GT was given sanctions as follows:
- a financial penalty of £4 million (discounted to £2.34 million);
- a severe reprimand;
- a declaration that the audit reports did not satisfy the audit reporting requirements; and
- a suite of non-financial sanctions requiring GT to report to the FRC for three years on the impact of GT’s remedial actions, a review of GT’s culture of challenge and additional monitoring of its audit work on bank and cash.
Further sanctions were applied to the key audit partner.
What went wrong?
In October 2018, PH stated publicly that an alleged fraud had been perpetrated within its business, including the likelihood that GT had been given misleading information. The matter impacted PH’s cash position and on 16 October 2018 PH clarified that ‘the misstatement of its accounts was extensive, involving very significant manipulation of the balance sheet and profit and loss accounts. Among other manipulations this involved thousands of false entries into the Company’s ledgers.’
The FRC’s findings are not based on a finding of fraud, and instead concern weaknesses in GT’s audit work in four particular areas:
(3) journals; and
(3) fixed asset additions.
The main failings were as follows:
GT’S audit work on revenue was flawed in that the team were not required to test large year-end revenue receipts or others which were disproportionately large and contained ‘red flags’ in supporting evidence when they should have done. The team did not perform the audit with professional scepticism. For instance, 73% of PH’s entire annual voucher revenue in FY16 was apparently received in a single payment shortly before the year-end. Concerns of a junior team member in this regard were not reported to the engagement partner.
The disproportionate growth in year-end cash from 2015 to 2017 was tested by confirming banking facilities and discussion with management in addition to transaction tests. However discrepancies in bank letters did not lead to challenge of management, and some of the documentation for cash transactions bore evidence of inauthenticity (e.g. typographical errors and missing company logos). Finally, there were very large reconciling items which were both received and recorded post year-end but added into cash balances, and these were accepted by GT without adequate investigation and challenge.
In an unusual move, in one of the years, the FRC criticised the auditor for choosing an inappropriately large (rather than small) number of journals to test, which reduced the quality and depth of the testing undertaken including failure to confirm that these were properly approved by PH. Journals were not appropriately tested in the other two years.
- Fixed asset additions
The FRC noted misclassification of motor vehicle additions as plant and equipment, and other additions for which invoices related to prior years or lacked detail.
Claudia Mortimore, Deputy Executive Counsel to the FRC commented that:
“This Decision Notice sets out numerous breaches of Relevant Requirements across three separate audit years, evidencing a serious lack of competence in conducting the audit work.
The audit of Patisserie Holdings Plc’s revenue and cash in particular involved missed red flags, a failure to obtain sufficient audit evidence and a failure to stand back and question information provided by management.
As a result of this investigation, GT has taken remedial actions to improve its processes and to prevent a recurrence of these types of breaches. The package of financial and non-financial sanctions should also help to improve the quality of future audits.”
Implications for other auditors
As noted in our previous blog on EY and Stagecoach, at the heart of many of GT’s failings in the PH audits is a lack of professional scepticism – a common finding in Mercia’s own experience of reviewing audit files. The Final Decision Notice observed that the issues noted ‘were not isolated shortcomings or failures’ and many concerned matters fundamental to the proper conduct of audit work and evidenced a serious lack of competence.
Our audit update courses cover these types of issues.
If you are interested in Mercia providing audit quality reviews for your firm in order to help identify weaknesses, then please contact us for further details.
The Final Decision Notice is available here.