FRC launches investigation into EY's Thomas Cook auditing

The Financial Reporting Council (FRC) has launched an investigation into EY for its 2018 auditing of Thomas Cook, following the travel company’s collapse.

Set to be conducted by the FRC’s enforcement division under the audit enforcement procedure, the investigation will cover EY’s audit of Thomas Cook’s financial statements for the year ending on 30 September 2018.

If EY is found to have provided unsatisfactory auditing for Thomas Cook, the firm could be hit with a fine up to £10m, with the potential for both disciplinary hearings and the banning of at-fault accountants.

The account, which PwC had held since 2008, moved to EY in 2017.

While no formal investigation has been declared for PwC’s involvement, the FRC has said that it will keep the investigation’s scope and any potential probes “under close review.”

The fall of a giant

After 178 years, Thomas Cook fell on 23 September 2019 after discussions between the UK government, shareholders and banks to rescue the company fell through.

However, there have been a number of concerns regarding the travel company’s accountancy practices, with the FRC placing the most scrutiny on EY’s involvement.

In October 2018, EY signed off on Thomas Cook’s 2018 accounts, noting them as a going concern. However, by doing so, it judged that the travel company could survive for another year.

The Big Four firm later said that there was a “material uncertainty related to going concern” in May 2019, with the travel company later disclosing that a £300m lending facility had been agreed on.

Back in December 2018, Thomas Cook introduced Sten Daugaard as its new chief financial officer, following two CFO changes in the previous year.

With his appointment, Daugaard changed how Thomas Cook reported its accounts so that they included items that had previously been treated as exceptional costs.

However, EY disagreed with this change, and first-half results reported in November 2018 showed that Thomas Cook did recognise £28m worth of charges, comprised of £14m write-off payments and £14m flight disruption and business transformation costs.

Regulatory changes

Spurred by the travel company’s closure, the FRC issued a revised going concern standard, requiring UK auditors to follow “significantly stronger requirements” than those currently required.

Thomas Cook’s accounts had repeatedly reported exceptional profits, making profits look more attractive than they were, while also having goodwill writedowns and heavy debts.

Even before Thomas Cook’s closure, the FRC itself was also facing criticisms following the breakdown of Patisserie Valerie, Carillion and other firms.

Following these collapses, Sir John Kingman, chairman of Legal & General, was commissioned by the Treasury to conduct a review of the FRC and its practices.

The Kingman Review recommended that the FRC be replaced with an independent regulator termed the Audit, Reporting and Governance Authority (Arga), which has been supported by various auditing bodies.

Ian Peters, chief executive of the Chartered Institute of Internal Auditors, said: “This latest high-profile corporate collapse demonstrates why it is so important for the government to get a move on with reforming the audit market and establishing the new Audit, Reporting and Governance Authority as swiftly as possible.”

The FRC is currently restructuring itself within Arga, with HMRC chief executive Sir Jonathan Thompson to begin leading the new body in early October.

Within the restructuring, the FRC’s investigation of EY is set to continue.