According to Begbies Traynor partner Peter Petyt, accounting errors will almost certainly cause a PLC’s share price to fall. “If a tax charge has been understated, stocks have been overvalued or debts are not recoverable, then profits will be reduced and lower profits lead to a lower share price.”
When TripleArc announced a ‘misallocation’ of around £1m of costs in 2005, its shares fell from 7p to 5.63p. The reported EBITA (earnings before interest, tax and amortisation) was adjusted from £4.5m to £3.5m and, to add to the headache, its budgets had been based on inaccurate data, so its revised 2005 expectations were around 50% of the 2004 figure.
Such errors can have a severe impact on a company’s reputation. “There’s the question of management credibility. Also, stockmarket analysts base their forecasts on factors including historical data. If it turns out the firm’s accounts contained errors, investors may ask what else has been missed,” Petyt says.
The question of accountability is a sensitive one, and a firm usually looks internally before blaming auditors.
Petyt explains: “The auditor’s job is not to prepare accounts. But you would expect an auditor to spot mistakes.”
Grant Thornton partner Daniel Smith explains: “It is not the auditor’s job to guarantee or certify the accounts – they can check facts, but in the case of a well perpetrated fraud, they’re not going to pick that up.”
Auditors and accountants are regulated under the Companies Act, which offers guidance on good practice, so if they fall short they could be deemed negligent.
“It comes down to who owed who a duty of care. Technically, the firm could sue the auditor, but negligence is extremely complex,” says Smith.
It is more likely the firm will order an internal investigation, which is another reason for analysts to shy away; investigations take time, and the analysts’ profit estimates have to rely on even more conjecture than usual, leading to a downgrading of forecasts.
Tax calculations
Printing.com revealed in January that its tax charges over the previous two years had been understated by £210,000. This year’s accounts will have to carry the charge as a one-off adjustment, and earnings will be reduced by almost half a pence per share. The company blamed an invalid claim for rollover relief on profits from the franchising of stores.
According to the firm’s chief executive, Tony Rafferty, Printing.com had retained its auditors, Baker Tilly, to prepare the tax computation. He adds that there is no suggestion the firm’s bookkeeping was erroneous, or that directors had adopted inappropriate accounting standards. “The mistake reflects the technical calculation of tax, not the firm’s performance,” he says.
The financial impact of errors can be alleviated with directors’ and officers’ insurance, but more important for the firm is reassuring investors of their reliability.
ST IVES: SERIOUS ACCOUNTING ERRORS
In August last year, St Ives revealed that serious accounting errors at its PoS printing division would wipe £2.8m off the group’s profits. The errors primarily affected the first half of the year ending 28 July 2006, and involved costs not properly expensed, an over-valuation of work in progress and unrecoverable debts. The news wiped almost 13% off the group’s value and shares fell 27.25p to 184.75p. St Ives group finance director Ray Morley blamed “a number of accountancy errors”. The financial controller of the PoS division resigned. Morley insisted there was “no indication of fraud or manipulated results” and that the firm had contained the problem and changed procedures.
