How did Tesco overestimate profit by £250 million?

 

It’s certainty true that the retail world was in shock as Tesco revealed it had been alerted by a whistleblower to £250m overstated forecast in profits for the first half of 2014. The trading update, in question, incorrectly predicted first-half profit would be £1.1bn, down from £1.6bn a year earlier.

How was such a large accounting error allowed to occur?

Although an independent investigation is still taking place, as well as a probe from the Financial Conduct Authority (FCA), at this early stage it seems that the fault lies with a premature recognition of revenue.

Reports suggest Tesco managers were too ambitious with forecasting the amounts of money due to the company from suppliers whose products had met certain sales targets or had been part special promotions, known as ‘co-op’ deals. Therefore, ‘co-op’ deals can be particularly difficult, as they are often made a year in advance and the cash may come in far in advance of actual sales.

Additionally, the costs of stolen and out-of-date produce may have been underreported, contributing to the error.

However, such a rudimentary error has already had dire circumstances with Tesco’s stock market value losing £4bn and four senior managers, including the head of Tesco’s UK food business being suspended. And the situation could yet get worse following the completion of several inquiries and a possible grilling of Tesco executives by MPs.

Interestingly, the retailer has chosen auditor Deloitte, rather than its existing external accountants PwC who somehow missed the error, and the law firm Freshfields to carry out an independent review.

Clive Black at Shore Capital said that Tesco’s error reflects the uncertainty and disorganisation at the head of the company.

He said: “Such an announcement is not the stuff of a well-operated FTSE-100 organisation … Clearly there can be no suggestion of impropriety on behalf of the new CEO to our minds, who has been in the job less than a month. However, this development may raise, indeed must raise, much more fundamental questions over the chairman’s position and the nature, composition and extent of the board, which to our minds has been lopsided between executives and NEDs [non-executive directors] for far too long. Such matters, of course, are for shareholders to decide.

“These are serious times for Tesco and its shareholders. We are flabbergasted by this development and have no choice but to put our ‘hold’ stance – which we only went up to through Mr Lewis’ appointment – under review.”

With large debt on its balance sheet, declining sales and a change in the dynamics of the industry with the emergence of online and budget chains such as Lidl and Aldi in recent years, critics such as

Crawford Spence, professor of accounting at Warwick Business School, says the mistake signals greater problems at Tesco.

“This revelation should be interpreted as a sign of distress. Tesco has essentially tried to recognise revenue too early and delay the recording of costs until a later date. Accounting is not a hard science and some of this behaviour is acceptable, within limits. What Tesco appears to have done is push the boat out a bit too far, ending up with revenue that hadn’t really been earned yet and costs that probably should have been booked earlier,” Spence said.

Tesco’s chief executive Dave Lewis joined the corporation in September from Unilever, but already his hands are full trying to recover the chain’s reputation. Yesterday, for example, Lewis revealed that he will be sending thousands of head office staff, including senior executives, on to the shop floor in the lead up Christmas sales as part of a campaign designed to win over disgruntled customers.

Independent analyst Louise Cooper said: “History is littered with companies that have timed their income and costs to make profits look higher. It is a classic accounting game to play. But what has happened at Tesco is very unclear. Is the allegation that the previous CEO used an accounting convention that made the numbers look better to try and stay in the job? Is it that Dave Lewis is trying to engineer a recovery by making the existing position worse? Or is it that two different CEOs have entirely different views on accounting policy – both of which are legal?

“From the few sentences on the Tesco news release it is impossible to tell what is going on. But at the very minimum it tells of a company in crisis at board level. One thing seems clear: Dave Lewis is stamping his authority on the group.”

Do you think giant supermarket chains have too much power? Do you think  a levy known as the ‘tesco tax’ might help revive independent high street retailers across the country? Feel free to tell us your opinion in the comments below. 

 

Jermaine Haughton is a journalist and digital media professional.

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