by John McCarthy Consulting Ltd. | Nov 25, 2019 | Blog, News
In a recent Financial Times story, it was reported that the EU is proposing to set up a new anti-money laundering body in the wake of recent money laundering scandals.
EU finance ministers are expected to meet in December and propose the setting up of a new independent body to enforce money laundering prevention measures across the EU.
The proposal would trigger a significant increase in the response to a wave of money-laundering scandals that have occurred since 2017. These scandals have revealed weaknesses in the EU banking system which have been exploited by criminals.
The two most notable recent scandals have involved two of Europe’s most high profile banks: Danske Bank and Deutsche Bank.
US law enforcement authorities uncovered institutionalised money laundering in 2018, at the now defunct Latvian bank ABLV — much of it linked to Russia. This was just one in a series of serious blows to European confidence in its banking system’s defence against crime.
Another setback involved revelations that €200bn in suspicious transactions had been moved through Danske Bank’s Estonian branch. ING was fined €775m for compliance failings and Deutsche Bank was ensnared in a scheme to illicitly shift criminal funds from Russia to the west.
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by John McCarthy Consulting Ltd. | Nov 16, 2019 | Blog, News
As we pointed out in our last two blogs here and here, Carillion was less than transparent in its 2016 financial statements about its reverse factoring arrangements.
For a much better explanation of supply chain financing (an alternative name for reverse factoring), see Note 19 ‘Trade and Other Payables’ on page 177 of the 2018 financial statements of AstraZeneca Plc.
Since Carillion commenced the arrangement in 2012 , Carillion’s customers were taking longer and longer to pay – by 2016, receivables were 38% of sales. Carillion was taking even longer to pay its suppliers. By 2016, if you include the reverse factoring, payables were around 50% of sales, or six months.
As Carillion was a very low-margin business, its operating margin (operating profit/sales) over the 10 years from 2006 was highly variable, but was in the range of 1% to 4% according to the LBS article. Its earnings margin (earnings/sales) was between 2% and 3%.
But what did these numbers actually mean? Long-term contracting always rings alarm bells because it offers companies discretion over when to report the income from a contract, with the risk that they will be tempted to report revenues earlier and costs later. Carillion’s financial statements offered no clue as to how it was accounting for long-term contracts.
IFRS 15 on Revenue Recognition would have forced the company to write down retained earnings by well over £100 million, according to a 2017 disclosure note. Apparently, Carillion included the change in the reverse factoring creditor – essentially a financing cash flow – as an operating flow in the calculation of operating cash flow and thus in the calculation of cash conversion.
In the 2016 financial statements, Carillion reported operating profit of £145 million and an operating cash flow of £115 million, which is a decent cash conversion ratio. But that operating cash flow was increased by the approx. £200 million increase in ‘other creditors’ during the year. Without that, operating cash flow would have been £-85 million.
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by John McCarthy Consulting Ltd. | Nov 10, 2019 | Blog, News
Factoring in Ireland and the UK worth more than €400 billion.
Last week we discussed how reverse factoring works. Now we look at how it works in a little more detail.
Broadly there are two different objectives from the originator for such schemes:
1) Supplier focused – to support smaller suppliers
2) Company focused – to support the originator’s working capital management and financing.
Whilst these two objectives are quite different, it is often difficult to assess from the available disclosure what the company’s objective is.
Normal payment terms might see a purchaser pay a supplier within thirty days. The switch to a reverse factoring facility might also see the payment terms increase, to as much as 120 days, as the facility provider will agree terms with the originator. Any increase in payment period will have the effect of improving the originator’s working capital cycle.
How prevalent is reverse factoring?
It is difficult to get accurate and up-to-date data but the European Factoring Association estimates that the total of factoring and reverse factoring for the UK & Ireland combined was £350bn (or over €400bn) in 2017.
Collapse of Carillion
According to a January 2018 analysis by the London Business School (LBS), Carillion used reverse factoring to its detriment.
Carillion was less than transparent about this arrangement in its 2016 financial statements. The facility was recorded in Carillion’s balance sheet within ‘other creditors’ of £760.5 million, on page 118 of the 2016 financial statements – without any explicit note.
More to follow next week in our last blog on reverse factoring.
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by John McCarthy Consulting Ltd. | Nov 1, 2019 | Blog, News
Some lessons for us all from the Carillion collapse.
A very useful publication was issued recently by the little known Financial Reporting Council Lab called ‘Disclosures on the Sources and Uses of Cash’.
Tucked away in the appendix of the publication is a very interesting explanation of reverse factoring. This financing method had a role to play in the downfall of Carillion as reported by the Financial Times in January 2018.
Reverse factoring is a type of finance transaction akin to factoring. In a traditional factoring arrangement a business will sell its accounts receivables (i.e. invoices it has raised with buyers) to a third party (usually a bank) in exchange for a significant proportion of the cash value of the invoices.
Factoring provides earlier access to cash from sales than would otherwise follow the traditional credit terms.
Reverse factoring is similar to factoring, but it is the purchaser rather than the seller who is the originator of the facility.
In reverse factoring the purchaser of goods organises a facility with their bank or other finance provider. This facility allows suppliers to get their invoices factored, and receive cash at a point before the purchaser intended to pay. This type of scheme is particularly beneficial to smaller suppliers who may not have sufficient financial strength to obtain competitive factoring terms themselves. Sometimes reverse factoring is called by a different name like ‘supplier chain finance’.
Whilst normal payment terms might see a purchaser pay a supplier within 30 days, the switch to a reverse factoring facility might also see the payment terms increase up to 120 days, as the facility provider will agree terms with the originator. Any increase in payment period will have the effect of improving the originator’s working capital cycle.
Unfortunately, in Carrillion’s Annual Report for 2016 the existence of reverse factoring arrangements was not fully disclosed. It can only be presumed to be included on page 116 of the 2016 Annual Report within Note 20 Other Creditors of £760.5m (2015 £561.7m). In 2012 Carillion had announced a switch from paying its suppliers on normal credit terms to paying them, after 120 days. If supplier needed payment earlier, Carillion had arranged a bank to pay them sooner.
The message for readers is: do your clients have financing arrangements like reverse factoring? If so, you need to ensure this is properly disclosed.
A good example of supply chain financing disclosure is in Note 19 Trade and Other Payables on page 177 of the 2018 financial statements of AstraZeneca Plc where it states ‘Trade payables includes $166m (2017: $64m; 2016: $nil) due to suppliers that have signed up to a supply chain financing programme, under which the suppliers can elect on an invoice by invoice basis to receive a discounted early payment from the partner bank rather than being paid in line with the agreed payment terms.’
More on this in our next blog.
For more on accounting matters please see our webinar on ‘Common Errors in FRS 102 Accounting’.
See our completely up to date 2019 AML Policies & Procedures Manual for Accountants.
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by John McCarthy Consulting Ltd. | Oct 29, 2019 | Blog, News
The UK audit regulator has revealed that among the key reasons for launching an investigation into the collapse of Thomas Cook were ‘issues around going concern and goodwill impairment.’
As if on cue, the Irish audit regulator IAASA, has just issued (October 2019) a revision to the audit standard on Going Concern, called ISA 570. This comes into effect for audits of accounting periods that commence on or after 15 December 2019.
The revised standard on Going Concern in Ireland will trigger additional audit work and evidence gathering for auditors in the following areas:
- greater work on the part of the auditor to more robustly challenge management’s assessment of going concern;
- thoroughly test the adequacy of the supporting evidence;
- evaluate the risk of management bias;
- make greater use of the viability statement;
- improved transparency with a new reporting requirement for the auditor of public companies, listed and large private companies to provide a clear, positive conclusion on whether management’s assessment is appropriate;
- to set out the work they have done in this respect; and
- a stand back requirement to consider all of the evidence obtained, whether corroborative or contradictory, when the auditor draws their conclusions on going concern.
This standard arrives at a very important time, in the midst of serious questions being raised about recent corporate collapses in the UK such as the travel company Thomas Cook, BHS and Carillion.
The ongoing FRC investigation into EY’s audit of the financial statements of Thomas Cook Group has raised questions about the sufficiency of the challenge auditors applied to management’s assumptions about going concern and goodwill, and the sufficiency of the audit evidence to support the work that was done.
Answering questions from the UK Business, Energy and Industrial Strategy (BEIS) committee, the FRC director of enforcement, Elizabeth Barrett, told UK MPs that there was sufficient information about potential issues within the audit to merit an investigation.
When asked to specify those concerns, Barrett replied ‘broadly speaking, in particular issues around going concern and goodwill impairment.’
While Thomas Cook had reported impairments to goodwill in 2011, there had been no further reporting on this until 2019, when £1.1bn was written down.
The UK audit regulator (FRC) has also amended the audit standards on going concern and goodwill impairment in recent times.
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by John McCarthy Consulting Ltd. | Oct 14, 2019 | Blog
In a rare speech, Sir Donald Brydon, chair of the Future of Audit in the UK, told a packed conference room that he is a little troubled at the current mood that ‘reaches for a shotgun aimed at auditors every time there is a corporate problem’.
Speaking at the first ICAEW Audit & Assurance Faculty Audit Conference on 4 October 2019, Brydon, former chair of the London Stock Exchange, stressed the importance of balancing the responsibility and the blame for company failures between auditors, audit committees and company boards.
Ultimately, Brydon said it was directors and their actions, not auditors, that should be to blame for recent audit failures. He did not name any names but recent failures like Carillion and BHS have likely triggered this response along with other reviews.
The Brydon Future of Audit review, an independent UK government review, received 120 responses – a total of 2,500 pages of comment, while over 100 meetings and roundtables were also held to gather views.
Brydon plans to report back to the UK government on his recommendations by the end of December 2019 and all the consultation responses will be published.
In his speech, Brydon revealed that the review would seek ‘to consider how audit can become a more informative process and product whilst not losing its compliance aspect’.
Brydon insisted that it was not his intention to ‘redesign Western capitalism’, adding that, it was ‘important to note that many people and organisations have expressed their frustrations with what they see as, essentially, a narrow, backward looking and increasingly rules-obsessed approach to audit’.
He said that one of the respondents to the Review ‘compared the audit to a high jump, in which auditors have little incentive to do more than the minimum required to “clear the bar”. I repeat that there is a hunger for audit to be informative and not just evidencing compliance.’
But what does this mean for the future of Irish audit practices? Much of the audit standards that are implemented in the UK, soon follow suit here.
As they say, watch this space.
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