Risk & Economy » Audit » Tesco’s fall from grace compounded by accounting blunder

Tesco's fall from grace compounded by accounting blunder

Tesco's accounting debacle has set the supermarket back a long way, but does it have the wherewithal to bounce back? asks Chris Warmoll

TESCO has come a long way since its modest birth in 1919 on a wind-swept Homerton market stall deep in the heart of London’s East End.

So too has its share price. But of late not in a way that has mirrored the upward trajectory of founder Jack Cohen’s old – and rapidly gentrifying – Hackney neighbourhood.

At the time of writing, it was trading at 173.4p – down from 372.2p 12 months ago. And that’s just seven times its 1947 float price when it made its debut on the London Stock Exchange.

In fact, so spectacular has its fall from supermarket pin-up been since news of its £250m overstatement half yearly accounts broke on 22 September, that the world’s second-largest grocer is now its third largest.

Since Tesco revealed that its commercial department had booked huge payments from suppliers into the wrong accounting period, it has seen £20bn wiped off its value, its credit rating has taken an epic battering and has received the kind of media mauling reserved for deeply unpopular cultural bogeymen. Even revered investor and billionaire, Warren Buffett, has publicly declared that his investment in Tesco was a “huge mistake”. This week he followed through and sold 75 million of his 322 million shares, taking his holding down by 0.98% to 3%.

A quick recap of the ever unfolding drama reveals just what a curveball Britain’s biggest grocer delivered to the market.

Tesco announced that Deloitte and its legal advisers Freshfields had launched a joint probe into its £250m profit overstatement and immediate suspension of four senior executives, including UK finance director Carl Rogberg, and its managing director.

Its shares have plunged by 25% since it revealed that it had overstated its profit forecasts for the six months to 23 August, primarily due to the “accelerated recognition of commercial income and delayed accrual of costs”.

On 29 August, Tesco issued a warning to investors that its profits would be in the region of £1.1bn for the six months to 23 August, dramatically down from £1.6bn the previous year. News of its overstatement means Tesco’s first-half profit would be even lower at some £850m. Publication of its first-half results, were pushed back from 1 October to 23 October.

Momentously rocky
The year had already been momentously rocky for the beleaguered supermarket chain, with previous chief executive Philip Clarke leaving in July when his doomed attempts to turnaround Tesco’s fortunes failed.

In August it announced that its half-year dividend would be cut by 75% and full-year profits would be in the region of £2.4bn to £2.5bn, less than its previous estimate of £2.8bn, and already £500,000 down on last year’s £3.3bn reported profits.

However, like a chronic illness, bad news seems to keep making an appearance for the grocer. In October, it emerged that Tesco was taking delivery of a £31.3m corporate jet – a Gulfstream 550 – ordered early last year during the reign of ousted chief executive Philip Clarke.

It added to growing shareholder ire when it was discovered late last year that the grocer had a fleet of four executive jets. A Tesco spokesman has said all its aircraft operated were in the process of being sold.

Chris White, head of UK Equities at Premier Asset Management says such news was the last straw: “Tesco is facing massive problems, including falling volumes, falling market share, falling prices and falling property values.

“Profits, cash flow and dividends are under pressure. Stories about corporate jets are a further reminder of the hubris which was at the heart of Tesco over the past few years.”

Hoodwinked and deceived
Questions now abound about what was going on at Tesco for such a catastrophe to happen. David Sables, CEO of Sentinel Management Consultants – sales negotiation experts who advise grocery suppliers – is uniquely qualified to comment on the debacle having earned his hardcore retailing experience at Procter & Gamble, the global consumer giant that spans everything from Dolce & Gabbana fragrances and Ariel washing powder to Duracell batteries. Core Tesco ground.

He says Tesco’s investors have been “hoodwinked” and the financial markets “deceived”.

“Tesco deceived the financial markets on their performance and subsequent market capitalisation by dodgy accounting. Investors have been hoodwinked but it’s not a crime against suppliers who were probably unaware of the accounting misdemeanours. Even the buyers may not have been aware, but they are sure being investigated for it.”

Sables points to increasingly aggressive and desperate demands being placed on suppliers by the supermarket’s stressed buyers.

“Tesco has asked for alarmingly increasing amounts and frequencies for support and promotional bonus money to come in early, saying that it will be accrued to the correct later period. It’s a standard endemic practice to fudge the numbers at a period end, practiced by all the retailers and most public companies providing that they can get it through the auditors – accounting as a grey art form,” explains Sables.

“When a growing business does this, the fear of pushing the gap or shortfall into the next period is low because more money can be raised in the next period and the hole can be made good, he explains, but “the real Tesco issue started when growth slowed and its share price began to decline”.

Ticking timebomb
Newly-appointed Tesco CEO Dave Lewis inherited “a ticking timebomb” and had no choice but to expose the practice, Sables believes. And he doesn’t think that PwC – Tesco’s entrenched auditor since the 1980s – will emerge especially well from the debacle.

While the Tesco profit overstatement relates to the interim figures to be released next week, which are unuadited, the Big Four firm focused on commercial income recognition for Tesco’s 2014 annual report, and had tested the controls management.

“My theory is that the rollovers have been lump sums in the past which have always been allowed through as doubt exists as to when they were truly earned,” Sables says.

He believes the wider auditor/auditee relationship is often too close and too mutually beneficial.

Prem Sikka, professor of accounting at Essex University, goes further stressing that, so seismic has the fallout from the scandal been, that it looks like shaming the wider accountancy world.

“I think confidence in the accountancy profession will be eroded by this,” says Sikka. “The pressure on accountantcy firms to deliver a good quality audit is almost negligible.”

He is critical of the lack of information available to shareholders, citing the paucity of detail regarding an auditor’s appointment available for investors to peruse, the scant insight into the make-up of the audit team, or how much time they spend on the job

While it’s unlikely that Tesco will go the way of Woolworths and head into retail extinction – it has a long way to go to crawl back to some sense of equilibrium.

But as Sables points out, just “declaring the business as it happens and reporting accurately to rebuild trust” will go some significant way to steering it back on to the righteous path.

2014: Tesco’s annus horribulus timeline

• Tesco kicks of the year with a profits warning after subdued Christmas sales and reduced market share of 28.7% – its lowest for ten years.
• News emerges that chief executive Phillip Clarke will booted out after another profit warning. He will stay on until October when he will be replaced by Dave Lewis, head of Unilever’s personal care business. August:
• Tesco’s credit rating slashed by Standard & Poor’s.
• Shares plunge.
• Releases third profit warning of 2014.
• Dividend cut by 75%.
• Alerts market that Lewis will begin his new job four weeks early on 1 September.
• Four top executives suspended when Tesco announces £250m profit overstatement.
• Tesco delays announcing half yearly results from 1 October to 23 October
• Tesco shares halve in value over space of 12 months
• BlackRock sells down its stock holding to below 5%
• Standard & Poor’s places Tesco’s credit rating under review
• The FRC – Britain’s audit and accounting watchdog – announces it is “closely monitoring the situation” as does the Serious Fraud Office.
• The Financial Conduct Authority launches a probe into the accounting scandal
• Tesco confirms it has effectively had no financial leadership when it reveals it had no finance director for five consecutive months.
• MP Adrian Bailey says Tesco execs could face a parliamentary committee grilling over the misstatement that slashed £2bn off its stock market value.
• Legendary Berkshire Hathaway investor Warren Buffet dubs his investment in Tesco “a huge mistake”. His Tesco shareholding has lost over £465m this year alone.
• Maverick Sports Direct boss Mike Ashley makes a £43m ‘put option’ bet with Goldman Sachs on Tesco shares making a Lazarus-like recovery
• Lewis appoints two new board members with retail experience Compass chief, Richard Cousins and ex-Ikea boss Mikael Ohlsson as non-executive directors
• Tesco asks three more executives to leave over £250m profit overstatement, taking number suspended to eight.

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