Members of Parliament Zero In On Carillion’s Accounting
During hours of testimony before members of Parliament earlier this month, the former leaders of Carillion, the doomed UK contractor, owned up to numerous mistakes, which combined with unexpected hardships, contributed to the company’s collapse on Jan. 15.
Among them were bidding on the money-losing Aberdeen bypass project in Scotland, the inability to collect payments from work in Canada and the Middle East, the need to rebuild a key beam in a Liverpool hospital and an acquisition ten years past that more than doubled the company’s pension fund deficit.
But on the central matter taken up—the company’s perception of the risk it was facing, its accounting methods and whether the top managers and directors met requirements for honest public disclosure—Carillion’s leaders were less contrite, even in the face of sarcasm and pointed accusations from members of parliament.
On these points, Carillion’s leaders claimed their judgments were reasonable and honest. Nevertheless, at the end of the hearing, one MP suggested the managers ought to have given back some of their pay from the last year for doing such a poor job.
The Feb. 6 hearing was part of the opening phase of multiple investigations into Carillion’s insolvency and liquidation. The inquiries include the company’s pension obligation, which cannot be met, and the role of KPMG, its accountant, in representing it as a going concern, albeit one with problems, in the last months of its operation.
A recovery plan undertaken by Carillion’s leaders was fashioned to put the company on the mend, despite a huge $1.8-billion debt and several bad projects that drained working capital. Having issued three profits warnings since last July, Carillion failed to secure funding from its creditors. With sales of about $7 billion a year and forecast losses exceeding $1.4 billion, the firm had become virtually worthless.
Carillion's failure prompted an outcry from Labor Party critics of the Tory government over privatized contracts awarded to Carillion as the company slid toward disaster.
At the hearing, Keith Cochrane, the former non-executive director who became interim CEO in 2017, explained that he learned of a problem with the company’s accounting of its cash flow and payables and receivables in May, 2017.
Receivables and Payables 'Netted Off'
Essentially, they were presented in a way that made them seem smaller.
Receivables and payables, he testified, had been shown with some “netting-off—rather than stating the gross values on Carillion’s balance sheet.
“They had been reversed,” Cochrane testified. “So they would reduce the value of receivables and reduce the value of payables. It was essentially a presentational issue.” Once Carillion's directors became aware of the issue, they ordered an independent review.
Questions soon turned to the upbeat tone in the company’s financial disclosure, even as short interest built against its shares and astute investors shed their holdings.
Frank Field, a Labor Party MP and former government minister, tinged his questions to Cochrane with sarcasm. “You are presenting us with a picture, are you not, that somehow the public face you presented was pretty or hunky‑dory, and then within a couple of months you began to drive the company into the ground? Is that the image you meant to put over to us?”
Replied Cochrane: “Do I wish we had done something about it sooner? Absolutely. I recognize that, again, with the benefit of hindsight, but I can assure you that, at the time, all of the decisions I took were very much seeking to do the best thing for the business at that juncture.”
Role of Carillion's CFO Questioned
The members of Parliament also questioned the role of the chief financial officers, including Emma Mercer, who last occupied that position, and whether the company’s accounting methods were too aggressive.
As her former colleagues did, Mercer noted that they were all engaged in a restructuring and recovery effort at Carillion.
She said that several important projects in 2016 had “operational difficulties,” which culminated in the company’s “provision,” or write-down to recognize the possible losses. She also testified that the company took a more aggressive approach to accounting at that time and that the approach required judgments about when the contract is going to get finished, what the company will be paid, any possible claims and what the claim may be worth.
“…Both the number of contracts we were taking judgment on and the size of those judgments had increased,” said Mercer of the critical months in mid 2017.
An MP asked Mercer to explain the difference between “the aggressive tone that you saw and what you saw before?”
Aggressive accounting generally refers to a more positive representation of a company’s financial condition, but Mercer answered this way:
“What that meant is that when we saw the deterioration in the first part of 2017 and into the second—when we saw those huge deteriorations on those contracts—because we were already at a more aggressive position, it was very difficult to withstand those deteriorations on those projects.”
The answer prompted the MP to turn to Mercer’s predecessor as CFO, Zafar Khan, and ask: ”Do you agree that this was the start of a slippery slope under your tenure, where legitimate earnings management could have descended into earnings manipulation?”
“I do not believe that there were any instances of earnings manipulation,” replied Khan, who only served as CFO for 11 months and is credited with providing his colleagues a warning about the company's precarious state.
“I signed off on the 2016 annual report," he continued. “The numbers within that were audited by KPMG, and in terms of how we have managed the business, we have a whole range of contracts. You have contracts in Canada; you have contracts in the Middle East; you have contracts in the UK. You have finance directors, managing directors and commercial directors in each of those businesses. You take into account all of the available information at that point in time, and come to a judgment.”