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September 22, 2014

Tesco revised outlook points to “aggressive” accounting practices

By Isabella Grotto

British retailer Tesco has cut its 2014 first-half profit forecast by £250m ($408m), following the discovery of errors in its accounts attributable to what some describe as a long-term policy of account stretching.

Today’s revision, which marks the third time the company has been forced to reduce its profit forecast this year, saw the most recent first-half expectations slashed by 23%.

According to Tesco, the mistake was due to "the accelerated recognition of commercial income" and a delay in the recognition of costs.

For Warwick University Business School professor Crawford Spence the revelations point to the routine use of aggressive accounting practices. "Tesco has essentially tried to recognise revenue too early and delay the recording of costs until a later date," he explained.

While this behaviour is generally accepted within limits, Tesco appears to have pushed it a bit too far, according to Spence. "What Tesco appear to have done is push the boat out a bit too far, ending up with revenue that hadn’t really been earned yet and costs that probably should have been booked earlier."

Richard Clarke, senior research associate at Sanford C. Bernstein, a brokerage firm, told International Accounting Bulletin (IAB): "In my opinion it’s [more] likely that this is something that has happened to some degree in the past and for some reason has not been flagged up by PwC."

PwC has been Tesco’s independent auditor since 1983, but contrary to Clarke’s suggestion, the accounting firm did flag to the Tesco board the risk of such practices in its last audit report.

"We focused on [commercial income] because of the judgement required in accounting for the commercial income deals and the risk of manipulation of these balances," the auditor expressed in its report.

Subsequently, Tesco had acknowledged the auditor’s concern in its annual report but said it wasn’t a ‘significant issue’ as "management operates an appropriate control environment which minimises risks in this area".

In a bid to help determine the extent of the issue, Tesco’s board has appointed Deloitte to undertake ‘an independent and comprehensive review’, working alongside the group’s external legal advisers, Freshfields.

As the internal investigation gets underway, four employees have been suspended. They include managing director Chris Bush, UK finance director Carl Rogberg, food commercial director John Scouler and head of food sourcing Matt Simister.

Once the scope and duration of the irregularity is determined, PwC might find itself cast under scrutiny.

"At the moment what we don’t know is how far back this goes," Clarke explained. "The only thing that’s been disclosed at the moment is that there is an overstatement in the first-half period that finished a month ago and those interim accounts are not audited."

In a note published earlier this year, Sanford C. Bernstein stressed the need for the company to clean up its accounts.

Clarke said: "We’ve long suggested there was some stretching of the accounts which has happened since 2007. Among them, the way the company accounts for its pension costs and operating leases, as well as its China joint venture, suggests a picture of habitual account stretching."

But the latest revelations go beyond that, he continued. "What we’ve had today is an admission that something has gone properly wrong inside their accounting."

So far there is no reason to believe the issue will prove terminal to the struggling retail giant, according to Clarke. But he believed some level of cleaning out of the accounts is to be expected.

"It’s interesting they’re bringing Deloitte in to do this investigation," Clarke added.

Tesco hasn’t put its audit to tender since PwC was first appointed as the retail company’s auditor in 1983. However in its annual statement it said that it has regularly rotated the audit partner, and that the current audit partner is due to rotate in February 2017.

Under the new audit rules coming into force form the European Union and the UK Competition and Markets Authority, Tesco will have to rotate auditor by 2020.

"I don’t think we are looking at an Arthur Anderson-type situation, but PwC may lose that particular gig," Clarke concluded.

Contacted by IAB PwC and Deloitte declined to comment.

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