Accounting Errors at CCC - Post 11/15 in a series - The £160m U-Turn & £218m Cover-Up

 11 – The £160m U-turn and £218m cover-up

The exposure from the first two Private Eye articles appears to have achieved what five years of campaigning and two formal objections failed to achieve.   

In May 2022, EY recommended making the £160 million correction to the 2020/21 City Deal grant and returning to the correct, accruals basis accounting after endorsing the incorrect accounting treatment in its previous two audits.  Mr Hodgson would not admit the error by using the term “accruals accounting”.  This is how it was explained in EY’s Audit Completion Report – Addendum in May 2022.  It amounts to the same thing:

“That when broken down, the City Dealagreement was in fact 5 annual grants of £40 million, determined on an annualbasis by Government within the overall 5-year funding agreement settlement, andtherefore should be recognised in that manner.”(Agenda item 8, page 9)

A simple reading of any of the City Deal 1 or 2 grant determination documents would have given him that same information.

Under International Accounting Standard 8 (IAS 8 - Accounting policies, changes in accounting estimates and errors), when a material error is discovered, and the same material error took place in prior years, the comparative amounts for the prior period(s) need to be restated and properly disclosed “as far back as is practicable”. 

The correct disclosure under IAS 8 is set out in paragraph 49

The erroneous frontloading of City Deal 2 revenue in 2020/21, which was corrected, is identical to the frontloading of City Deal 1 revenue in 2015/16 and the corresponding overstatements of debtors and usable reserves between 2015/16 (prior period adjustment) and 2019/20.  The  City Deal 1 accounting errors were material, amounting to £217.8m in the aggregate, as set out above.  Nobody at CCC or EY or BDO has challenged that figure with counter evidence.

As the Financial Reporting Council’s final decision notice in the matter of Grant Thornton’s audits of Patisserie Valerie noted last year, the principal objective of audits is…

“to obtain reasonable assurance about whether the financial statements as a whole were free from material misstatement, whether caused by fraud or error”.

The case for CCC and EY therefore to comply with IAS 8 with respect to the City Deal 1 accounting errors back to 2015/16 appears to be overwhelming.

However, in its final 2020/21 financial statements published in July last year, CCC declined to comply with IAS 8.  On page 51 of the final, audited accounts, under the section on General Accounting Policies and Judgements, the CFO wrote:

“The Council have considered whether a prior year adjustment is required, due to the judgement made about income recognition in respect of the second City Deal funding agreement. The Council has concluded that a Prior Year Adjustment is not required, as it is not material to the users of the accounts under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.”

In its Independent Auditor’s Report, which forms part of the published financial statements, EY made no mention of the £160m correction made during that audit, or of any consideration of prior period adjustments.

The auditor issued his 2020/21 audit opinion in July 2022 without having accepted or rejected my objection, just as he had done in the two previous years.

At the 29^th September 2022 meeting of the A&A Committee (two months after the 2020/21 accounts were signed off), the Chairman asked EY’s audit partner to comment on the absence of prior period adjustments in those accounts.  Mr Hodgson replied:

“…On City Deal, we did, as part of our opinion for 20/21 consider the need for prior year adjustments – both the immediate prior year and the whole life of the previous City Deal “tranche”.  We concluded a prior year adjustment was not merited.  One consideration point is that neither we nor management in place now could have gone back and understood what information upon which management made their decision in 2015/16 was based, as nobody was around to validate that.  And clearly, as we have gone through City Deal, you could take one view, or you could take another view, depending on which element of weight you gave to the accounting and evidence base behind them.  So on balance, a prior year adjustment was not required.” (Timestamp 51:51)

It is important for the public to understand the full import of the above statement.  It falls into two parts.

Mr Hodgson’s first argument is nonsense.  As set out in Sections 6 and 7 above, all that information is in the public domain and was known to Mr Hodgson. But even if he had been unaware of it, that begs the question: why did EY slavishly follow the same incorrect accounting “policy” for two years, without ever questioning it?  By law auditors are required to maintain “professional scepticism” throughout the audit:

“In accordance with ISA (UK) 200 (Revised June 2016), the auditor shall maintain professional scepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor's past experience of the honesty and integrity of the entity's management and those charged with governance.” (Paragraph 13)

But even if EY had not known why CCC accounted incorrectly for City Deal 1, that is no argument for not entering prior year adjustments for the same acknowledged error that the auditor and his client have just agreeed should be corrected for City Deal 2.  Accounting policies, once chosen, have to be applied consistently.  The CFO signs a certification to that effect in each year’s published financial statements (see above).

The second part to Mr Hodgson’s response to the committee Chair – highlighted in yellow above, makes even less sense.  In March 2022 the EY audit partner told the A&A Committee that his decision on the correct accounting treatment for City Deal 2 would be a binary choice between revenue frontloading and accruals basis accounting.   

Here Mr Hodgson is effectively saying that there is no objective right or wrong, and you can choose either one or the other accounting treatment depending on how you feel.  He is contradicting his own conclusion from May 2022 when he correctly stated that accruals accounting was the correct policy for the discrete City Deal 2 grants, paving the way for the £160m correction to the 2020/21 financial statements.

Furthermore, even if one posits that there is no right or wrong and therefore the Council and/or EY can make a subjective choice on the accounting treatment of hundreds of millions of pounds based on nothing in particular, then the consistency imperative for accounting policies would compel CCC to stick with the previous revenue frontloading arrangement for the sake of consistency, and not make the £160m correction to the 2020/21 grant.   

The fact that the £160m correction was finally made means that EY recognises that the previous accounting treatment was incorrect.  That means the same correction should be followed through to City Deal 1 and prior year adjustments should be made to implememt those corrections, as prescribed in IAS 8 (see above).  

Mr Hodgson’s statement at the September A&A meeting therefore makes no logical sense.  His conduct indicates that he is simply trying to divert attention away from his own complicity in the incorrect accounting in 2018/19 and 2019/20 which he, as auditor, conspicuously failed to challenge. 

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