121. KPMG's blind spots with regard to Carillion were not isolated to its audits of that company. The FRC examines a sample of audits for each major audit firm operating in the UK in annual audit quality reviews (AQR). Though Carillion was not part of the FRC's 2016-17 KPMG sample, the report of that review called on KPMG to "re-assess [its] approach to the audit of revenue and the related training provided" and found that "insufficient revenue testing was performed on certain audits".367
122. The AQR report also noted weaknesses in KPMG's testing for impairments to goodwill, stating that there was sometimes "insufficient challenge of management's assumptions".368 Carillion's balance sheet was propped up by goodwill. In the 2016 accounts it was recorded as £1.6 billion, 35% of the company's gross assets and more than double its net assets of £730 million.369 This goodwill was accumulated through acquisitions, as the difference between the book value of the company purchased and the price Carillion paid. It accounts for intangible assets of the purchased companies, such as the workforce, brand, and synergies with Carillion. It is reasonable to posit that these assets might decline over time, particularly if, like Eaga for example, the purchased business proved to be loss-making. Accounting standards require the assumptions used to estimate goodwill to be tested each year to evaluate whether it should be impaired, or reduced in value, in the accounts.370
123. Carillion's goodwill was never impaired in its annual accounts.371 This indicates the company remained confident that the amount it paid for each acquisition was justified due to the continued economic benefits it expected to derive from them. This is difficult to justify for some of Carillion's purchases. £330 million of goodwill was recorded when Eaga was purchased in 2011,372 yet after five consecutive years of substantial losses, that figure remained unchanged, despite Philip Green admitting the purchase was a "mistake".373 KPMG's 2017 half-year update to the board indicates the flimsiness of Carillion's calculations that justified not impairing any of their goodwill. They found that "historically at least 80% of the Group's net present value has been derived from the perpetuity calculation".374 This means that 80% of the value of cash flows Carillion hoped to achieve through acquisitions was predicated on the assumption that those cash flows would continue in perpetuity. Such assumptions were not disclosed by the company or its auditor. The Secretary of State for Business, Energy and Industrial Strategy has confirmed that the FRC are looking at Carillion's treatment of goodwill as part of their investigation.375
124. KPMG audited Carillion for 19 years, pocketing £29 million in the process. Not once during that time did they qualify their audit opinion on the financial statements, instead signing off the figures put in front of them by the company's directors. Yet, had KPMG been prepared to challenge management, the warning signs were there in highly questionable assumptions about construction contract revenue and the intangible asset of goodwill accumulated in historic acquisitions. These assumptions were fundamental to the picture of corporate health presented in audited annual accounts. In failing to exercise-and voice-professional scepticism towards Carillion's aggressive accounting judgements, KPMG was complicit in them. It should take its own share of responsibility for the consequences.
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367 Financial Reporting Council, KPMG LLP KPMG Audit plc Audit quality inspection, June 2017
368 Financial Reporting Council, KPMG LLP KPMG audit plc Audit quality inspection, June 2017
369 Carillion plc, Annual Report and Accounts 2016, p 93 and p 109
370 International Financial Reporting Standards, IAS 36 Impairment of Assets, accessed 1 May 2018. Up until 2004, the reporting standards allowed for goodwill to be amortised rather than tested annually for an impairment. Amortisation reduces the value of an intangible asset annually so if this accounting treatment had still been in force, Carillion would have had to report substantially lower levels of goodwill in their accounts.
371 An impairment of £134 million was included in the interim financial statements for 2017. Carillion plc, Financial results for the six months ended 30 June 2017, p 1
372 Carillion plc, Annual Report and Accounts 2011, p 92
373 Letter from Philip Green to the Chairs, 20 February 2018
374 KPMG, Enhanced contracts review and half year update, 9 July 2017 (not published)
375 Letter from the Secretary of State for Business, Energy and Industrial Strategy to the Chairs, 30 April 2018