The £250 million Tesco accounts hole

A week may be a long time in politics but it seems as though a month may be an even longer time in retail management. On the 1st September 2014, Dave Lewis began his tenure as the new boss at Tesco by vowing to return the brand to being the customer’s champion once more and on the 20th September, Mr Lewis celebrated new changes and a new way of thinking by telling Tesco store managers to put more staff on the floor.

On the 22nd September, a £250m deficit was discovered in Tesco half-year accounts and the honeymoon for Mr Lewis was over before it had really begun. The ‘Tesco hole’ was made public, and four senior managers including UK MD Chris Bush, were asked to step aside whilst an investigation is carried out.

The following day, a newly recruited chief financial officer, Alan Stewart, joined Tesco from M&S a month early. The next day it was reported that the UK accountancy regulator, the Financial Reporting Council, said it was closely monitoring Tesco’s handling of it’s own internal financial crisis to decide whether intervention was necessary. The media then reported on 25th September that Tesco admitted it had effectively been without a director in charge of finance for the previous five months.

The four days of news seemed to indicate that some fairly important wheels had come off the Tesco wagon. As if to confirm such a fact, the Financial Conduct Authority (FCA) then promptly announced that it was launching its own investigation into the £250m hole in the company’s accounts.

It seems that there might be an explanation for the £250m hole, in the way that Tesco gathered and managed estimated financial information sought from individual Tesco managers operating their stores. The problem could have been that individual managers had to subjectively estimate a particular component and most of them individually erred on the wrong side, collectively contributing to a very large over-estimation of income, some £250m.

According to some observers, the problem relates to a component called extra incentives, often called “rebates”, that Tesco receives from suppliers for hitting a certain level of sales, for preferred display on shelves or support for promotions of suppliers products – these rebates are volume-sales driven target sums and are only paid if the product target sales are hit. The Tesco managers were asked to estimate what these would be. The simple explanation for the £250m hole is that the managers individually and collectively over-estimated the potential rebate income, which was then entered at headquarters as a potential income on the plus side of the company half-year accounts.

Why a collective overestimate? Again it is suggested by observers that managers estimated the promotional rebates on historic precedent of year-on-year sales growth, rather than on the current dropping sales volumes Mr Lewis was brought in to reverse. The over-estimations may also have been overly optimistic in what each manager thought or hoped would happen, because the rebate figure could be linked to commission and bonus payments. One banking industry observer commented:

‘It’s all about receivables, not what has been received – it’s not cash in the bank. It’s quite subjective, judgemental and estimated, because you don’t know the actual answer – what real figure will actually emerge’.

The issue of how such payments are recognised does seem to have been signalled as an accounting risk area by the Tesco auditors in Tesco’s 2014 Annual Report. However, the problem emerged in Tesco’s next first-half year results, which do not have to be audited. The question remains – was the problem a one-off in unusual circumstances? Or is the problem systemic within Tesco’s financial systems and management? Since there are now a number of investigations underway, we could yet hear much more about Tesco’s £250m hole before the turn of the year.

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