Tesco PLC

One of the biggest grocery chains in the world is Tesco PLC. Jack Cohen founded the business in London in 1919, and since then it has expanded to operate in more than 11 countries and employ more than 470,000 people, making it the third-largest grocery and merchandising firm in the world. The company, which bases the majority of its operations and activities in the United Kingdom, has expanded its product line to include anything from household goods to financial services. The ambition of the business to grow both geographically and in terms of its product offerings can be considered as the cause of the company’s expansion (Gerson, Brolly and Skalak 2006.). The company also started offering fuelling service in its own Tesco branded petrol stations across the United Kingdom. The company is listed in the London stock exchange and is included in the FTSE 100 Index. The company has aggressively adopted an oversea expansion strategy in Europe Asia and the USA. This has been driven by the increasing competition in the United Kingdom as new entrant’s squeeze market share. This has led the company to focus on venturing into foreign market so as to increase its profits (ACCA, 2017). The company has adopted several strategies in venturing into new markets. It has penetrated the international market through buying local store chains as especially in the European market in Czech Republic Hungary and Poland.

In Asia the company adopted a different strategy form the one used in Europe manly due to local customer expectations. It has entered into partnership with local ventures so as to start is business. The company has set up stores in South Korea Japan china and Thailand. The company also operated a chain store in the United States named Fresh and Easy. The chain owned over 200 stores in Arizona Nevada and California before it was sold to YFE Holdings Inc. in 2013. The aggressive foreign expansions portrays the company’s desire to remain profitable in the ever changing UK market. It is also essential to note that the company holds the largest British market share (28.4 %) amongst its peers (Wood, 2017). The company has maintained consistent profits for over 37 years since late 1970s when the company undertook a restore following bad reputation and culture in its operations (ACCA, 2017).

The Scandal

In the 2014 the company’s reputation and success went through a bashing when it was discovered that the company had overstated its profits by a whopping £250 million. The company had overstated its figures when it released its half year financial reports. This led to the not infamous Tesco accounting scandal that led to the indictment of several of the company’s executives. The scandal also tarnished the name of the company’s auditors, PWC who are accused of colluding with the company to dupe the general public (Shoaib 2017). The overstatement was believed to have been the result of an aggressive accounting method that accelerated the recognition of income while delaying the accrual of costs.

After an independent audit by Deloitte the company was found to have boosted its figure in the previous two years showing a consistent trend in irregularities. It is believed that the company was boosting it figures to appeal a healthier image to the public. This came into the light of dropping annual profits as result of growing competition in the grocery sector. The growth of discount stores such as Aldi and Lidl has largely inflicted a huge damage on the company’s market share. It’s estimated that the competition led to £10billion wipe out in market value when the company announced the first drop in profit after a two decade dominance (Ruddick and Kollewe 2017). The scandal is believed to have been undertaken with collusion with the suppliers who agreed to make payments before the delivery of their products to the store in exchange of benefits that were carried forward in the next financial year. These secret agreements were never reported in the financial statements of the company. This helped the company to meet short term financial targets at the expense of the long-term growth the reputation of the company. This were the same accounting methods that led to the debacle of WorldCom and Enron in the early 2000s (Phillips 2017).

Upon the revelations of the scandal the Financial Conduct Authority undertook investigation into the scandal leading to the resignation of the then chairman of the board of directors Sir Richard Broadbent (Muckett 2017). The case also attracted the attention of the Serious Fraud Office agency who pursed investigation into the scandal. The company agreed to pay fine amounting to over £ 235 million for the charges to be dropped. The company however did not admit to any wrong doing in the settlement. In the deferred prosecution agreement the company was to pay a £129 fine to the serious fraud office and another £ 85 million to the Financial conduct Authority for the compensation of all investors affected by the scandal. The settlement however did not prevent the investigation on three of the key executive that were blamed for the scandal. Former Tesco executives Carl Rogberg John Scouler and Christopher Bush are in accounting trial that cites the abuse of their positions and fraud accounting that led to the scandal. The company was quick to accept the deal to salvage its image and reputation (Montagnon 2017).

Ethical Issues

The scandal has raised several issues in regard to the importance of financial reports from company whether private or public traded. It is clear that some executives have been using the reports as way of improving the public outlook of the company. This boosting of figures hide the true image of the company which in most cases is used to hide debts. WorldCom using the same styles of accounting was able to hide over $ 11 billion dollars of debt. This has a huge and adverse impact of the stock of a company. In the short run numerous investors buy the stock with the hope of increased earnings. These investor stand to lose when the fraudulent accounting is made public leading to an impact on the brand reputation amongst investors.

Fraudulent Triangle

The scandal was brought about the desire by the executive to boost the figures that would portray that the company was healthy despite the immense competition. The executive viewed overstatement as the best tool to enhance investor confidence despite the company’s decreasing performance. The boosted earnings would bolster the stock and thus the reputation of the company. This was a fraudulent short term solution to the company’s problem. They did not want to report the decline on profits the first of a kind in over two decades. The investigation revealed that the company had perpetrated this fraud for two previous year prior to the scandal.

The executives were willing to compromise the integrity and transparency of the company for the sake of short term goals. The company had been facing intense competition from discount stores such as Albi and Lidl with a decreasing market share (Manger. and Brazil 2015). This was due to the competitor’s strategy of low pricing. In a move to engage the completion the company had undertaken price reduction and closed over 43 loss making stores (Mohamed and Handley-Schachler 2015). Despite all these the company wanted to portray financial reports. This led the need for innovation of ways of to improve its earnings.

IFAC Ethical Principles in the Case

The executive contravened ethical standards set out by the in by the International Financial Federation of Accountants. Professional accountants should uphold a very high level of integrity in their work. The accountant should present straight forward information that is honest. The accountant ensures that the information they prepare should be free of mislead statements, reckless and obscure information (IFAC 2017. The executive of Tesco intentionally engaged in fraudulent activities that lead to the presentation of falsified information and hence contravening the IFAC code of ethics

The code of ethics further requires the accountant to remain objectivity in their preparation of report and statements portraying the position of a company. They should remain unbiased and should not allow influence to be exerted on them. They should further not influence their juniors to engage in activities that may harm the reputation. The executives at Tesco lost objectivity in the preparing of the company financial statements. The started engaging in short term activities rather than focusing on the long-term objectives to improve the company’s earnings (IFAC 2017. They started focusing on the performance of the company’s stock rather that the general earnings of the company.Professional accountants should always exercise due care and competence in their conduct. This will help secure the professional and maintain high standards. They should always maintain diligence in their work that is above reproach.

Accounting Irregularities.

The Tesco accounting scandal facilitated several irregularities that contravened internationally recognised standards. Form the year 2012 the accountants in the company engaged in fraudulent activities that contravened basic accounting standard. The company reported fictitious and premature commercial earning form the suppliers. The international standard clearly state that the revenue is only reported after the completion of transaction. It is provided that a company can estimate its earnings provided there is reliable method estimating the income. In the cases of Tesco there is no reliable methods established by the company to establish the estimates (IFAC 2017. The company however reported the estimates as earnings without clearly due diligence in their calculations.

The company further breached international standards in tis reporting of rebates and purchase discounts. It is generally agreed that purchase discount and rebates are not recorded as revenue. They are reported as reduction of cost of inventory if the goods have not yet been sold. For the goods that have already been sold its prudent to report them as a reduction in the cost of sales (IFAC 2017. Tesco in the fraudulent endeavour reported rebates and purchase discounts as reduction to the cost of sales even before the goods were sold. This failed to follow this principle due to executive desire to inflate the gross margin percentages. Tesco further to disclosure and reveal objectively all its commercial income in its financial reports (van Rinsum 2017).

Subsequent Events

When the scandal was discovered it had huge impact on the company’s reputation. Previously the company had maintained a high reputation due to its success both in the UK and overseas. The revelations of the scandal had a huge impact on the company’s financial statements. As they had bene highly inflated the company had to report the correct figure which portrayed its weak performance and reduced profit (Crump 2017).  The company low profitability was due to the increased operating costs and decreased revenue. The company had highly inflated the commercial income while deferring costs. The scandal led to the loss of over seven executive of the company as the investigation proceeded. Three of the executive namely Christopher Bush, John Scouler and Carl Rogberg are still facing charges in the Southwark Crown Court. The chairman of the board of directors resigned following the revelations of the scandal.

Shareholders lost millions of money as the stock plummeted following the scandal. The stock fell from £ 228.41 to £ 171 during this period. The market value capitalisation the company dropped by over half compared to that of the previous year. The credit rating of the company was also lowered by rating agencies making it hard for the company to acquire credit (Berg and Moré 2016).

PwC had audited Tesco reports for over 30 years from 1983. This presented the risk of familiarity among which may compromise the quality of the auditing process. The chairman of the auditing committee at Tesco was a former partner at PwC which clearly present conflict of interest. Auditors generally audit full year result therefore PwC may justify it failure to note the overstatement in the year 2014 (Kamal, Saleh and Ahmad 2017). However it cannot justify its inability to identify the overstatement in the previous two years. There is suspicion of collusion between the two companies as justified Deloitte’s report. After the scandal Tesco appointed Deloitte as the new auditors. They discovered glaring errors that had not been reported by PwC. The engagement of PwC had actually contravened the European Union regulations which required companies to contract new auditors after every ten years (Friedman and Gerstein 2016)

Recommendation and Conclusion

The scandal has further intensified the debated on several issues concerning financial reporting in public companies it is evident that some companies uphold the short term perception of accompany more than the long-term. It is clear that some audit firms have been colluding with companies to misreport their financial statements. There should be stringent fines for professional accountant who collude with companies to present falsified reports. Audit firms found in collusion with their customers should be delicensed so as to emphasis on diligence (Kukreja and Gupta 2016). The Financial Conduct Authority and the Serious Fraud Office should receive more funding to enable them to pursue investigations related to irregularities in accounting. Companies should fiend heavily and if possible the cancelation of their licences when found to be conducting irregular activities.

References

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van Rinsum, M., 2017. How can auditors avoid the perils of aggressive accounting?. RSM Discovery-Management Knowledge, 30(2), pp.14-16.

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