Carillion, a British professional services firm which provided facilities management and

construction services to the UK public sector, prior to its liquidation - officially,

"the largest ever trading liquidation in the UK"
In 2002, the scandalous collapse of the energy company caused the demise of one of the Big
Five audit firms, Arthur Andersen, resulting in the Sarbanes-Oxley Act’s stern reforms.
The now Big Four are in the crosshairs of U.K. regulators, following the spectacularly
speedy collapse in January 2018 of Carillion, one of Britain’s largest construction firms.
It was the largest insolvency in U.K. history, jeopardizing some 20,000 jobs and
countless pensions. The company went into liquidation with liabilities of $9 billion and
only a few million dollars in the bank. KPMG was paid £29 million to audit Carillion for
19 years.
All four auditing giants were connected to Carillion in some capacity, with KPMG its
external auditor. A House of Commons report says KPMG failed to challenge
management on “highly questionable assumptions” about construction contract revenue
and accumulated goodwill from acquisitions. As with Enron, this roiling hurricane has
whipped up urgent calls in the U.K. for auditing reform. Some want Parliament to
separate the audit work of the Big Four from their prized consulting services; others
suggest shattering them into multiple firms. While the first has been done in the United
States, some here are still calling for the second.

Big-Four accountancy firm KPMG has suspended Peter Meehan, the audit partner for
failed outsourcing company Carillion, and three other staff members after finding issues of
concern in documents given to the Financial Reporting Council’s (FRC’s) audit quality
review (AQR) of Carillion in 2017.

Meehan signed off Carillion’s accounts four months before the construction and services giant
issued a profit warning in July 2017, revealing an £845m writedown in the value of its contracts.

Missed red flags

At the crux of the committee’

At the crux of the committee’s line of questioning to the auditors was how the assessment of

Carillion’s accounts was able to change so drastically between March and July.

MPs brought questions to Michelle Hinchcliffe, head of audit at KPMG, Peter Meehan,

Carillion’s external auditor from KPMG, and Michael Jones, Carillion’s internal auditor from

Deloitte.
 Meehan attributed this dramatic re-assessment to the complex nature of the contracts, the
wide number of judgements needed to be made and a range of developments that
transpired between the March 2017 accounts sign-off and the July profit warning.
MPs expressed incredulity that KPMG saw no red flags prior to March, particularly in
relation to several problem contracts in which debt was mounting. Meehan said that he
was aware the company had its challenges but he believed it “had the reserves to deal
with those challenges.”
Referring to the increasingly tenuous position of Carillion, and KPMG’s insistence that it
only came to light between March-July 2017, Reeves commented:  “Investors seemed to
know, people who worked for the company seemed to know, the only people who didn’t
see what was happening were those who were paid to–  the directors and the auditors of
the company.”
When asked whether he would have done anything differently with the benefit of hindsight,
Meehan said: “I think me and my team all did the best we could and I stand by the
decision we gave on the 31 December 16 accounts.”

Problem contracts and cash flow constraints

Four problem contracts that were at the root of Carillion’s downfall – one in Qatar, the Royal

Liverpool University Hospital, the Sandwell Midland Metropolitan Hospital and the Aberdeen

bypass.

Carillion directors and auditors pointed to the Qatar contract as a major factor in the collapse, as

the contract racked up £200m in unpaid bills and exacerbated pre-existing cash flow problems.

“It had 2,500 design variations to it, and essentially we were not paid for 18 months prior to the

business failing.”

However, due to the nature of the contract, Howson explained Carillion could not “wilfully

abandon” the project despite not being paid, as Msheireb Properties, the Qatari client company,

would “pull the performance bonds.”

Despite unpaid bills piling up and auditors being aware of the problems surrounding the Qatari

contract, no provision was made in the March 2017 accounts, which said that Msheireb owed a

mere £70m in comparison with Carillion’s estimate which was closer to £180m at the time.

When KPMG auditors were in the hot seat MPs also raised the issue that Msheireb disputes the

£200m bill, who claim that in fact they are owed that figure.
MP Peter Kyle questioned Meehan over why this debt was not recognised in the accounts signed

off on in March 2017, asking incredulously: “You don’t know whether your client was owed

£200m or it owed £200m?”

Aggressive accounting, revenue recognition and goodwill

Former CFO Emma Mercer added: “What I saw when I returned to the UK is that both the

number of contracts we were taking judgment on and the size of those judgments had increased.”

When MPs asked the auditors whether they recognised these practices, Meehan said “I

personally would not use the word more aggressive” but said that he told Carillion directors that

on the spectrum of cautious to optimistic, they had moved towards the optimistic end when it

came to appraising “riskier contracts”. 

In the 9 July assessment KPMG concluded there was a general lack of consistency around how

the group recognised value on claims, with claims being booked earlier in comparison with

others in the industry. Meehan was steadfast that this only came to light after the March sign-off.

Carillion’s high reliance on goodwill in valuing its assets was also a problem referenced by MPs.

Ruth George pointed out to Carillion directors that in 2016 “84% of your balance sheet was

made up of goodwill”, amounting to £1.57bn, which essentially disappeared overnight when the

company’s troubles came to a head. In Carillion’s 2016 accounts it is stated that management

decided that no impairment to goodwill was necessary.

Pension deficit nearing £1bn

Carillion’s collapse put thousands of jobs at risk and jeopardised the pensions of around 27,000

individuals, resulting in a £990m pension deficit.

MPs questioned former executives and The Pensions Regulator (TPR) over whether it was

worrying that the company was paying “mega dividends” and large bonuses while such a large

pension deficit persisted and continued to grow. In late 2017 Carillion’s contribution payments to

the pension scheme were deferred.

MPs pointed to the fact that in 2016 higher dividends were paid than the previous year. Put

simply, MP Andrew Bowie said: “You were prioritising the share price and dividend over

funding the pension scheme.”

A 15 year deficit recovery plan was agreed with trustees, which MPs said seemed unacceptably

long. When queried over how many other existing recovery plans are over 10 years long, TPR

could not answer.

“In January 2018 due to KPMG’s involvement in the firm as it collapsed, the Financial
Reporting Council launched an investigation into KPMG’s audit of the financial
statements of Carillion for the years ended 31 December 2014, 2015 and 2016, and
additional audit work carried out during 2017.
In the meantime, it has been announced that KPMG now faces the threat of a legal challenge
from the UK agency tasked with unwinding Carillion, the outsourcer that collapsed last
year, over allegations that the Big Four accountancy group’s audit of the company was
negligent. According to reports from the Financial Times, Quinn Emanuel, a US-
headquartered law firm, has been hired to pursue a legal case by the official receiver, a
civil servant employed by the Insolvency Service on behalf of Carillion’s creditors, and
PwC, who managed Carillion’s liquidation, according to two sources close to the firm.

It is now preparing to notify KPMG that it plans to file claims at the High Court, the
people said. KPMG will have three months to respond to the firm’s letter, meaning a
claim could be filed early next year.

https://www.accountancyage.com/2018/02/26/carillion-inquiry-missed-red-lights-aggressive-
accounting-pension-deficit/