This article was first published in the November/December 2019 UK edition of
Accounting and Business magazine.

There were enough red flags flying in Thomas Cook’s last annual report to wrap the leaning tower of Pisa.

Here are a few from the travel company’s annual report for the year to 30 September 2018: sales rose but profits fell; interest costs overwhelmed earnings before interest and tax (Ebit); the dividend was passed; net debt swelled as cash flowed out; two changes of finance director in 12 months; weaknesses in internal controls. The financial review includes the dreaded words ‘the group’s lenders remain supportive’.

Should a question have been raised over its going concern status? It was – as discussed in the auditor’s report from EY, which crawled over cashflow forecasts, covenant resets, business plans, and so on. It ended up concurring ‘with the directors that no significant uncertainty has been identified’.

The antidote to hindsight is that the company had a turnround plan, for which the lenders had provided additional ‘headroom’. It could sell its airline and this year received several bids (later abandoned). With a name like Thomas Cook, one might have expected a rescue bid or investment, ahead of its collapse (rather than waiting until it had to be salvaged by Hays Travel during the administration process). And who knew in the autumn of 2018 that the following holiday seasons were going to be worse than expected?

EY drew attention to ‘separately disclosed items’ – costs and losses that Thomas Cook excluded from ‘underlying profits’. At least the company had the decency not to call them ‘non-recurring’. These created a large gap between £250m of underlying Ebit and a mere £97m in the statutory equivalent. EY did push back, but this is a common abuse that must be sorted out by standard-setters and supervisors. Most shocking (but again not unique to Thomas Cook) is that ‘underlying Ebit’ featured in both the performance measures used for directors’ bonuses and the basis for determining compliance with banking covenants.

The auditor also questioned the carrying value of goodwill, which at £2.56bn dwarfed equity (loss-absorbing capital) of £291m. Six months later, a £1.1bn impairment was booked as the profits outlook deteriorated. Should the write-down have happened earlier? Maybe, but again problems are rife with accounting for acquired intangibles. At this stage, EY did warn of a ‘material uncertainty related to going concern’.

The Financial Reporting Council, which may investigate Thomas Cook, published a revision to the auditing standard on going concern a few days after its collapse. Would the exhortation to auditors to pay more attention to narrative items, such as principal risks, the business model and potential management bias, have made a difference in the Thomas Cook case? I very much doubt it on the question of the going concern basis for accounting. This looks more a case of management failure in tough market conditions than audit failure.

Jane Fuller is a fellow of CFA Society of the UK and co-director of the Centre for the Study of Financial Innovation.