Eleven months before Carillion went into liquidation, the British outsourcer’s lead auditor at KPMG invited chief executive Richard Howson to use the firm’s luxurious, hotel-style meeting rooms in Mayfair.

The offering of hospitality by auditors to clients is restricted under the profession’s rules because it threatens their independence.

But Peter Meehan, the audit partner, allegedly told Howson’s staff in an email that he was welcome to use the private club “as long as he says it [is] in his capacity for Wood Group [where he was a non-executive director], not Carillion”, according to documents filed in court by the outsourcer’s liquidators, which are pursuing a £1.3bn claim against KPMG.

Howson’s team declined the offer. KPMG has denied any wrongdoing and plans to “robustly” defend the claim.

Carillion’s collapse in January 2018 fuelled calls to improve the standard of audits and stamp out cosy relationships with clients. A long-awaited shake-up of the audit market and boardroom rules by the UK government is still in the works following three independent reports and a public consultation.

While audit failures have been widespread across British businesses in recent years — affecting sectors from hospitality to transport — construction and contracting companies have appeared particularly prone to problems, despite the attention thrust on the sector from the high-profile fallout from Carillion.

In November the Financial Reporting Council said it was still finding cases where auditors failed to challenge significant accounting judgments by construction groups.

Investigations into PwC’s audits of contractors Kier, Galliford Try and Babcock have been revealed since January. All three companies had disclosed accounting errors in recent years.

Other auditors under the watchdog’s eye include KPMG for Carillion, Deloitte for Mitie and mid-tier accountant BDO, which is being investigated over its auditing of NMCN, a London-listed construction company that went into administration in October.

Noble Francis, economics director at the Construction Products Association, a trade body, said these sectors were more prone to failures because large contractors, such as Interserve and Mitie, chiefly win and manage projects rather than actually carrying out the work, which is subcontracted to thousands of smaller building or facilities management companies.

“The pressure to win contracts is high so they often bid low, underestimating the complexity of the project, major delays, changes in specification and labour and material costs,” he said. “Sometimes they can add this to the bill later or it can be offset by making money on other large projects, but it doesn’t always work.” 

Accountants have pointed to the level of estimation and judgment required as well as the difficulty of determining the correct time to book profits or costs from a multiyear contract. “It’s probably one of the most difficult areas to audit,” said one.

The FRC has also highlighted the treatment of long-term contracts by company management. In some cases, auditors relied on management’s controls over accounting estimates without testing the robustness of those controls, it said in November.

IFRS 15 — a new accounting standard introduced in 2018 — makes it tougher to book revenue from some contracts before the work has been fully completed, but auditors and companies are still wrestling with its implementation.

Nick Hood, senior adviser at financial consultancy Opus Business Service Group, and a former senior financial executive at housebuilder Bovis, said the auditors of construction groups were at “the mercy of the good or bad intentions of the management”.

 “The contractors start with suicide, lowball bids and then they haggle with clients and their surveyors month by month by month about the pricing of the work. So what you have on the construction company’s balance sheet is a huge and opaque blob, which is the contract value, some of which has been billed but is not yet paid and may be disputed, while the rest is work in progress.

“The scope for fiddling these numbers and pulling the wool over the eyes of auditors, lenders and trade insurers is enormous. It is the most significant part of any construction company’s balance sheet and it is beyond the ability of any external auditor to unravel. The chances of finding wrongdoing without a whistleblower are very slight.”

The problems are likely to intensify as a result of Covid-19 and the rise in costs of materials, labour and energy, which are leading to an increased number of bankruptcies in the sector.

In November the FRC identified “a downturn in profitability and reduced margins on large infrastructure contracts as well as the operational and economic pressures arising from Covid-19” as one factor in the growing number of investigations.

The slew of investigations has begun to result in penalties for the auditors. Grant Thornton was fined £700,000 by the UK accounting regulator in November for audit failures at Interserve, the former FTSE 250 outsourcer that fell into administration in 2019 and is in the process of being wound down.

But it is often the small contractors paying the highest price. Kevin McLoughlin, managing director of McLoughlin Group, a decorator, was owed up to £400,000 by Carillion when it went into liquidation. Although his business has continued, he acknowledged he was “lucky.” “I know others that never recovered,” he said.

The date for the Carillion court hearing is yet to be set. But like many others still wrestling with the effect of the contractor’s collapse, McLoughlin will be watching the trial of KPMG closely.

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