September 22, 2018

Time for transparency

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Carillion plc is a British multinational facilities management and construction services company, employing around 43,000 people worldwide (20,000 in the UK) with annual revenues of around £5,000m.

Last month, as news of the collapse of Carillion filtered through, shareholders in Carillion plc must have been wondering just where their investment went wrong. To find out, they may have gone to the company website, discovered its’ unusual new homepage and then clicked on the ‘Shareholders’ link. This is what they will see today:

‘Unfortunately, as a result of the liquidation appointments, there is no prospect of a return to Carillion’s shareholders.’

The last time many of the investors (particularly small ones) might have interacted with Carillion was to cash their dividend cheques and perhaps look at the most recently filed audited annual financial statements for the year to 31 December 2016.

Some investors may have simply been delighted with a rise in the dividend paid from £80.0 m in 2015 to £82.7 m in 2016 despite general poor economic conditions.

Some might also have looked at the profit and loss account and seen a drop in profit for the year from £139.4 m in 2015 to £129.5 m in 2016 and frowned, firstly, at why such a large percentage of the profit each year appears to have been paid out as dividends and, secondly, why the dividend is increasing whilst profit for the year is going in the opposite direction.

Some, in addition to being delighted at the dividend and looking at the profit and loss account, might have consulted the company’s balance sheet, its statement of assets and liabilities. What they would have seen were net assets (i.e. all assets less all liabilities) of £729.9 m in 2016, down from £1,016.6 m the year before. Two questions might have been asked:

  • What is the largest single asset comprised of?
  • Why did the net asset value of the company fall by nearly 30%, given that the company declared a profit in 2016?

Consulting the notes to the accounts would have shown ‘intangible assets’ at £1,669.3 m as the largest single asset and a ‘remeasurement of net defined benefit liabilities’ causing a £439.7 m reduction in the net asset value in 2016. Accounting gobbledygook?

Note 11 to the accounts reveals ‘intangibles’ to be mainly goodwill generated when Carillion acquired its various subsidiaries. Goodwill should be an asset whose value reflects an assessment of the anticipated value of future cash flows to be generated from these acquired companies. In light of the subsequent liquidation of Carillion, this rings a bit hollow perhaps.

‘Remeasurement of net defined benefit liabilities’ translated into further accounting jargon by note 30 to the accounts, would appear to be a major contributory factor to the increase in the pension fund deficit. Measured by whom? Remeasured by whom? Why? The myriad of in accounting adjustments disclosed in note 30, gives all the appearance of smoke and mirrors at play. Perhaps alarm bells should have rung?

Investors with some financial background may have done some in-depth analysis of the financial statements, but most would not have performed even a fraction of the above, and so would probably not be concerned about the prospects for their investments.

A set of financial statements, with an unqualified audit opinion from KPMG, should be able to give investors some comfort as to the performance of their investments. The figures in this article refer to the position at 31 December 2016.

It is not yet clear what occurred in 2017 to force the collapse and eventual liquidation of Carillion plc in January 2018. What appears clear is that it came as a bolt from the blue to most investors. The clues were perhaps already in the December 2016 accounts but the lay investor seems to have been unable to spot them due to accounting opaqueness. Some other investors, notably hedge fund managers, were suspicious from 2014 and more recently, before its collapse, because Carillion was the most shorted stock on the London Stock Exchange. A shorted stock is one that is sold at today’s price in the belief that price will fall and the investor can then repurchase the stock later at a reduced price.

Will this liquidation force the accounting profession (and perhaps even compel government intervention) to make published corporate financial statements transparent, giving more explanation and reasoning for accounting adjustments in plain language that all can understand?

Investigators into the collapse of Carillion might just want to take some time to reflect.

Colin Garvie, Teaching Fellow About Colin Garvie, Teaching Fellow

Teaching Fellow and Chartered Accountant, delivers Accounting to on-campus students in Edinburgh, Malaysia and Dubai.