Equitable accountants

Last week the Accountants' Joint Disciplinary Appeal Tribunal released its verdict on the role of Ernst & Young as auditors of Equitable Life. The charges were of 'professional incompetence' in carrying out the audit of Equitable Life's accounts for 1998, 1999 and 2000 and of 'a lack of objectivity and independence'.  These proceedings were on appeal from the Joint Disciplinary Tribunal decision of October 2008. The Tribunal had found Ernst & Young 'guilty' on both charges but this judgement was not published pending the appeal.

It is to be hoped that the verdict of the Appeal Tribunal is final. Equitable Life's collapse can be dated to 2000 when the House of Lords issued its devastating judgement against the life assurance company and ten years is a very long time for this to be hanging over all concerned. Both the original Tribunal and the Appeal Tribunal have had to consider evidence not just about the highly complex nature of accounting for mutuals but also what should be best practice for the extremely specialist job of their auditors. To give some idea of the difficulty of resolving this matter one has to bear in mind that the demise of Equitable Life followed three entirely different court decisions in the same case and that none of those decisions followed the unequivocal legal advice that Equitable Life's directors had received. The Joint Disciplinary Scheme has worked thoroughly, painstakingly and, crucially, with enormous professional expertise to reach its verdict and it is very hard to see how justice could be better served by any other process.

With the benefit of hindsight the evidence is damning; Ernst & Young issued successive clear audit reports on accounts that effectively ignored the whole problem of guaranteed annuities even after the Court of Appeal had ruled, at least partially, against Equitable Life. At best the audit staff appear complacent and one might almost describe them as useless. However, in amongst the vast sea of evidence from reports, memoranda, audit working papers, emails and witness statements there was virtually no tangible material that suggested that Ernst & Young was ever guilty of a lack of objectivity and audit independence. So the original tribunal upheld this 'charge' against the auditors on the basis that the failings in the audit process were so severe that they must have come about because the auditors were too close to the company and its directors.

That one of the large firms of accountants, with all its systems and procedures, could still be guilty of a lack of objectivity and independence regarding a major audit client was an appalling indictment. Not as shameful, perhaps, as the revelations about a shredding orgy at Arthur Andersen when Enron imploded but still highly, perhaps fatally, damaging for Ernst & Young. However, the more favourable decision on appeal has removed the element of guilt by implication leaving us with an account, albeit long and highly technical, of an audit that was feeble and inept but not corrupt. Many accountants, including the Accounting and Bookkeeping College, will share the relief of Ernst & Young and especially Paul McNamara, the audit partner, that justice has finally been done.

The joint account

A few years ago Mark married Eva. They celebrated their wedding in fine style and settled down to make a beautiful home for themselves. Mark, trusting and adoring set up a joint bank account and gold credit card in their new married name. Even at the wedding reception some of their closest friends, however, had serious doubts about the marriage and whether they were really compatible. They all agreed with the happy couple, though, that they could never, ever get a divorce.

Mark is a mature man, very sensible, even a little bit boring. He has a good business that generates enough income to pay the school fees and health insurance. He can even save some money for their retirement. Mark has never spent beyond his means so he doesn't have to borrow money. His business, although very steady and professionally organised, needs a good deal of working capital so he has negotiated an overdraft with the bank manager, Ms Wong, who he sees regularly. She regards him as her ideal customer and has made it clear that she would be delighted to lend more.

Eva is much younger and very beautiful. She is the cherished daughter of an aristocratic Mediterranean family. Mark was her only lover but she naturally inspires complete devotion. Eva is a self-employed travel agent, or "vacation consultant" as she describes herself. Her career has never been truly profitable and recently it has been increasingly difficult to find work. She isn't at all interested in keeping proper accounts so she scarcely realises that she spends far more than she earns. A couple of years ago Eva became obsessed with the housing boom and gambled unsuccessfully in property.

During the first decade of their marriage Mark has tried very gently to steer Eva towards a way of life more like his own with careful budgeting and such like. She has listened patiently and has tried hard not to upset him. Rather than ask him to arrange an overdraft on their bank account she has been financing her lifestyle on the gold card. The credit card company automatically takes the minimum payment each month from their bank account so that doesn't look too bad.

Not long ago Eva reached the credit limit on the gold card. You couldn't really blame her because the credit card company had actually lowered the limit following a shift in their commercial policy.  She promptly arranged a handful of storecards. Mark had warned her several times about storecards and the astronomical interest rates that they charge but it was either that or she would have had to give up all the expensive activities that she treasured.

When Mark found out he was utterly exasperated. Now he had to make a very delicate decision: should he pay off Eva's storecards so that she wouldn't be liable for any more of their punitive interest or should he step back and leave her to her own financial mess? Reluctantly he decided to take action.

Although it wasn't the time for their regular meeting, Mark made an appointment to see Ms Wong. She was charming and sympathetic, as ever, but couldn't altogether hide her surprise at the amount Mark was asking to borrow for "personal" reasons. She agreed the loan but at a significantly higher rate than she had been offering up until now. After he had left her office, still evidently unhappy at finding himself in this situation, Ms Wong placed a warning note on the bank's personal file for Mark and Eva.

To be continued.....

Accountants report on football future

Hull City have two more games to play in the Premiership but, after losing to Sunderland at home on Saturday, all hope has gone of remaining in the top flight.

At this point the Hull supporters might be forgiven for wishing that the club had, like Portsmouth, already gone into administration. After all, the points deduction that a club suffers on entering an insolvency process does not matter when relegation is certain. Now there is the fear that Hull City will not not be solvent next season in the Championship and, on being forced into administration, will find that the points deduction opens up the drop to League One.

Unusually, Hull City's auditors, Deloittes, have already predicted an equally disastrous financial outcome by issuing a qualified auditors' report on the company's most recent set of accounts. Deloittes could see that even if the club achieved its goal of remaining in the Premiership its debts were unsustainable: if Hull failed to avoid relegation that would only make the situation worse. For many businesses a qualified auditors' report leads directly to insolvency because the company's bankers and other creditors no longer have any reason to believe that there is a future for the enterprise. Football, apparently, somehow finds this less inevitable and even now Hull's chairman, Adam Pearson, believes that the club can avoid administration. This is a remarkable case of double-think because Mr Pearson also knows that the club's bill for players is far too high, writing in a match programme "Just under £6m spent on agents' fees in two years and the deal breakdown and size of agent payments is abhorrent. A wage bill of just under £40m when the club turnover is £50m in the Premier League. These figures, added to the significant transfer fees owed, clearly show that the maths don't add up."

Like Portsmouth, the hope is that the club can sell its better players to bring down its debts and that sale will certainly go ahead. Look at that qualified report, though, and it's clear that Deloittes have anticipated that even after the club replaces its Premiership personnel the accounts will never 'add up'.

Accounting for football failure

We can see now the full extent of Portsmouth Football Club's indebtedness and, at £119M, it is quite staggering. Although Portsmouth fans are able to look forward to their team's appearance in the FA Cup final on 15 May there is no cause for optimism about the future of the club.

It seems as though the company's administrator, Andrew Andronikou, has successfully taken control of the catastrophic situation that he found on his appointment. He must also be somewhat relieved to think that the administration process, with the benefit of the cup final appearance, will not have squandered cash in the spectacular fashion exposed by the club's trading figures leading up to his appointment. He shouldn't get carried away, though. Portsmouth FC, in administration, has had the luxury of being able to play football without having to buy new players. The amortised cost of players' contracts, aside from wages, in the last five years before administration has been over £70M.

Almost everyone seems determined to secure the best possible outcome for the club and its creditors in the form of a Company Voluntary Arrangement (CVA). There is good reason for this. If the club cannot reach an agreement with its creditors, including the taxman who is owed at least £17M, then the only option for the administrator is to put the company into liquidation. If that were to happen then all the players' registrations would revert either to the Premier League or the Football League. This would be a disaster for the creditors as the players' contracts are valued by Mr Andronikou at £30M on a going-concern basis. Apart from selling players the club has almost no other way of returning funds to its creditors.

So what would happen in a CVA? Firstly Andrew Andronikou would be appointed as 'Joint Supervisor' with control over all the company's business. That sounds simple but it isn't. His report to creditors includes the trading figures for the last five years. These reveal spectacular and increasing losses totalling £58M. That is quite some trend that Mr Andronikou would have to buck. Yet, as an able accountant, Portsmouth's would-be supervisor might wonder whether the accounts do not tell the full story of the losses at Fratton Park. Football finances are extraordinarily obscure, with some owners running their clubs as an expensive hobby whilst others milk them as cash cows, but the basic bookkeeping equation still holds true, 'Liabilities = Losses + Assets' (Accounting and Bookkeeping College free taster course). The statement of affairs for Portsmouth FC can only find assets with a book value of less than £40M leaving a further loss, not accounted for, of £20M.

History doesn't provide any encouragement. Portsmouth FC is following in the footsteps of Leeds United, amongst others. The accounts at Elland Road didn't look as bad as they do at Fratton Park as Leeds tumbled out of the Premiership after a couple of seasons of over-spending. So Leeds with its enormous football reputation and hordes of fans was a more attractive prospect for a buyer but still only managed to secure a very shaky deal with Ken Bates before dropping further into League One. Perhaps, after considering the fate of Leeds United, Mr Andronikou ought to consider the story of Wimbledon which went from the top flight to oblivion?

It isn't part of the administrator's brief to secure footballing success for Portsmouth only to try and keep the club alive in some form and return the maximum amount of cash to the creditors. At first sight those two objectives seem to be neatly aligned but the accounts revealed in the administrator's report look very bad indeed. The CVA, approved by the Premier League and the Football League, is the sensible way out of administration but, once the players are sold, the way out of the CVA, in the absence of an indulgent new owner, may be abrupt and terminal.

A debt to the past

At the Accounting & Bookkeeping College we are delighted to learn that some effort is being made to preserve Bletchley Park, not a million miles away from here. Culture Secretary Ben Bradshaw has announced £250,000 funding for Bletchley Park museum.

The work of Alan Turing and others at Bletchley Park helped bring computers into the modern world and is rightly celebrated. Computers have transformed our lives, not least in the field of bookkeeping and accounts so that we no longer live in a world of Bob Cratchits scratching figures into soul-destroying ledgers. Now that the hard labour has been relieved anyone can maintain good business accounts as long as they have learned the skill of double-entry bookkeeping.

The wartime devotion of the staff at Bletchley Park was dedicated to the field of codes and ciphers. As computers and the Internet have become such an important part of our lives encryption has been a vital enabling technology. As long as you don't present your username and password details to anyone else you can safely buy, sell and do all your banking on the Internet. Many businesses rely mainly or entirely on online sales that would not be possible otherwise.

So lets not forget that we owe a real debt to the war effort at Bletchley Park both technologically and financially.