Carillion and FRC investigation

I know that some members are taking a very active interest in what went wrong at Carillion. The email below from the FRC contains a link to a document which you may find both useful and interesting to support your own research and in helping to reach some initial conclusions.

“From: FRC
Sent: 29 January 2018 09:54
To: Various
Subject: News Alert – Accounting and reporting framework for the construction and business support services sectors

In the light of the collapse of Carillion, the Financial Reporting Council (FRC) reminds Boards of companies in the construction and business support services sectors of their reporting obligations (PDF).
This guidance will also be relevant to other companies.
https://frc.org.uk/news/january-2018-(1)/accounting-and-reporting-framework-for-the-constru

(ends)”

I found these paras of particular interest:

Cash flow and net debt indicators

As explained in our letter to Audit Committee Chairs and Financial Directors in October 2017, clear information on the levels of debt, cash flows and the conversion (including the processes of conversion, such as invoice discounting and reverse factoring) of operating profits into cash is also important.

Users have an interest in good quality net debt reconciliations that clearly identify cash and non-cash drivers of changes. We draw attention to the amendments to IAS 7 Statement of Cash Flows (effective for periods beginning on or after 1 January 2017) which require an explanation of changes in a company’s financing obligations over the period.

It is sometimes unclear whether operating cash inflows recorded represent cash received from the customer/paid to the supplier or cash received from/paid to the third-party provider of these financial facilities. The new requirements provide an opportunity for companies to improve the clarity of their disclosures, particularly in those areas where investors have voiced disappointment; for example, on the disclosure of financing facilities such as invoice discounting and reverse factoring arrangements.

Lack of disclosure in this area, particularly in non-recourse arrangements where the customer receivables are derecognised, may hide reliance or changes in the reliance that a company has on such facilities. We strongly encourage companies to provide detail about, and explanation of their reliance upon, these facilities.

I also had a quick look at some key ratios for the past 4 years, taking data from the annual reports and working out the ratios:

				Change in		/turnover x 365(days)			As % of turnover
	Turnover	Trade receivables	Trade Payables	Trade receivables	Trade Payables	Trade receivables	Trade Payables	Intangible assets	Intangible assets
2016	4,395	1,664	2,090	393	376	138	174	1,669	38%
2015	3,951	1,271	1,714	(55)	(13)	117	158	1,634	41%
2014	3,494	1,325	1,727	113	139	138	180	1,614	46%
2013	3,333	1,212	1,589			133	174	1,553	47%

The shrinking value of intangible assets (the major part of which is the NPV of future profits on long-term deals), when measured as a % of turnover, shows a problem. It reduced from 47% to 38% in 3 years.

Page 110 of the 2016 annual report (Note 11 Intangible assets) explains the methodology:

The cash flows used to determine the value-in-use calculations are from the latest three-year forecasts approved by management, which are based upon secured and probable orders and the Group’s overall strategic direction. The cash flows are extrapolated from year four, with a terminal value using a growth rate of 2.5 percent. This growth rate does not exceed the long-term industry average and reflects the synergies from acquisitions.

Management has undertaken sensitivity analysis on a number of key assumptions in the value-in-use calculations. Sensitivity analysis on the discount rate shows that the discount rate would have to increase to a minimum of 21.3 percent for Construction services (excluding the Middle East) and to a minimum of 19.0 percent for Support services before an impairment was triggered in any CGU. On the basis of the sensitivity analysis undertaken in relation to cash flows, management concluded that there is a more than adequate amount of headroom in the value-in-use calculations before an impairment would be triggered.

Cliff Weight

Post Date: February 5, 2018

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Carillion and FRC investigation

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