to the board in every one of the years the audit firm audited Thomas Cook, from 2007 to 2016. In particular, the accounts and annual report signing were delayed in 2011 because the firm required additional evidence about its financial position.

However, Hudson and audit partner Paul Cragg faced a grilling over the presentation of a number of separately disclosed items, which led to a £35m adjustment. There was also a barrage of questions to EY audit partner Richard Wilson, who took over the Thomas Cook audit in 2018, about the timing of the writing down of £1.1bn of goodwill.

Wilson explained that the going concern considerations involved assessing whether or not Thomas Cook still had the support of its lenders. While there was clear evidence of this in December 2017 and in 2018 when a new bond was agreed and new credit facilities, by March 2019 the tests of the bank covenant were ‘very tight’.

The decision to agree the going concern statement in the half year review in March 2019 hinged on EY seeing the banks’ commitment in writing to an additional £300m funding. However, Wilson told MPs that subsequently the banks added conditions to this loan which included Thomas Cook receiving a binding commitment for the sale of its airline by 30 September.

There followed an exchange with Antoinette Sandbach who said the company had ‘nothing to sell to reduce its debt levels without going into insolvency.  How can that be a company that is a going concern?’

Another committee member said: ‘This kind of accounting defies common sense. If you strip out the airline Thomas Cook has no business and no income, so how can it be a going concern?’

MPs also pressed Wilson about the content of two management letters, written by EY in 2017 and 2018, which stated there was ‘too much scope for interpretation and potential manipulation on exceptional items’.

One committee member stated: ‘The key question is why where the accounts not qualified as a consequence of something as signification as potential manipulation?’

Sandbach also queried whether the two firms had taken on board comments by the Financial Reporting Council in its reports on audit quality about insufficient challenges in relation to the impairment of goodwill and other intangibles, saying that a £1.1bn write down over a 12 month was difficult to understand. 

Non audit services

BEIS select committee chair Rachel Reeve MP pressed Hudson over the level of non-audit work carried out by PwC during the period in which the firm was Thomas Cook’s external auditor. Hudson said that from 2007 to 2016 this totalled £21m. She pointed out that in the earlier years, the rules regarded the provision of non-audit services were different from those currently in force.

Hudson said: ‘There have been changes to the rules, following societal expectations. In the past we did rely on processes – strong process – to counter threats to independence. It’s a question of transparency. In the firm we relied on processes and controls that were not obvious to the outside world, and it is now better to have the environment we have.

The rules mean we have got better at giving confidence to people that this is the case; I don’t think our non-audit did impair our independence, but the perception undermines this.’

Remuneration advice

Some of the non-audit service fees included £4m for reward and remuneration advice, with Reeves challenging Hudson over whether this meant there was a conflict of interest because bonus calculations for senior management were based on information provided by the PwC audit team. Since there were questions about the accounting for exceptional items, which when stripped out flattered underlying profit, this could have resulted in a benefit to Thomas Cook’s executives.

Reeves also said that as PwC partners shared in the profits of the firm as a whole, there was an incentive for the audit team not to challenge the basis on which other teams in the firm were advising clients.

Reeves said: ‘Do you not understand why some people think that it’s impossible to separate  out and get rid of conflicts of interests when the remuneration of the people doing audit work depends on the success of people in other parts of the firm advising on same business they are auditing?’

Hudson said: ‘I do understand concerns about how people are sharing in the same profit pool.  But we need access to a breadth of skills – there will be 15% to 20% of people outside core audit practice skills we need access to.’

Reeves said that this potential conflict of interest was a strong reason to separate out the two parts of the firm’s business, since it was not possible on the one hand to say PwC relied on the skills of other parts of the business and then say they were totally separate.

Hudson said the firm would not have such a ‘dual role’ with a client today, even if it were permitted, stating: ‘We understand people’s concerns and have moved further than the rules and have done so this year by stopping non audit work to FTSE 350 clients’.

However, Reeve said: ‘PwC’s behaviour has only changed because the rules changed, that was the only thing to actually change your behaviour. Only public pressure and changes in the law did that, which is why it is so imperative that we have got to actually change the laws on the consultancy side and the audit side.’

Concluding the hearing, Reeve said: ‘How many more company failures – cases of egregious accounting – until your [audit] industry opens its eyes? We need a tougher regulator as your industry is not prepared to make the changes.’