FRC Sanctions Ernst & Young Over Thomas Cook Audit Failures

Key Takeaways

• Sanctions Imposed: Ernst & Young (EY) received a £4.875 million penalty for breaches in auditing standards during the 2017 and 2018 audits of Thomas Cook. An individual audit partner was fined £105,000 for the same violations.
• Audit Failures: The audits of Thomas Cook’s Goodwill impairment and Going Concern were found to lack sufficient professional scepticism and failed to properly challenge critical assumptions, particularly in light of the company’s financial struggles.
• Corrective Actions: EY has been ordered to review audits, particularly related to Goodwill Impairment and Going Concern, and evaluate the effectiveness of its remedial measures. They also need to overhaul their training programs related to independence risks.
• No Misstatements: While the FRC found breaches in auditing standards, it did not assert that any balances in the 2017 or 2018 financial statements were misstated or that the Going Concern basis was inappropriate.

Deep Dive

The Financial Reporting Council (FRC) has issued a Final Settlement Decision Notice, making it clear that Ernst & Young LLP (EY) and an individual audit partner were found in breach of key auditing standards in their work on the Thomas Cook Group plc audits for the financial years ending 30 September 2017 and 30 September 2018.

The FRC’s investigation uncovered serious failings in the audit process, particularly regarding the valuation of Thomas Cook’s Goodwill and the company’s Going Concern status. Both areas are crucial for any audit, and in this case, they were mishandled in ways that raised concerns about the overall integrity of the financial statements.

The FRC hit EY with a £6.5 million penalty, though this was reduced to £4.875 million, thanks to the firm’s early admissions and cooperation. In addition to the financial penalty, EY received a severe reprimand and a formal statement declaring that the audit reports for both 2017 and 2018 didn’t meet the necessary requirements. Further, EY is now required to take corrective action, including:

• Conducting a bespoke review of audits, particularly those related to Goodwill Impairment and Going Concern.
• Evaluating the effectiveness of steps already taken to prevent further breaches and reporting back to the FRC.
• Reviewing its training programs on independence risks and proposing any necessary adjustments.

The individual audit partner involved was also penalized, receiving a £140,000 fine, reduced to £105,000 due to early cooperation. In addition to the fine, the partner received a severe reprimand, and it was noted that the 2017 and 2018 audit reports were not in compliance with the relevant requirements.

The Heart of the Failures

Thomas Cook’s Goodwill balance was a major figure in its financial statements, making up a substantial £2.6 billion, or 40% of the company’s total assets. However, during both the 2017 and 2018 audits, EY and the individual partner failed to critically assess the validity of Thomas Cook’s Goodwill impairment model. In particular, the 2018 audit should have raised red flags, given the company’s worsening financial health. Yet, insufficient professional skepticism was applied to the assumptions behind the Goodwill impairment calculation, potentially leaving a critical risk unexamined.

The audit also fell short when it came to assessing Thomas Cook’s Going Concern status. In 2018, EY and the individual partner failed to adequately challenge management’s assumptions, particularly concerning liquidity and financial covenants. This failure meant they could not properly assess whether there were any material uncertainties about Thomas Cook’s ability to continue operations as a going concern.

While the breaches were serious, the FRC made it clear that there was no suggestion of deliberate or reckless behavior on the part of EY or the individual involved. However, the consequences of their failures in this case were significant.

Claudia Mortimore, Deputy Executive Counsel at the FRC, underscored the importance of this case, stating, “Thomas Cook’s Goodwill balance and Going Concern status were fundamental to its financial position. EY and the individual partner had a public interest duty to challenge the forecasts and assumptions underpinning Thomas Cook’s valuation of Goodwill. Their failure to apply sufficient professional slepticism and obtain corroborative evidence led to significant breaches of auditing standards.”

The FRC noted that while no assertions were made about misstatements in the financial statements, the lack of proper professional scrutiny undermined the key objective of any audit i.e., providing reasonable assurance that the financial statements are free from material misstatement.

The sanctions and remedial measures imposed are designed to prevent these kinds of failures from recurring. EY will now be expected to overhaul its approach to certain audits and implement stricter safeguards to maintain independence and apply greater scrutiny in future work. The FRC’s action serves as a reminder to all in the auditing profession that high standards are not just necessary but non-negotiable, particularly when the stakes are this high.

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