Accounting Scandal: Tesco Case

Tesco’s accounting scandal caused a major division among its employees. In 2013, the company faced serious financial difficulties and lost its share of the global market. To avoid reputation-damaging issues, company executives have decided to overestimate annual profits by 2014, which he said is £250m. Some of the stakeholders involved in the scandal were shareholders, employees and suppliers. However, the fraud was exposed in 2014 after Amit Soni, the company’s senior accountant, was exposed and explained the extent of the hole. The company was forced to lay off four executives. It also experienced a decline in its financial performance due to the reduced consumer base and the lack of public trust. Tesco was also slapped with fines and penalties for its involvement in fraudulent activities and misleading the investors. In the quest of avoiding similar fraud in the future, it will be necessary for the company to embrace a culture of integrity and transparency. The firm will also be required to ensure that it abides by the set accounting standards and ethics.

Keywords:

Stakeholder: individuals or parties that have stake in an organization or system

Immense: massive

Loopholes: escape routes or paths leading to irregularities

Tesco Accounting Scandal

Introduction

Tesco PLC operates under the retailing industry and is an international company. The organization has its headquarters in Welwyn Garden City, England. Over the years, Tesco has enjoyed immense growth, and it currently has 6,553 stores around the world. Some of the organization’s products include supermarkets, superstores, and hypermarkets. Having been founded more than 90 years ago, Tesco remains a giant in the retail sector, and this is attributed to its business strategies such as aggressive marketing and advertisement as well as the production of high-quality commodities that meet consumer satisfaction. Dave Lewis serves as the Chief Executive Officer of the company and is mandated with the role of ensuring that there are smooth operations and that it enjoys a large market share. As of 2016, Tesco had an estimated 476,000 employees across its stores. Subsidiaries of the company include Dunnhumby, Tesco Kipa, Tesco Bank and Tesco Mobile. In 2014, the company was involved in a major corporate scandal that ended up tarnishing its reputation and negatively impacted its financial performance. In this paper, an assessment of Tesco’s corporate scandal is conducted as well as its ethical implications.

Discussion

A Review of the Tesco Accounting Scandal

Tesco’s financial troubles began way back in 2013, but as a giant retailer in the UK, it had to ensure that it maintained its reputation through its financial statements. The organization’s chairman and other heads realized that meeting the set financial goals would have been difficult and rather than informing the public; they decided to overstate profits and lie to the public about their ever-swelling earnings (McNiss 2017, Web). The accounting scandal went public in mid-2014, and this was followed by the immediate stepping down of Broadbent as the firm’s chairman. The company had originally predicted that its profits in the year ending 2014 would have been £1.1bn which was not true. Apparently, the earnings for 2014 were overstated by £250m while those of the first quarter of 2014 by 326 million pounds (Hobson 2014, Web). A few weeks after the announcement of the involvement of the company in the fraudulent activities led to a significant weakening in the Tesco’s brand as well as its reputation (Ruddick 2017, Web). Shareholders that had invested a lot of money in the company ended up losing millions of dollars. The Serious Fraud Office (SFO) launched a probe on the company in 2014, and this led to the charging of three former executives in 2016. The firm was also slapped with a financial penalty of £129m and a compensation of £85m plus costs to the investors (Ruddick and Kollewe 2017, Web). After an investigation by the Financial Conduct Authority (FCA), the company was forced to pay fines totaling over 500 million pounds and more than 100 million pounds that shareholders incurred in losses.

IFAC Ethical Principles in the Case

In the Tesco’s accounting scandal, two IFAC Ethical Principles are evident. Integrity is one of the accounting codes of ethics that the company failed to uphold. Tesco Corporation’s financial performance was on the decline in 2013. However, instead of coming out and informing the public about the challenges it was facing, it decided to embrace fraudulent channels to maintain its reputation. The failure by the organization to adhere to the set accounting regulations and the Company Act is a clear evidence of lack of integrity (Butler 2017, Web). Another IFAC Ethical Principles that can be derived from the case study is professional behavior. The company’s top executives and accounting team that were the main architectures of the corporate scandal failed to comply with the relevant accounting rules and regulations (Ethicsboard.org, 2017, Web). Some of those staff members that were forced to make erroneous profit recording felt that it was unethical to engage in the practice and that their integrity was being put to test, and they opted to resign from the company.

Ethical Issues

There are various ethical issues that are evident in Tesco’s corporate scandal. First and foremost, the company lacks faithful representation in the preparation of its financial statement, and this means that some of the information in the 2014/2015 annual report is misleading and non-reliable to the public. According to the accounting concept, companies are required to ensure that their financial statements are an actual representation of the business, and this is hardly the case with Tesco. Another ethical issue that is outstanding is the lack of professional integrity within the organization. Integrity and transparency are critical components in the success of any organization (Economia.icaew.com. 2017, Web). Consumers and investors will always prefer companies that are bound by these accounting elements (Shaw 2017, pp.34-37). The quest by Tesco to maintain its market share, even with the declining financial performance drove its executives in breaking the ethical codes of conduct and integrity principles. They overstated the company’s profits and manipulated financial figures with the aim of portraying to the public that it was enjoying immense growth (Ruddick 2017, Web). By not coming out and being honest with the consumers and investors, the company lacked transparency. Any form of material misstatement and erroneous adjustments of the accounting figures an organization is considered unethical. When the company realized that it would not meet its set performance goals, it decided to add up financial figures contrary to accounting regulations. Finally, the accounting manager and the senior executives of Tesco engaged in the abuse of office by involving in the corporate scandal, an act that is against the ethical code of conduct and Company Act.

Fraud Triangle and Its Application

Fraud triangle refers to the framework that describes the reason behind fraudulent activities within a given organization. There are three factors that make up the triangle, and these include the pressure on the individual to commit fraudulent acts, opportunity that one has to commit fraud and the ability of an organization or individual to rationalize fraud (Brumell Group 2017, Web). Tesco’s accounting scandal was driven by its pressure to retain sustainability in the market. In 2013, the company’s financial performance was way below its set target, and the management realized that its market share would slump significantly in the following year. To deal with the issue, the company identified several opportunities that it could utilize in committing accounting irregularities (Brinded 2017, Web). One of these loopholes was the failure by the audit team to identify any form of inconsistencies, and this gave them the confidence to overstate its profits by £250m. The weak accounting ethics applicable within the organization also made it easy for the executives to push on with their plans of engaging in financial irregularities.

Regarding rationalization, the executives convinced the accounting team at the organization that the move was aimed at preserving the firm’s public reputation and ensuring that it continued enjoying a competitive edge over its rivals in the market (Shoaib 2017, Web). Some of the staff members that were told to misreport profits, however, resigned because they felt that their professional integrity was being compromised by the organization’s top leadership (Brinded 2017, Web). Senior Accountant at the firm, Amit Soni, blew the whistle on the massive fraud that was taking place in the company in September 2014, claiming that it would have reached £600m by the end of the year. The public announcement on the organization’s misdeeds almost brought it to its knees, especially when fraud investigators moved in to unearth the accounting rot in the firm. Had the company prevented all the three fraud triangle factors, it would not have sunk deep into the accounting scandal. The company was forced to pay an average of £400 per investor in 2017 as compensation schemes for its misleading trade statements (ACCA 2017, Web).

Accounting Irregularities

Various accounting irregularities were committed by the Tesco Corporation in the year 2013/2014. On realization that the company was plunging into financial troubles, rather than embracing faithful representation, it decided to manipulate accounting figures which is contrary to the set regulations. The staff involved in the scandal also failed to maintain their professional integrity which is a vital principle of the accounting regulations (Crump 2017, Web). Apparently, the overstatement on its profits was linked on its booking of payments from the suppliers. Another accounting irregularity committed by the companies was its financial statement errors that were knowingly committed by the senior executives and the accountants in the company. The unethical act led to the resigning of several staff members that believed in integrity and never wanted to be a part of the fraudulent activities (Muckett 2017, Web). Finally, it is the lack of transparency that made the organization fail to inform its investors on its financial troubles way before it was swallowed by the corporate scandal. Before the matter came to light, Tesco had successfully escaped the eyes of the accounting watchdogs in various countries around the world.

Subsequent Events or On-Going Consequences of the Accounting Scandal

After the public announcement of Tesco’s accounting scandal, its share prices on both the London Stock Exchange and the New York Stock Exchange fell significantly and most of the investors pulled out of the organization. The stock prices fell by 10%, and the new head of the organization had more fears about the preceding financial risks. In two weeks, shareholders lost approximately 65 million pounds in the organization. Chief Executive, Philip Clark was sucked for having masterminded the scandal. The chairman, Richard Broadbent, released a statement saying that he would resign from the company (Anderson 2017, Web). Senior staff members suspended included Chris Bush (UK CEO) and Carl Rogberg (finance director). The Serious Fraud Office launched its criminal inquiry into Tesco’s dealings. The Financial Conduct Authority, on the other hand, ordered the company to pay £85m to the investors due to the losses that they had incurred (Vandevelde and Binham 2017, Web). In its report, FCA claimed that the company had committed market abuse by inflating its profits to £1.1bn (Farrell 2017, Web). Nevertheless, it further states that there was no evidence that the board members of Tesco could have identified the misleading information on the company’s financial statement.

Tesco’s UK subsidiary, after the findings by the SFO on its fraud culpability, it agreed to pay a £129m fine. It also charged three senior staff members at the company that were directly linked to the accounting fraud and corporate scandal. The retailer also faces a 100 million pounds civil lawsuit brought by more than 100 institutional funds as well as a law suit filed by Manning & Napier seeking £150m in damages (Wearden 2017, Web). The company agreed that it would fully cooperate with the investigations by the FCA and the SFO (Shoaib 2017, Web). According to the company’s CEO, Lewis, upon paying all the settlements, the company will find it easy to restore its reputation and strengthen its brand. As a part of its recovery and restructuring, Tesco has in the past three years conducted an overhauling of its leadership and set up new organizational culture that will help it win public trust. Regarding its position in the retail market, Tesco recorded losses amounting to 6.4 billion pounds in 2015 and such poor performance was also witnessed in 2016 and 2017. The firm’s CEO argues that the financial troubles have been attributed to the reduced consumer base and aggressive competition in the market, especially after its accounting issues.

Recommendations

There are various measures that can be put in place to help in avoiding future fraudulent activities at Tesco. Firstly, the company needs to stick to the accounting standards and regulations when preparing its financial statements. Watchdogs such as Financial Conduct Authority and the Serious Fraud Office have to ensure that the company abides by the set rules and principles. On its part, the firm has to ensure that all its employees adhere to ethical codes of conduct and that any staff member that contravenes the law is punished (Boylan 2014, pp.67-69). Additionally, Tesco needs to create an organizational culture that is founded on integrity and transparency, and in so doing, this will help in enhancing its relationship with the customers and the shareholders. Sarbanes Oxley Act calls for regular auditing on an organization, and this implies that the company will have to source the services of established audit companies such as KPMG that will occasionally assess its annual financial statements and transactions to ensure that they are in line with accounting regulations. Finally, it will be essential for the company to come up with an internal fraud monitor units whose aim will be to ensure that all operations are done per the stipulated codes of ethics and accounting standards (Dale 2016, pp.587-592).

Conclusion

Tesco was once a giant in the retail market. However, its involvement in accounting scandal tainted its reputation, and this has ended up weakening its brand and cutting down its consumer base. The company has also been slapped with various penalties, and this according to the CEO has contributed to a decline in its productivity. In the quest of avoiding similar fraudulent activities in the future, it will be vital for the company to abide by the accounting regulations and ethical codes of conduct.

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