Auditing Assignment: Case Analysis of Ted Baker Accounting Scandal
Task: Prepare an auditing assignment critically discussing about the case of Ted Baker Accounting Scandal.
The report sheds light on the accounting mismanagement contemplated by the Big Four audit firms, PricewaterhouseCoopers (PwC), Deloitte, KPMG, and Ernst & Young (E&Y) leading to its litigation settlements. Accordingly, this report would focus on the accounting scandal of the fashion retailer – Ted Baker, and the price the company and its auditor, KPMG has to pay. The report would start by stating the matter briefly that led to the lawsuit, then it would go through the culpability of the concerned parties. It would also throw light on the plausible damages caused owing to such audit exercise by the statutory auditor.
The report attempts to raise the auditing and accounting concerns along with the root cause of the matter intended Ted Baker to get into the accounting crisis and financial mismanagement. The report apparently shows the mistakes committed by the auditor aggravating the matter to court. It focuses on the sort of problems or misrepresentations by the defendant, KPMG owing to its unfavourable judgement by the court and pay a hefty compensation. Lastly, the report would come up with recommendations as the most important part enabling the auditor to contemplate improvement in its audit strategy, audit program, and issues ought to consider to avoid such things in the future.
Ted Baker, the Glasgow-based luxury clothing retailer got into trouble when its accounting scandal came into light. The accounting firm, Deloitte revealed a hefty amount of £58 million misrepresentations in its balance sheet by overvaluing its inventories(Jolly, 2020). Deloitte took charge of the accounting investigation in January 2019 with the pre-conception that there was about a financial misconduct worth £20-£25 million. But as the work proceeded, the amount was aggravated to £58 million.The revelations sent shock waves to the market as the company stock declined by 10% to 288p and an immediate measure for a comprehensive business review. Deloitte revealed that the overstated assets were the non-cash resources for its previous year, 2018-19. To everyone’s astonishment, this sort of financial blunder has been rampant in Ted Baker for a while. Ray Kelvin, its former CEO and founder resigned in March when the matter was unearthed, though he refused to such sorts of financialmisconduct. It was the shareholders who suffered the most as the stocks of Ted Baker lost its sheen, say three-fourth of its worth since the beginning of 2019.
The revelations in its financial book intensified the issues for Ted Baker reporting a loss of £23 million in October 2019, a rare phenomenon since its establishment(Butler, 2020). It shook the retail leadership as Lindsay Page and David Bernstein, its Chief Executive, and Executive Chairman left the firm in December 2019. The financial debacle of Ted Baker also affected the performance of hedge funds as Toscafund bought 12% of the company shares. So the loss in Ted Baker’s shares is not limited to its shareholders only but to the broader investors in the market. The financial misconduct was not limited to the company alone as the statutory auditor, KPMG is also to be blamed for not able to point out such gross violation(Afa.asn.au, 2019). The competent authorities levied a fine of £3 million owing to conflicting interests and unlawful commitment to its work affecting the business interest of Ted Baker.
Culpability of the parties:
Ted Baker executives –
The accounting scandal of Ted Baker could be attributed to the alleged role of the senior executives of the UK fashion retailer. In this context, three distinctive executives of the company bore the burnt – Ray Kelvin, Founder and former CEO; Lindsay Page, Chief Executive; and David Bernstein, Executive Chairman of Ted Baker. Kelvinwas the foremost in the brigade to leave the company in March 2019.Since December 2018, he was on voluntary leave owing to inappropriate behaviour with the Ted Baker staff along with the allegations of financial misconduct(Gay & Simnett, 2017). The accounting scandal also led Kelvin to compromise on his payout as refinancing of the company reduced Kelvin’s stake from 55% to 15.8%while raising £95 million through equities(Butler & Jolly, 2020). So the accounting scandal not only brought a bad image to Kelvin but cost him his position and stake in Ted Baker which was his brainchild.
After Kelvin, the serving CEO and Executive Chairman was in line say, Lindsay Page and David Bernstein. Both Page and Bernstein were asked to step down amid a profit warning scenario for the fourth time in a row. It has been lessthan a year since Page got the coveted position of CEO after the exit of Kelvin in March 2019.In the same year, October 2019 she resigned amid pressure due to the continuous loss-making scenario in Ted Baker. Page has to contend with worth £500,000 and no bonus while Bernstein has to contend with 50% of his remuneration at £100,000(Jolly, 2020). So the senior executives were disgraced owing to their respective roles in the organisation for being not able to control the financial mishap leading to a gross financial violation.
Statutory auditor –
The UK regulator, the Financial Reporting Council (FRC) enforced sanctions on the statutory auditor of Ted Baker, KPMG. Michael Francis Barradell was the audit engagement partner who was chastised and fined by the authorities as the partner admitted to the gross financial conduct in the case of the retailer. KPMG was associated with the retailer for a substantial period and the financial misconduct took place between January 2013 and January 2014 which the auditor was unable to locate. The Executive Counsel of FRC fined KPMG a hefty amount of £3 million along with a severe rebuke(businessinsider, 2020). But the fine was later adjusted as the auditor pursued to settle the matter at £2.1 million only.
The UK regulator made the Big Four also pay for the financial debacle to Ted Baker for £112,000 for bearing the expenditure of the Executive Counsel(Butler & Jolly, 2020). The audit partner, Barradell was also not spared as charged £80,000 but it was mitigated at £46,800.It was an instance of ethical misconduct on the part of the auditor diverging the independence of the auditor. The audit partner strived to serve Ted Baker in the legal matter of its commercial court claims(Accaglobal, 2008). It was the greed of the auditor to represent the client in such matters as such fees were more than the audit fees indicating the moral decay of both KPMG and Barradell. Both of them admitted that their behaviour was inappropriate with the due standards of the Fundamental Principle of Professional Competence and Due Care directives set by the Institute of Chartered Accountants in England and Wales (ICAEW).
Relevant issues in auditing and accounting raised in the case:
The accounting scandal of Ted Baker raised quite an eyebrow as it pointed out several loopholes in the process. The various accounting and auditing aspects could be discussed in the following manner:
Conflict of interest –
The corporate scandal of Ted Baker posed as an ideal instance of conflict of interest wherein the senior company executives like Kelvin, its founder and former CEO could not look beyond his narrow means. Though he held a trustworthy position in the company but exploited his position to harass the workers and inflate the company assets for window dressing the company books of account(Paulin, et al., 2017).It is to show the prowess of the company in the competitive market and overstatement of the inventories worth £58 million is the resultant factor(Afa.asn.au, 2019). The alleged role of the Ted Baker senior executives in financial mismanagement led to the emergence of widespread conflict of interest in the public domain.
Accounting fraud –
Deloitte after taking charge of the accounting investigation was shocked to know the intensity of the financial mishaps in Ted Baker. The retailer was suspected to overstate its inventory by £20-£25 million but a thorough investigation by the agency revealed the actual truth. It was found that Ted Baker inventories are overstated by £58 million(Butler & Jolly, 2020). The accounting fraud took place during the realm of Kelvin who besides this thing was also charged with gross behavioural misconduct. This sort of overstatement shook the fundamentals of the company which readily required cash injection for its working capital. The company fooled its shareholders as the stock value declined gradually reaching its nadir at 288p. Such sort of accounting debacle has broad implications in the market as Ted Baker is a listed entity in the London Stock Exchange(Asic.gov.au, 2014). The inappropriate stance of the retailer posed an environment of mistrust and lower confidence on the commercial entities as established players like Ted Baker could falter.
Self-interest of the auditor –
The statutory auditor, KPMG, and the audit partner, Barradell were more interested in making money than seeking the audit truth of the company. They admitted before the Executive Counsel set by the FRC to investigate the accounting matter and found that the auditors were more into providing non-audit services to the client. This is because such sort of services like representing the client in commercial court claims proved to be more rewarding than the audit fees(Dlamini, et al., 2017). This is a gross violation of the auditing task to be delivered by the statutory audit contradicting the professional standards and morality set by the authorities. The auditors were so busy serving their self-interest say earning more money over their audit fees that ignored the books of account completely(Gay & Simnett, 2017). So KPMG is invariably responsible for the financial debacle the shareholders of Ted Baker are into as the stocks of the retailer reached its bottom at 288p pushing them into uncertain financial situations.
Auditor liability -
The matter of Ted Baker points out the failure of the auditor in proper disbursement of their auditing liability. It paved for improper professional conduct on part of the auditors as well. The phenomenon made it difficult for investors to ascertain the true worth of the retailer from the financial performance presented in its financial statement (Messier & Schmidt, 2018). It laid for wrong business decisions on part of the existing and potential investors. The accountants and auditors had breached the fiduciary obligations as failure to provide reliable and accurate financial statements in the best interest of the investors and other stakeholders. The Ted Baker management overstated the inventories to show favourable position of the company (Ahmad & Omar, 2016). In this way, the corporate governance scenario of the firm acted deceptively to uphold its financial lies to its stakeholders – the creditors, suppliers, government and tax authorities, and other users of the financial statement. Again, the incidence of tax evasion leads to a loss in government revenues which could have used for developmental purposes. The arrangement did not pave for proper evaluation of the company performance concealing the true picture.
Cause of corporate scandal in Ted Baker:
The corporate scandal of the leading retailer, Ted Baker grabbed headlines across the corporate world.Itisdueto the prevalence of several loose ends in the various sphere of the business as discussed in the following manner:
Absence of effective leadership –
The leadership of Kelvin though was fruitful in establishing the business but not sustaining it over the long-run in the intensely competitive market. Kelvin was not effective in providing a suitable business direction rather took a short-cut of window dressing the balance sheet(Molala & Nkate, 2015). It resulted in the overstatement of the inventories by £58 million and when the matter was brought to daylight, it was shocking for the stakeholders. This sort of financial misconduct was not a matter of overnight rather it took years to have such a phenomenon. It broadly depicts the incapacity of kelvin as an effective leader to tackle such situations. Again when Kelvin had to leave on account of misbehaviour in March 2019, the office was graced by Lindsay Page but she also had to resign owing to the poor performance of the company(Butler, 2020). It created a leadership vacuum in the business scope of Ted Baker which needs to be fulfilled immediately to provide the retailer in a suitable direction.
Weak corporate culture –
The corporate culture of Ted Baker was not strong enough to buffer the financial misdoings unto a certain state. The series went on for a longer-term without any sort of interruption or auditing diktat (Paulin, et al., 2017). The scandal pointed out the absence of a strong internal control system in the retailing house, otherwise, the matter would not have intensified to such a state. There might be instances wherein some of the junior executives tried to raise their voices. But they were silenced to protect the narrow interest of the senior executives of the firm (Boiral, et al., 2019). For instance, the retail analysts at the context fear that a slight recovery in profitability by the firm is severely doubted and evaluated with suspicion.
Inappropriate leadership behaviour –
Ray Kelvin, the founder and former CEO of Ted Baker was charged with inappropriate behaviour with the fellow staff of the company by forcibly touching and becoming overtly friendly. So it is quite well depicted that the business leader was more into his personal capacity than his professional responsibilities(Hay, et al., 2017). The senior executives discovered it would be better to hide their incapacities by overstating the inventories to depict an impressive financial performance but it boomeranged them in the long-run(Gay & Simnett, 2017). Kelvin was charged for inappropriate behaviour with the staff of the company along with the financial misconduct leading to the overstatement of inventories and in both cases, he claimed innocence. It shows that the financial debacle was not bothered by Kelvin to take measures to control the situation rather he was busy proving his clean image.
Auditors’ liability and responsibility–
The audit partner facilitated the unfolding of the corporate scandal to a great extent by not exercising the proper audit procedures to prevent the accounting malpractices at the right moment. It is the failure of the audit partner, Barradell to exercise the audit testing on inventories through physical checking or sampling as per the standards of ICAEW to tame the fraudulent activities right at the beginning (Accaglobal, 2008). He was in charge of auditing for a substantial time when Kelvin was holding the realm of Ted Baker. But neither the statutory auditor nor the audit partner did not take any positive step to prevent such kind of business malpractices. There were certain indications or hints around which could have been quite easy for a seasoned auditor to sniff out the accounting malpractices but in vain(Groomer & Murthy, 2018). The role of a professional accountant consists of consideration of several business elements while going through the books of accounts and that was not followed while reviewing the accounts of the retailer.
Mistakes, misrepresentations leading such scandals:
Ted Baker’s accounting fraud is a noteworthy aspect in the modern era affecting millions of pounds of the hard-earned money of the fellow investors and shareholders. Besides the company executives, the audit partner is held responsible for facilitating such massive accounting fraud (Accaglobal, 2008). This is because it had the option of audit testing on executive benefit and reparation, and related party transaction which was not conducted at the right time, or else the catastrophe could have been avoided. It could be stated that the auditor failed to understand the gravity of the situation and despite going by the ICAEW standards failed to demarcate the financial misdoings. It led to the auditor’s liability as it might happen he did not understand the plausible extent of the fraud being committed therein(Afa.asn.au, 2019). But this is quite unlikely for a seasoned auditor like Barradell and KPMG, one of the Big Four firms. The auditor had to pay off with its incapacity to prevent the fraud by compensating worth £3 million to the regulators. The punishment was extended to the audit partner, Barradell as wellcosting him £80,000(Butler, 2020). In the same manner, the senior executives of Ted Baker like its former CEO, existing CEO, and Executive Chairman has to pay a hefty price.Each of them heldarespectable and influential position,socould not be written off on the ground that it was a petty mistake on their part. Their actions led to offence of embezzlement of funds to serve their narrow means at the behest of the company resources (Boiral, et al., 2019). It was a crime committed by the senior executives who ought to assume responsibility for the financial debacle of the company. It led to their gross humiliation unravelling their improper business conduct.
Conclusion & Recommendations:
The report concludes that the Ted Baker accounting fraud is the gross violation of the misconduct of the senior executives along with the reluctance of the audit partner to prevent it at the right moment. Both the parties paved for their narrow means overlooking the broad interest of the shareholders and the community at large. The case study of Ted Baker pointed out that the auditor ignored measures like checking the inventories, running any checks or verification. Such kinds of loose initiatives led to the overstatement of the balance sheet by £58 million and decay of trust.
It is the most important part of the report trying to come up with certain plausible solutions to avoid this sort of unforeseen activity in the upcoming future. In this section, relevant audit programs and strategies would be suggested to improve the business practices and keep the risks at bay.
Audit strategy –
The audit strategy would set for the entire audit scope, timing, and audit direction considering the relevance of the prescribed audit regulations of the ICAEW. It could be done if the auditor conducts a favourable groundwork before commencing the actual audit work. It would help him to understand the corporate history and how it record its financial transactions would be recorded. It would be better to have an open-communication system during auditing. The phenomenon would be effective for the auditor to take in suggestions and address queries and doubts in case of any unscrupulous financial event or transactions and avoid any sort of major financial mishaps.
Audit program –
The audit program would consist of various tests and physical checks for the auditor to ensure that the recordings in the financial statement are conducted favourably. Taking relevance with AS 1301, the audit partner would establish an effective communication channel for proper contemplation of the task. Most importantly, the auditor has to be independent enough to contemplate effective decisions regarding auditing and ask for suitable tests and verifications if felt necessary. The audit program ought to be strong enough seeking the full co-operation of the client in matters to divulge the necessary financial details to present a fair and transparent financials of the audited firm.
Other programs –
Besides the duties of the auditor, it is the responsibility of the firm as well to unfold the necessary audit events properly. It could be rightly established by having a strong internal control system which would be answerable to the Board and present its finding to the authority. This particular measure would be purposeful to make the perpetrators stay away from such mishandlings of funds and corrupt activities. Again the firms like Ted Baker could arrange motivational and orientation session to inculcate the custom of fair business practice to conduct the business activities effectively and fairly. The participation of the staff in the process and making them understand the broad scenario would enable them to apply their judgement and stay away from fraudulent business activities.
Accaglobal, 2008. Auditor liability | ACCA Global. [Online]
Available at: https://www.accaglobal.com/an/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/auditor-liability.html [Accessed 14 September 2020].
Afa.asn.au, 2019. AFA Code of Conduct - Association of Financial Advisers Ltd. [Online] Available at: https://www.afa.asn.au/afa-code-conduct [Accessed 19 August 2019].
Ahmad, S. & Omar, R., 2016. Basic corporate governance models: A systematic review. International Journal of Law and Management, 58(1), pp. 73-107.
Asic.gov.au, 2014. Corporate governance | ASIC - Australian Securities and Investments Commission. [Online] Available at: https://asic.gov.au/regulatory-resources/corporate-governance/ [Accessed 26 August 2019].
Boiral, O., Heras-Saizarbitoria, I. & Brotherton, M., 2019. Assessing and improving the quality of sustainability reports: The auditors’ perspective. Journal of Business Ethics, 155(3), pp. 703-721. businessinsider, 2020. Calls for watchdog to review KPMG’s £58m Ted Baker accounting scandal | Markets Insider. [Online]
Available at: https://markets.businessinsider.com/news/stocks/calls-for-watchdog-to-review-kpmgs-%C2%A358m-ted-baker-accounting-scandal-8491319# [Accessed 25 September 2020].
Butler, S., 2020. Ted Baker's bankers call in experts to weigh prospects. [Online] Available at: https://www.theguardian.com/business/2020/jan/08/ted-baker-bankers-experts-financial-review Butler, S. & Jolly, J., 2020. Ted Baker founder cuts stake by 55% in emergency funding bid. [Online]
Available at: https://www.theguardian.com/business/2020/jun/01/ted-baker-founder-stake-could-be-diluted-in-105m-fundraising-ray-kelvin-coronavirus [Accessed 25 September 2020]. Dlamini, Z., Mutambara, E. & Assensoh-Kodua, A., 2017. Establishing the relationship between an effective audit committee and infusion of a good control environment. Corporate Board: Role, Duties and Composition, 13(3), pp. 52-58.
Gay & Simnett, 2017. Auditing & Assurance Services in Australia. 6th ed. Sydney: McGraw Hill Education. Groomer, S. & Murthy, U., 2018. Continuous Auditing of Database Applications: An Embedded Audit Module Approach1. In: Continuous auditing. New Yok: Emerald Publishing Limited, pp. 22-41. Hay, D., Stewart, J. & Redmayne, N. B., 2017. The Role of Auditing in Corporate Governance in Australia and New Zealand: A Research Synthesis.Auditing assignmentAustralian Accounting Review, 27(4), pp. 457-479.
Jolly, J., 2020. Ted Baker balance sheet error worse than feared as woes deepen. [Online] Available at: https://www.theguardian.com/business/2020/jan/22/ted-baker-balance-sheet-error-worse-than-feared-as-woes-deepen [Accessed 25 September 2020].
Messier, W. & Schmidt, M., 2018. Offsetting misstatements: the effect of misstatement distribution, quantitative materiality, and client pressure on auditors’ judgments. Accounting review, 93(4), pp. 335-357.
Molala, M. & Nkate, J., 2015. AN ANALYSIS OF THE KNOWLEDGE AUDIT METHODOLOGY: A CASE STUDY ON THE NATIONAL SCHOOL OF GOVERNMENT. National School of Government, 2(3), pp. 423-434.
Paulin, A., Anthopoulos, L. & Reddick, C. e., 2017. Beyond bureaucracy: Towards sustainable governance informatisation. Vol. 25 ed. Reading: Springer.