Special Report: Thomas Cook auditors ‘breached multiple requirements’

The investigation of the Financial Reporting Council (FRC) into the auditing of Thomas Cook in the run-up to it entering liquidation in September 2019 sheds new light on the industry’s biggest failure.

The FRC, the accounting regulator, imposed fines of £6.5 million and “a severe reprimand” on auditor and consultancy firm EY and £140,000 on EY audit partner Richard Wilson last week after finding multiple breaches of auditing requirements in the financial years to September 2017 and September 2018.

This followed a near six-year investigation which identified a series of failings, including:

• A failure to collect evidence to support Thomas Cook’s attribution of £2.6 billion in goodwill as the largest asset on its balance sheet;
• A reliance on Cook’s own forecasts for its UK tour operator which predicted growth in 2018 at more than six times the rate of an independent forecast for the sector;
• A breach of independence standards by allowing a restructuring partner at EY with a “long association” with Cook and its chief financial officer to perform “substantial” work on signing off the group as a ‘going concern’ in the 2018 accounts.

EY took over auditing Thomas Cook for the 2017 financial year having previously carried out consultancy work for the group and admitted it incorrectly recorded its team comprised people “with no prior history of performing services for the client”.

The FRC found “serious failings” in the 2017 and 2018 audits, including “a lack of professional scepticism” and “inadequate disclosure”.

Thomas Cook’s 2017 balance sheet recognised total assets of £6.6 billion and net assets of £280 million, with 40% of the total assets due to the ‘goodwill’ assessment.

More than £1 billion of this was attributed to Cook’s UK tour operator, with the FRC noting it “arose predominantly from [the] mergers with MyTravel Group and Co-op Travel”.

Cook had merged with MyTravel in 2007 and took over running The Co-operative Travel in 2011, completing a buyout in 2016.

The FRC noted that when the value of ‘goodwill’ is greater than “the recoverable amount” from selling or using the asset, it should be recognised as impaired and written down. But Cook and EY left the goodwill valuation unimpaired in 2017 and 2018, despite deteriorating trading and a series of profit warnings.

Only when Cook was forced to revise its forecasts for the UK business in March 2019 did it write down the goodwill by more than £1 billion to zero, leaving the group requiring additional funding to continue trading.

‘EY’s failings in goodwill evaluation particularly serious’

EY and Wilson admitted serious breaches of standards. The FRC found they had failed to show “sufficient professional scepticism to corroborate management’s assumptions and estimates” and “failed to adequately challenge management”.

It concluded the failings in the audit of ‘goodwill’ in 2018 were “particularly serious given Thomas Cook’s deteriorating trading performance”.

The FRC noted that in 2019, Thomas Cook “was re-phasing cashflows and amending its net debt to ensure adequate headroom”, and EY should have “assessed the reasonableness of Thomas Cook’s actions.

However, the regulator stated: “It is not suggested that the breaches were intentional, dishonest, deliberate or reckless.”

The fines were reduced by 25% due to EY and Wilson’s cooperation, but costs of £1.6 million were imposed.