tesco accounting scandal 2014 case study

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Corporate Governance – A Case Study of Tesco Accounting Scandal 2014

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Type of Academic Paper – Case Study

Academic Subject – Governance

Word Count – 1700 words

Introduction

In present times, the subject of corporate governance is the most crucial one and a large number of corporate scams have recently been reported. This is due to a lack of attention paid by the board of directors, auditors, and other regulatory bodies, making it problematic for shareholders and stakeholders of a company to think strategically for the betterment of the company.

According to Bebchuk, Cohen, and Ferrell (2008, p.783), corporate governance is defined as the set of rules and regulations, and practices that can be implied on the company so as to control the business operations. The corporate governance of a company is mainly concerned with maintaining a balance between the company operations and the interests of stakeholders and shareholders of a company (Bhagat and Bolton, 2008, p.257).

However, there are recent additions in the corporate governance scams amongst which the accounting scandal of Tesco PLC 2014-2015 is the most prominent one. The aforementioned UK retailing business came under the regulatory scanner because of the scandal of overstating the profits of the company; where nearly around £263 million worth of profits were overstated (TheGuardian.com, 2014).

This essay highlights the lack of corporate governance while exploring major loopholes in the corporate structure of the company which resulted in this major accounting scandal. A conclusion is presented in the end while summarising major findings of the essay and effective recommendations are presented in this essay for the companies to avoid such corporate governance failures in the future.

Overview of the case

In the year 2014, Tesco, UK’s largest retailing giant, was plunged deeper into the crises which resulted in the suspension of four senior executive directors of the company. The suspension was followed by the scandal of overstating the company profits by £250m (TheGuardian.com, 2014). Tesco had overstated the first-half profits of the company to be £1.1bn, but later on, it was revealed that the company had experienced a profit of £263m. This overstatement of the profits in the forecasted profit figures was to attract shareholders and to increase investments and funds to the retailer (FinancialTimes.com, 2014).

After the accounting scandal in Tesco PLC, the legal authorities and board of directors significantly took this matter under consideration and wiped off £2bn of the net value from the UK’s biggest retailing company. Following the accounting fraud, Tesco PLC was alleged to pay a £500m fine by the end of the year and more than 125 investors filed against the accounting fraud made by Tesco PLC and claimed that the company had been lying to gain funds and investments (TheTelegraph.co.uk, 2014).

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Failure of Corporate Governance

Tesco PLC has been known for its corporate governance framework and its commitment to safety and ethics towards the environment as well as the people. However, the accounting scandal of Tesco PLC in 2014 has been reported to be one of the influential events that declined the overall reputation of the company. Because of this corporate governance failure, several people of the company were suspended including four executives as well that were engaged in the accounting fraud (Awolowo, 2016, p.23).

Moreover, the audit committee and company (Deloitte) were also reviewed and brought under the consideration after the incident. The major corporate governance failure, in this case, is because of the massive process failure of Tesco PLC. More importantly, the resignation of the Chief Finance Office just before the accounting scandal brought the headlines left the company with no CFO (TheTelegraph.co.uk, 2014).

Additionally, the resignation of the CFO followed with the resignation of several other great senior executives which is the case of pure poor corporate governance. The board of directors and the non-executive directors paid no attention to the inflated and overstatement of profits to grab the attention of shareholders.

Similarly, the external audit committee, PwC, and the internal audit committee of the company were equally responsible for their lack of activeness in this matter. However, the EU Audit Directive and Code of Ethics pose a strong push on the internal audit committees of the company, including their role on financing, reporting, and disclosing of honest information to the shareholders and stakeholders of the company (Müller, 2015).

It is evident that the role of the board of directors to have vigilant corporate governance is the prominent one which implies that in order to establish excellent corporate governance, it is necessary that the company board of directors are the key players in maintaining effective corporate governance (Bhagat and Bolton, 2008).

The Board of directors of the company is responsible to establish the key vision and mission of the company while setting strategies to obtain a nominal position in the market (Woods, 2007). However, this is not in the case of Tesco PLC. The board of directors was ignoring the Code of Ethics and EU Audit Directives which led to accounting fraud. Moreover, the board of directors of the company failed to take strategic decisions and raise their voice against the irregularities while focusing their recognition on revenue generation.

According to Ismail (2017), the UK Code of Governance provides provisions for the audit committees as well which ensures that the audit committee of the company is responsible for maintaining integrity in the financial statements of the company, along with reviewing the financial controls, judgments, and operations of the company so as to avoid the mishaps or misstatements in the financial statements.

However, in the case of Tesco PLC, the audit company of the company PwC paid no attention to the misstatement hence this led to the removal of PwC from the external audit committee of Tesco PLC (Müller, 2015). According to Courteau et al. (2017, p.1), the internal and external audit committee of the company is responsible to manage the financial activities such as reporting, external and internal audit, disclosure, and monitoring the regulatory operations of the financials of the company.

However, the audit committee of Tesco PLC has long been avoiding their responsibilities which resulted in the accounting scandal of Tesco PLC in 2014. According to Kukreja and Gupta (2016), the disqualification or resignation of the potential board members also results in the failure of corporate governance. This may be in the case of Tesco PLC. The accounting scandal in 2014 broke out soon before the resignation of the CFO of the company and left Tesco with no supervision of the CFO, however, the scandal led to the dismissal of three responsible board members which included the chairman, Richard Broadbent, and CEO Phillip Clarke as well.

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Corporate governance – a theoretical perspective.

In the light of stakeholder theory, corporate governance can be seen as the collection of policies and principles that are necessary to maintain the morals and ethics of conducting a business while valuing the stakeholders and their interests. According to Courteau et al. (2017, p.1), stakeholders theory is known for its managerial side and declares that the company and the board of directors are responsible to value the interests of the stakeholders while valuing the morals and ethics of conducting the business (Alpaslan, Green and Mitroff, 2009).

In the case of Tesco PLC, the company has failed to value the stakeholders’ interests during the governance process. The board of directors failed to value the interest of their shareholders while disclosing the fake information and overstated the company profits to gin investments and profits from the investors. Similarly, the company audit committee of Tesco PLC also paid no attention to the values of its stakeholders which led to the fraud (TheGuardian.com, 2014).

Lessons Learned

The weak corporate governance structure of Tesco PLC and no attention to the overstatement of profits results in such fraud which not only penalizes the company with extra charges, but it also affects the overall market reputation of the company in the eyes of the shareholders and customers. Because of the accounting fraud of Tesco PLC, it has been evident that the internal and external board of directors of the company are responsible to make strategic decisions for the avoidance of such mishaps in the reporting or disclosure of financial statements (Kukreja and Gupta, 2016).

Moreover, it is also recommended that the company must be including effective regulations and viable accounting practices so as to avoid such fraud. Similarly, good leadership and governing practices should also be incorporated within the corporate governance of the company in order to keep the employees on track to meet organisational goals while meeting and valuing the stakeholders’ interests and legal rights. If the corporate structure and board of directors of Tesco PLC could have valued the stakeholders’ values and concerns while keeping the personal gains for the company aside, the company might not have indulged in such serious accounting fraud.

As a concluding statement, it has been observed that Tesco PLC has been known for its misstatement of profits in accounting books to grab the attention and investments of the shareholders to increase profits. This has occurred because of a weak corporate governance structure and a lack of attention from the board of directors and audit committee to this issue. Hence it can be recommended that the company should have an effective corporate governance structure with the inclusion of Governance Code provisions and potential board members in order to avoid such frauds and scandals.

Abdullah, H. and Valentine, B., 2009. Fundamental and ethics theories of corporate governance. Middle Eastern Finance and Economics , 4 (4), pp.88-96.
Alpaslan, C.M., Green, S.E. and Mitroff, I.I., 2009. Corporate governance in the context of crises: Towards a stakeholder theory of crisis management. Journal of contingencies and crisis management , 17 (1), pp.38-49.
Awolowo, I.F., 2016. Financial Statement Fraud: The Need for a Paradigm Shift to Forensic Accounting. system , 7 (10), p.23.
Bebchuk, L., Cohen, A. and Ferrell, A., 2008. What matters in corporate governance?. The Review of financial studies , 22 (2), pp.783-827.
Bhagat, S. and Bolton, B., 2008. Corporate governance and firm performance. Journal of corporate finance , 14 (3), pp.257-273.
Courteau, L., Di Pietra, R., Giudici, P. and Melis, A., 2017. The role and effect of controlling shareholders in corporate governance. Journal of Management & Governance , pp.1-12.
FinancialTimes.com, 2014. Available at: https://www.ft.com/content/71118e80-4a20-11e4-bc07-00144feab7de
Ismail, I.N., 2017. The Roles of Corporate Governance and its Influances on Risk and Performance: Tesco Plc.
Kukreja, G. and Gupta, S., 2016. Tesco Accounting Misstatements: Myopic Ideologies Overshadowing Larger Organisational Interests. SDMIMD Journal of Management , 7 (1), pp.9-18.
Müller, M., 2015. Critical Analysis Of The Financing Policies of Tesco plc.
TheGuardian.com, 2014. Available at: https://www.theguardian.com/business/live/2014/sep/22/tesco-launches-inquiry-after-overstating-profit-forecasts-by-250m-business-live
TheTelegraph.co.uk, 2014. Available at: https://www.telegraph.co.uk/finance/newsbysector/epic/tsco/11181686/Tesco-crisis-what-you-need-to-know.html
Woods, M., 2007. Linking risk management to strategic controls: a case study of Tesco plc. International Journal of Risk Assessment and Management , 7 (8), pp.1074-1088.

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Accounting Fraud At Tesco Stores (A) Harvard Case Solution & Analysis

Home >> Harvard Case Study Analysis Solutions >> Accounting Fraud At Tesco Stores (A)

Accounting Fraud At Tesco Stores (A) Case Study Analysis

A PwC audit does not help. The auditors looked back on the long history and did not ignore the large-scale fraud. In addition, Tesco is in situations where auditors are generally unaware of the frauds, for example: Tesco paid £ 5.5 million to PricewaterhouseCoopers during the 2013/14 audit and then £ 5.7 million for non-audit work - all in coordination with Tesco (Tesco). "Non - Audit Services Policy". Tesco is offering a revolving door to PwC College students - members of Tesco’s two boards are PricewaterhouseCoopers (PwC) and a number of former CFOs, including the defendant McIlwee. Since 1983, PricewaterhouseCoopers has been the auditor of Tesco.

According to Tesco’s financial report; PricewaterhouseCoopers faced accounting problems and drew the company’s attention. PricewaterhouseCoopers provided the following explanation for “recognized operating income” in Tesco’s 2014 Annual Report “Independent Auditor’s Report of Tesco Members”:

Revenues recognized during the year (promotional payments, rebates and supplier rebates) are essential to the income statement, and the value accumulated at the end of the year is assessed. We focus on this area because we have to make decisions when reviewing the business income transactions and there is a risk that we will process these balances.

In PwC's 2013 annual report, PwC's independent auditor's report did not include a language on the company's income. This shows that PricewaterhouseCoopers has strongly proposed a trade revenue adjustment in 2013/14, and PricewaterhouseCoopers has given an ultimatum to Tesco: explain the trade revenue adjustment, otherwise we will include it in a note to focus on this area for risk management. Tesco’s management obviously chose the latter.

Recommendation:

Tesco’s current financial scandal is a symptom of a potential problem that has occurred as a result of a company whose deeper issues are still visible at a boarder level. Leaders shouldn’t just develop good leadership standards, but should also ensure a strong corporate governance culture. This type of crisis could be avoided by fair accounting firms that apply good accounting practices rather than internal reporting structures, which are subject to high levels of pressure. For outsourced accountants; high levels of pressure do not improve the matters, because their livelihood does not depend on the manager’s good aspect. Third-party auditors are more likely to issue fair reports and adhere to the strict accounting practices.

As the company’s 2014 annual report states, “At least 70% of the bonus is based on the financial performance. Typically, about 30% of the bonus is used to limit performance. Once the desired level of performance is achieved; all bonuses would be based on performance. Therefore, Tesco officers and directors are encouraged to increase the company’s income, in order to meet the financial objectives, i.e. bonus, standards and internal control measure.Toincrease its profits; the company's short-term compensation policy should be reviewed, reducing the share of financial performance bonuses or by making them more expensive.

In addition, Tesco can only report revenue and sales growth if it incorrectly recognizes the business’s income generated by bonuses, rebates and rebates from UK suppliers and by applying British accounting standards that do not explicitly separate the disclosure of vendor-based information. We recommend that the seller’s trading revenues should be disclosed separately to avoid the replication of the plan used by Tesco.

Conclusion:

Tesco, the UK’s largest retailer, has agreed to pay $ 162 million in fines and damages to the conduction of 2014 fraud investigation, the biggest crisis in the company’s nearly 100-year history.

The supermarket group has entered into a so-called deferred fee (DPA) in the UK, with the Serious Fraud Office (SFO), which allows it to avoid the criminal convictions, provided they meet certain conditions and pay fines. The company will pay an approximate total of £ 85 million in compensation to some of the investors.

The retailer has also entered into an agreement with the UK’s Financial Conduct Authority (FCA) in which it accepts an abusive market conduct in its commercial report issued on 29 th August, 2014. The FCA did not impose a fine on Tesco. As part of the transaction, Tesco will set up a compensation plan for investors who purchased the shares or bonds for cash between 29 th August 2014 and 19 th September 2014, at an interest rate of 24.5 pence per share, and depending on whether or not the investor buys - It depends on different interest rates,institutional or retail business.

In order to delay the accumulation of costs; paper invoices should be transferred from the fixed process itself, which requires an internal control. This means that the management is fully aware of the accounting irregularities. However, the reporter’s warning was highly ignored, and the warning was allegedly withdrawn, deliberately.

PricewaterhouseCoopers had previously expressed concernsover the recording of Tesco’s commercial revenues in the annual report, but the company’s internal reporter warned the board of directors about the severity of the problem. PricewaterhouseCoopers clearly warned the company about the risk of artificial manipulation, but it eventually allowed the company to pass it on, and it also issued an unqualified opinion on the company’s erroneous financial statements .

The conclusion of this study is that the accounting scandal can be attributed to the negligence of internal controls and auditors. Regardless of the control measures taken or the accounting and reporting standards established; if people working in the system choose to circumvent the control system; it would be almost impossible to prevent such fraudulent activities.....................................

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The Tesco Accounting Scandal

Christopher Bush, Tesco UK's former managing director, Carl Rogberg, the company's former UK finance director, and John Scouler, its former UK food commercial director, have been accused of abusing their positions to falsely inflate the grocer's profits in 2014.

The three men have been charged by the Serious Fraud Office (SFO) with one count of fraud by false accounting and one count of fraud by abuse of position, which can lead to prison sentences of up to seven and 10 years, respectively. [1]

The three former Tesco executives were "generals" who manipulated accounts, bullied and coerced subordinates to falsify figures and lied to auditors in an effort to massage the profits of the struggling supermarket. [2]

The men are alleged to have inflated Tesco's 2014 interim profit forecast by "pulling forward" or improperly recognising income from suppliers.

They are also accused of falsifying accounting records and concealing information from auditors between February and September 2014.

This is the Tesco scandal in 2014.

However, when the Enron scandal came to light there was a great expectation that this type of scandals would not be repeated, and Sarbanes-Oxley, or SOX, came to life in 2002. Enron was one of the biggest and, it was thought, one of the most financially sound companies in the U.S.

In 2003 Parmalat, "Europe's Enron", a dairy company that is a household name in Italy and was one of the country's few international businesses, discovered that it had a €14bn ($20bn) black hole in its books. It collapsed virtually overnight.

Mr Tanzi and some of his fellow executives had enmeshed Parmalat in a bewildering array of borrowings, false accounting, and misleading reports to investors and regulators. These were created to hide accumulating losses that were the result of a series of expensive acquisitions.

The common element of these cases is false accounting, confirming once more how alive the myth of the amoral business is. What this myth claims is simply that business is concerned with a highly pragmatic search for profits and individual careers, and that moral concern is and should be left out of the reflection around practical business problems. If fraud and corruption exist in business, that is no cause for alarm or action.

Tesco's case is not different and that it is illustrated by the former Tesco executives' actions and behaviour. They not only had "massaged" Tesco's profits to make them appear better than they were but also had "pressured others to conduct themselves in such a way that the stock market was ultimately misled."

Ms Sasha Wass, QC, said that Tesco had set aggressive and unrealistic profit targets despite falling sales, resulting in an environment where "unorthodox" practices took place. The motivation of the three men was not clear, but she said that they may have wanted to keep their jobs and lucrative compensation packages, which were worth more than £1m a year.

The myth of the amoral business does not explicitly say that business is immoral, rather that business leaders sometimes act without concern for moral aspects, thus creating scandals along the way.

On the other hand, silent and cynical bystanders remain passive because they believe that corrupt behaviour is the norm among managers and, accordingly, nothing to be too upset about.

In the Tesco's case there were no bystanders, some employees left because they could not bear the idea of what was happening and were not prepared to be part of it, and two employees took action. It came after a document, called the "legacy paper", was "prepared secretly" by two employees in Tesco's commercial finance department.

An important lesson to be learnt is how important is to be aware and stay alert of actions and red flags of fraud and corruption.

And I will leave it with a question to reflect on: should the quality and standard of audit be raised in order to be able to detect this level of irregularities which could lead to fraud?

[1] http://www.telegraph.co.uk/business/2017/09/03/former-tesco-directors-face-trial-accounting-scandal [2] https://www.thetimes.co.uk/past-six-days/2017-09-30/business/tesco-chiefs-bullied-staff-to-massage-the-figures

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Accounting Fraud at Tesco Stores (A)

Format: Print
| Language: English
| Pages: 21

About The Authors

Jonas Heese

Suraj Srinivasan

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Accounting Fraud at Tesco Stores (B)

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Accounting Fraud at Tesco Stores (B) By: Jonas Heese, Suraj Srinivasan and Julia Kelley
Accounting Fraud at Tesco Stores (C) By: Jonas Heese, Suraj Srinivasan and Julia Kelley
Accounting Fraud at Tesco Stores (A), (B), & (C) By: Jonas Heese and Suraj Srinivasan

Accounting Fraud At Tesco Stores (A)

Case Solutions

Accounting Fraud At Tesco Stores (A) Case Study Help

To keep the falling margins of the organization confidential and to retain the highly paid jobs of the executives;defendants Clarke and Mcllwee were misleading the representation of the organization’s financial status because the executive bonuses were mainly associated with the organization’s financial performance. Based on the information provided in the Annual Report of 2014, an approximate of 70 percent of bonus was found to be associated with the financial performance. In general, around 30 percent of the bonus is paid for the thresholdperformance, around 50 percent of the bonus is paid if the delivery of target level performance is with full bonus that is known to be paid to deliver stretching performance level.

The chairman of the Remuneration Committee–Stuart Chambers at Tesco,stated about the annual executive bonuses that “Bonuses will only be paid if profits have grown.”Thus, for stretching the commercial income;the defendants were incentivized to meet the requisite financial target for the payment of bonus. Considering the improper accounting practices and business approach; the market was flooded with the misleading statements and false financial reports by the defendants,in regards to the successful organizational transition.

Through the class period, the organization represented an ability to only report the sales and revenue growth by an improper recognition of commercial income from rebates, discounts, and premiums,which were claimed by the Tesco’s British suppliers. This was mainly to support the promotions and to reach the certain targets of volume purchase. Although rebates and premiums are not considered as uncommon practices in the supermarket industry, but the violation of accounting rules by the organization to report fictitious and premature commercial income was illegal. Similarly, the advantage was taken by the accounting rules of the United Kingdom,which did not represent the explicitrequirement of separate disclosure of income based on supplier.

Fraud Analysis:

Accounting practices that result in false claims about Tesco’s profits, have so far been discovered in the company’s food market in the UK, where the relationship with defendants is closest and in highest control. In the accounting scandal; eight senior officials were asked to resign. Defendant participated in a complex billing plan that Tesco violated International Financial Reporting Standards (IFRS) by using unfair and illegal accounting practices, to cover its distressed profit margins:

Early and fictitious recognition of corporate income.
Delayed accumulation.
Exaggerate the stock.
Distortion of "transactional profit" and "basic profit"

If there isn’t any bad accounting practice; Tesco can report a sudden drop in profit or even a loss, during the course.

Tesco’s Supplier Agreements:

In the global food industry; the revenue of trade can be obtained in several ways from suppliers and sellers. For example: supermarkets can make money to reduce the net cost of their inventories by placing products on affordable shelves or displaying posters provided by suppliers in stores. This type of premium can be accounted as revenue or as a reduction in the cost of inventory or sales, depending on whether the retailer sells the goods during the reporting period or not. Supermarkets may receive discounts and rebates for exceeding the pre-determined sales or purchase targets and for reducing or agreeing to return goods. Although bonuses and rebates are all business income, which are generally considered as income only if the third-party supplier, manufacturer, or distributor pay cashto Tesco.

Due to the sales’ difficulties, even if the turnover is inaccurate or incorrect in accounting standards; the business still depends on the recognition of turnover,for example: if Tesco runs out of £ 50 million; it will force its suppliers to offer and confirm rewards and rebates, even if there is no guarantee that the seller will receive them. If Tesco’s deficit is only temporary and exceeds at least £ 50 million set for the next period; it will reimburse the reinforced shadow or early income. However, if another £ 50 million breach occurs the next year; Tesco will be forced to borrow the full £ 100 million loan, in future.

Defendants Knowledge of Improper Accounting Practices:

Defendant Clark himself created a culture of despair and negligence at Tesco. According to a source, Clark put tremendous pressure on people to work out numbers, and the speaker line said, "I do not care what you do, you just do it." As such, insiders suggested they were "under pressure to improve their performance."

According to the Sunday Times, it was the same Tesco employee who warned the new CEO, David Lewis, pointing to the company’s inappropriate accounting practices and as the CEO of Defender Clarke;concerns were raised during the period, but they weren’t taken into account. Lewis confirmed the severity of the accounting problem over the weekend, pointing out that Defendant Clark is very wise to ignore the reporter’s warning.

Tesco will only be able to report income for the entire duration of the course if it incorrectly identifies the insurance premiums, discounts and rebates from Tesco suppliers, which the suppliers support for promotions or anumber of other procurement purposes. Sales growth,bonuses and rebates are not uncommon in the supermarkets, but Tesco has falsely and prematurely declared this type of trading income and applied the British accounting rules that do not require suppliers’ income to be disclosed separately, thus violating the accounting rules. Without this wrong accounting practice; Tesco’s revenues would decline drastically, sales costs would increase significantly and profits and revenues would decline drastically.

Role of External Auditor:

PricewaterhouseCoopers is currently being reviewed by the FRC for the 2011/12, 2012/13 and 2013/14 Tesco audits. According to the 2011 review; the Audit and Audit Report of the Accounting Supervisory Board of Listed Companies (PCAOB) of PricewaterhouseCoopers (London, UK) is dated back to 1 October 2013,with the following conclusion: "The deficiencies identified include such serious deficiencies indicating that the audit team believes that the company’s audit did not provide sufficient evidence to support the issuer's financial statements.".............................