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A Tale of Audit Woe (BHS, Taveta and PwC)

By Julia Penny

The FRC report on the audit of Taveta Group, including its subsidiary BHS, was finally issued on the 8 August 2018. There had been a substantial delay since the fines being levied were first mentioned, due in part by an effort to obtain an injunction on the publication. The request for an injunction was denied but still the report was not published, perhaps due to fear of further legal reprisals?

In any case, the full report is now available and it paints a sorry tale of problems with the audit including:

the very limited time spent by the engagement partner on the audit
a lack of appropriate safeguards with regard to threats to independence
backdating the audit report signature and 

•falsifying the date on which the final review of the file was carried out.

It is, in my opinion, always worth analysing this type of report for indications of situations that other auditors may find familiar. I suspect that the engagement partner had no real intention to do a poor audit and that the firm did not think its procedures or oversight of audit work lacking in any way. But clearly that did not stop the failure occurring. So why and how does something like this arise? Let’s look first at the problems identified.


Completion of the audit

BHS had been loss-making for a number of years and was being supported by the Taveta group. It also had, as I am sure everyone knows by now, very significant pension scheme deficits. During the audit the partner became aware of the likely sale of BHS. All of this should immediately set the auditor’s mind on a path of a high-risk audit. A change in owner could change the support given to BHS and also could provide incentives for management to misstate information in the accounts.

The audit report was signed on the 9th March 2015, but this was backdated to 6th March, with the final completion work also backdated, with a false assurance that IT problems had prevented a sign off on the relevant date. BHS went into a Creditors Voluntary Arrangement on 23 March 2016, followed shortly thereafter by administration, leaving a pension scheme deficit of £571m.


Supervision and review

Auditors are all familiar with the need for the engagement partner to supervise the conduct and review the outcome of the audit evidence, ultimately taking a decision on whether there is sufficient appropriate audit evidence to support the opinion. However, the FRC found that:

The audit was primarily conducted by “B”, who was an audit manager with only one year post-qualification experience;
The engagement partner only recorded 2 hours of audit work between December 2014 and the date of the audit report being signed and the senior manager, “A”, only recording 7 hours;
B did not know of the imminent sale of BHS whilst undertaking the audit work;
Areas identified as being of significant risk at the planning stage, including impairment, were not reviewed by either A, the senior manager, or the partner.


Independence and objectivity 

Threats to independence seemed not to have been recognised as no adequate safeguards had been put in place. The key areas of threat were:

Non-audit fees of £2.9m against audit fees of £355,000 in 2014 (although the report to the audit committee indicated non-audit fees were even higher at £3.3m);
A contingency fee was charged in relation to pensions incentive work;
The partner and senior manager, A, spent considerable time undertaking non-audit work for the client;
The partner was the single point of contact with Philip Green and had a central role in the provision of non-audit services;
The partner had a long and close relationship with the client as indicated by his own statements, including that the … “incidence of [the client] asking other firms for help or advice is very limited”

Despite these apparently serious threats to independence there was no consultation with the ethics partner, or appointment of an engagement quality control reviewer. There was also no consideration given to separating the audit teams from the staff that conducted non-audit work.


Going Concern

There has been much in the press, following the Carrillion collapse, regarding the auditor’s work on the going concern concept. We all know that we need to consider if the company will continue in operational existence for the foreseeable future. This should start with management’s assertion that the business is a going concern and the evidence that they have to back this up. However, this had not been obtained by PwC in their 2014 audit of BHS and they had not sought to understand how the company would continue in operational existence without the support of Taveta Group. 

This sounds weak enough from an audit evidence point of view, but on top of this the holding company’s support letter was “qualified” with a statement that “whilst the companies continued to be under the control of Taveta 2” they would be supported.

So where was the scepticism and challenge that should have questioned whether, in fact, BHS was a going concern? And, more importantly for the future, is it possible for you and your audit teams to be drawn into making assumptions that a loss-making subsidiary will always be supported by the parent as it has in the past, without considering the evidence? It may be time to remind all staff and partners of the importance of double checking the evidence regarding going concern in group situations.


Impairment testing

Management of BHS had carried out an impairment review of fixed assets and investments and found that there was no impairment, as the value in use of the assets exceeded the carrying value (by a relatively small amount).

PwC failed to adequately understand and test management’s assumptions and estimates made in this review. For example, an assumption was made that sales would go up by 6.7% in the following year, despite history of falling sales and the entire UK market’s growth only expecting to be 2.9% for womenswear and 3.6% for menswear.

It is vital that, as auditors, we challenge the information that is provided to us. How were growth rates established? What could they be checked against? Do they seem reasonable in light of what we know about a client? It’s possible to make a forecast say anything you like by varying the assumptions, so to see a consistently loss-making business forecasting reducing losses, when the trend was increasing losses should have set alarm bells ringing. 

Management of BHS had also made adjustments in the forecasts which improved BHS profits. Many of these did not have audit evidence and some appeared incorrect. For example, £12m was included as an adjustment of “profit held in Arcadia” relating to profits from concessionaries. But if that were the case the profits did not belong in BHS accounts. The problems here arose from concentrating on the picture at the group level and not doing enough audit work on cross-company charges and receipts.


Other group companies

To add to the litany above, when BHS was sold on March 11 at a price of £1, there was no mention of this in the previous holding company’s (Taveta 2) accounts signed two months later. This was a significant post balance sheet event requiring disclosure and also an indication of impairment of the investment, which stood at £201m in Taveta 2’s accounts.

As well as the investment not being impaired, there was a loan of £236.5m to BHS from Arcadia, another group company, which was written off as part of the sale of BHS on 11 March. However, the amount was not written off in the Arcadia 2014 financial year, even though the audit report was signed off on 21 May 2015 when it was known that the debt was not recoverable.

The list goes on, with problems in the audit evidence for:
Revenue at a subsidiary level (ie testing was performed at a group level, without adequate work at the level of BHS as a subsidiary of Taveta);
Cost of sales at a subsidiary level;
Materiality thresholds in subsidiaries;
Very material manual journals, especially in relation to the subsidiaries’ separate accounts.


Fines and conditions

The findings detail the various failings in both the application of ethical and auditing standards. The firm was fined £10m (reduced to £6.5m for early settlement) and Steve Denison, the engagement partner, was fined £500,000 (reduced to £325,000 for early settlement) and banned from being a senior statutory auditor for 15 years. In addition, PwC agreed to monitor and support its Leeds audit practice and provide detailed annual reports to the FRC for the next three years. It must also review and amend its policies and procedures to ensure that all non-listed high risk or high-profile companies (including private companies with at least 10,000 employees) are subject to an engagement quality control review. 



So can the rest of us learn anything from the failures that occurred in this audit? We might like to think that our procedures and application of ethics are too robust to allow such a failure. But I suspect PwC thought that was the case too. It may be beneficial to get audit partners/responsible individuals together and have a think about the sort of issues that have come out of this case. Are there any similarities with your own clients, on individual issues identified in BHS? 

For instance, loss-making subsidiaries being supported by parents are fairly common and the audit work can sometimes be rather lacking. Has proper consideration been given to the possibility of the company no longer being supported by the group, whether because it is being sold or the parent just decides to cut its losses? 

What about the risks of over-familiarity with a client or doing too much other work as well as audit? Has someone independent of the audit team been involved in considering the level of the risks? Has there been a regular review by the ethics partner of situations in which there are risks to independence, objectivity or integrity? Although it did not arise as an issue in the BHS case, remember that the new Ethical Standard is clear that a managing partner or equivalent is always a covered person for audit purposes. 

Finally, how do we ensure that an adequate amount of time is spent on all audits by the engagement partner? Do we monitor the levels of time posted and review whether we think it is adequate? Do we ask more junior team members to whistle-blow if they have concern that the partner is not sufficiently involved (or is too involved in getting the outcome the client wants)? Do we check that the workload for partners and staff is appropriate?

We need to challenge ourselves and turn over some stones, just to check what lies beneath them. If the results are not pretty, better to find out now, than after a company failure or disciplinary action.

(We have an ethics webinar available if you want to update audit teams and we can facilitate workshop discussions around risks of audit failure. If you need management skills training on how to challenge your client without upsetting them then let us know).


September 2018 


This article is published with the understanding that SWAT UK Limited is not engaged in rendering legal or professional services. The material contained in this article neither purports, nor is intended to be, advice on any particular matter. This article is an aid and cannot be expected to replace professional judgment. SWAT UK accepts no responsibility or liability to any person in respect of anything done or omitted to be done by any such person in reliance, whether sole or partial, upon the whole or any part of the contents of this article.