In light of the Tesco accounting scandal, the Financial Reporting Council has announced it will focus on food retail in its upcoming audit inspections.
The scandal has highlighted the complexity of some commercial arrangements within the supply chain and the FRC will be looking at the quality of the audits of both food retailers and suppliers. These arrangements impact on the recognition of revenue in the financial statements of both a supplier and a customer.
Incentive agreements arising from commercial negotiations between buyers and suppliers have become an industry norm. They can take several forms including volume-based rebates, discounts for promotions and contributions towards marketing. The income generated from suppliers has grown significantly as the retailers have widened the incentives for suppliers to drive volumes through their stores.
The FRC will focus on whether the auditor has demonstrated they have obtained sufficient and appropriate evidence and applied scepticism in respect of: the operating effectiveness of controls in place to capture and record supply agreements accurately; the ability of management to override controls; accounting estimates that have been made in respect of supply agreements, such as forecast volumes and use of appropriate rebate rates; the substance of ‘relationship’ payments made to customers; and the appropriate recording of receipts, payments, deductions and credit notes in an accounting period in relation to these commercial arrangements.
The audit inspection reviews will run alongside FRC’s investigation into Tesco’s former auditor PwC in relation to accounts going back to February 2012.
The conclusions on this and the audit inspections into the sector are likely to be several years away. Nonetheless, there is a clear benefit for food retailers and suppliers in early engagement with the auditors around this thorny topic. Over the next few years, increased focus on these arrangements may well lead to greater simplicity and transparency over the commercial arrangements within the supply chain.
Paul Davies is audit partner at BDO LLP
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