Why didn’t auditors spot Ted Baker’s overstated inventory?

Another accounting failure.

Another week and the UK has another accounting/auditing and corporate governance failure.

This time it is at Ted Baker plc, a luxury international clothing retailer listed on the London stock Exchange with 3,600 employees.

The company says that its inventory shown in its accounts for the year to 26 January 2019 has been overstated by £58m.

Just seven weeks earlier on 2 December 2019, the company’s preliminary estimate had said the inventories were overstated by £20m to £25m. The problems go back to a number of years and £58m may not be the end of it.

The overstatement of inventory is significant. The Group’s 2019 post- tax profit was £41m.  The write-off of the overstated inventory value would more wipe out more than a year’s profits. 

The overstated inventory enabled the company to report higher profits and paint a rosy picture of its affairs.

The company paid record £27.3m in dividends in 2019, compared to £24.5m in 2018. The dividend per share was 40.3p in 2015 and by 2019 it rose to 58.6p.

This is even though in a difficult trading environment the company’s pre-tax return on capital employed had declined from 32% in 2015 to 20.9% in 2019 i.e. the productivity of its assets is declining.

The company says that its inventory problems relate to “prior years” but does not say how far back.

Since 2001, Ted Baker has been audited by KPMG and the firm has always given the accounts a clean bill of health.

Its audit report dated 31 March 2019 stated that inventory valuation as a significant item but did not say that anything was wrong.

The directors stated that “on the basis of their audit work, the external auditors reported no inconsistencies or misstatements that were material in the context of the financial statements”. 

Accounts show that KPMG collected fees of £445,000 in 2019 and £397,000 in 2018. Nothing is publicly known about the time that KPMG staff spent on the audits, the composition of its audit teams, significant questions that the firm asked, replies from directors, or the audit work carried out to corroborate the company’s inventory valuation.

Despite scandals at BHS, Carillion, Thomas Cook, London Capital & Finance, Patisserie Valerie and elsewhere there is a no mechanism to enable stakeholders to monitor any aspect of the external audit.

Ted Baker is part of a long line of companies who boast the usual paraphernalia of corporation governance. The company has non-executive directors, audit committee, risk committee, internal auditors and sundry advisers.

The effectiveness of such structures and individuals must be doubted. The company also claims to have complied with the voluntary Code of Corporate Governance. The Code is not legally enforceable and does not give enforcement rights to any individual stakeholder.

The company also has a remuneration committee which doles out remuneration of executives. The remuneration package is based on a number of variables, one of which is “profits”. The overstatement of inventory would have resulted in overstatement of profits and higher executive pay and bonuses.

Directors also held shares and share options whose value could have been enhanced by higher reported profits.

It remains to be seen whether any executive pay would be clawed back, or auditors would return their fees.

KPMG is not the only firm collecting fees. PricewaterhouseCoopers (PwC) advises the company on risk management, effectiveness of its internal audit function and executive pay. The fees are not known.

In December 2019, the company appointed law firm Freshfields Bruckhaus Deringer to various issues and it subsequently brought in Deloitte, another of the big four accounting firms, to look at inventory problems.  The £58m error is an outcome of a review by Deloitte. Its fee is unknown.

In due course, it looks like Ted Baker will need to write-off the overstated inventory. This will reduce reported profits and erode the company’s ability to pay dividends.

Stock markets are not keen on companies not paying dividends so the company will have to consider ways of boosting its earnings.

Maybe it will reduce repairs, maintenance and other discretionary expenditure and also consider job losses. Yes, employees always get it in the neck for other people’s failures.

The Ted Baker episode is part of a steady stream of corporate governance, accounting and auditing failures. These have not resulted in any meaningful reforms.

In the corporate world, executive directors continue to appoint their friends as non-executive directors who almost always fail to invigilate companies. Auditors continue to deliver poor audits but face puny sanctions. 

At company AGMs, auditors are (re)appointed but the resolutions are not accompanied by any information about the audit process, recent regulatory sanctions against the firm or anything else.

There have been reports by Competition and Markets Authority and Sir Donald Brydon but even those weak recommendations have not been implemented. Well, there is no business like accounting business as firms collect fees and other bear the consequences.

Ted Baker declined to comment.

Prem Sikka is a Professor of Accounting at Sheffield University and a contributing editor to Left Foot Forward.

The Carillion collapse was followed by promises of reforms, but more avoidable scandals are inevitable – Prem Sikka

How companies use debt to line their pockets – Prem Sikka

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