By Simon Bartram
Tesco is being investigated by the Financial Conduct Authority following its admission that it overstated its half-year profit guidance by a quarter of a billion pounds, leaving the troubled supermarket giant red-faced. However, what do we know about this accounting scandal, and why should people care?
Tesco has been embroiled in scandal after the supermarket giant admitting it had overestimated first-half profits to the tune of a quarter of a billion pounds.
Early reports suggest that Tesco misapplied the accruals concept which is a fundamental principal in accounting. The basic idea is that income and expenditure should only be recognised in the period to which they relate, not when cash is received and not by any other criteria. To take a very simple example, if a contract grants income over three years, the income should be split and recognised over that three-year period, regardless of whether the cash is paid upfront. To take another easy example, when we pay our rent we spread the expenditure over the period to which the rent relates, regardless of whether we make a prepayment in one lump sum.
For sure, when considering more complex commercial income there are judgemental areas regarding what amounts to accrue and when to accrue it. When we accrue income, we recognise an asset on the balance sheet (a debit balance) and income on the income statement (a credit balance). The accruals concept is supposed to provide a fair representation of income and expenditure within financial statements and allows those statements to be compared and analysed by economic users – lenders, investors and other stakeholders. If Sainsbury’s and Tesco adopted wildly different accounting policies, then the financial information that would be publicly available would be difficult to compare.
Tesco’s confession is a huge embarrassment but its saving grace is that an internal control alerted Dave Lewis, their CEO, to the problem, rather than an external auditor. Their whistle-blowing policy cannot be faulted. Yet whistle-blowing suggests that there was conscious knowledge of what occurred, rather than a simple error. Indeed, the aggressive early recognition of £250 million-worth of supplier income (or delay of expenditure) is hard to dismiss as a mere error. There’s also a clear incentive to misstate profit given the scrutiny that Tesco’s declining market share receives from the press. Dave Lewis insists that the dismissal of his senior management is neither a disciplinary action nor an accusation of guilt, but it’s hard to believe that sheer incompetence is the cause of this mess. But if it was, would that not be just as shameful?
In the worse-case scenario, this is a £250 million fraud. However, because they’re suited, respectable and in a privileged business environment we glibly use language such as “misstatement” and “accounting error”. “Fraud” is the word we use for benefit fraudsters who routinely dominate the news agenda because they lack that cloak of respectability that big business provides. Ironically, it is the more qualified professionals to whom we give the benefit of the doubt, whereas we issue a lot more hasty judgement towards benefit cheats. Indeed, the connotations of a person who misrepresents their health or income on government forms are much more sensational, much grubbier and much dirtier. The difference between exaggerating a pain or disability and misrepresenting when precisely income should be recognised is not so great. Except a benefit cheat is not a qualified doctor, whereas the accountancy cheat is, usually, a qualified accountant, whose actions financially affect many readers of the financial statements that they produce, and they get paid generously for doing so.
If the worse-case scenario is to be believed, then by distorting financial information to suit their paymaster’s expectations, they have neglected their public duty to report accurate information to the outside world. Many people, pensions funds, and other forms of investors may have relied on their reports and lost out when Tesco’s share price plummeted. We can’t let well-paid men in suits cook the books and get away with it. We should expect and demand their immediate disqualification from any accounting body to which they belong if intent is proven, or if sheer incompetence is demonstrable. This is the least that can be done to restore high expectations in financial reporting and financial markets.
Simon Bartram is a freelance writer, having graduated with a first-class degree in Modern History and Philosophy from the University of St Andrews. He works full-time in the City of London and is a student of the Institute of Chartered Accountants in England and Wales. You can follow him on Twitter @Simon_M_Bartram