“Accounting tricks”: How Carillion duped the market

Carillion used a variety of techniques to hide its ailing health and its "aggressive accounting" was only exposed when it revealed an £845m financial black hole in July last year, MPs have concluded.

The UK’s second biggest construction firm before its January collapse consistently overestimated the profitability of its projects, counted as revenue uncertain cash that clients had not signed off, and hid its mounting debt to suppliers so as to appear more financially sound than it really was.

Angry MPs accused the Big Four accountants of being an "oligopoly", and of turning a blind eye to Carillion’s "accounting tricks" in the final report of their inquiry published today.

They urged the government to consider breaking up their audit arms, whom they called a "cosy club incapable of providing the degree of independent challenge needed".

Inside Carillion, MPs laid the burden of blame on Richard Adam (pictured), its chief financial officer from 2007 to 2016.

Calling him "the architect" of Carillion’s aggressive accounting policies, they said his departure with a £1.1m final pay package in December 2016 was "perfectly timed", since he sold all his Carillion shares for £776,000 by May 2017, before the July revelations caused the company’s share price to plummet.

Carillion’s "unsustainable dash for cash" took money from pensioners, suppliers and investors while paying out handsome dividends to shareholders, MPs said in today’s concluding report of the inquiry by the joint Work and Pensions-Business, Energy, and Industrial Strategy (BEIS) committees.

Meanwhile this week, the total of jobs lost from Carillion’s crash rose to more than 2,300.

Not counting the costs

On its construction projects, MPs found that Carillion consistently overestimated the revenue they were generating, even to make big loss-making schemes appear profitable.

Contractors can calculate and report a project’s profitability by adding up costs incurred on it so far and expressing that as a percentage of the project’s total agreed cost.

Carillion had two ways of assessing project costs and implied profit margins. One was monthly management contract appraisal meetings, and the other was more challenging peer reviews.

Deloitte examined all such reviews Carillion conducted between January 2015 and July 2017, which concerned contracts making up Carillion’s £845m black hole revealed in July 2017, and found that management consistently overrode the peer reviews to overlook costs in order to express higher profitability.

The outstanding example of this practice occurred on the £355m Royal Liverpool University Hospital (RLUH) PFI contract.

In November 2016 the project team discovered serious cracks in integral concrete beams, which required immediate work stoppage and rectification, at significant cost to Carillion.

That same month a peer review of the contract concluded that the additional costs meant the RLUH project was making a loss of 12.7%, but senior management overrode that and recorded an expected profit margin of 4.9%, which translated as an additional £53m in revenue for the 2016 accounts.

When the wheels came off in July that figure reverted to a £53m provision for the RLUH contract.

By 2017 at least 18 of Carillion’s projects were loss-making.

Non-existent cash

MPs also found that Carillion habitually declared considerable amounts of construction revenue that was "traded not certified".

This is revenue that clients have not yet signed off, such as pay-outs for claims and variations, which has no guarantee of ever arriving.

In December 2016, Carillion was internally counting £294m of "traded not certified" revenue, an increase of over £60m since June 2014, but was not disclosing it as "traded not certified" in public financial statements.

Hiding debt in the supply chain

The third "accounting trick" MPs slammed was also discovered by ratings agencies Moody’s and Standard & Poor’s (S&P).

This was the use of "reverse factoring" to hide debt and make the company’s working capital appear better than it really was.

Reverse factoring, or supply chain finance, is when a company arranges for a bank to pay its suppliers, and the bank claims these payments back from the company at a later date.

Carillion was a heavy user of reverse factoring, leading it to rack up hundreds of millions of pounds in debt to its supply chain, without recording it as such.

As S&P flagged up in March, in its 2013 financial statement, Carillion mentioned that it had begun using an "early payment facility", but did not explain what this meant.

This week one of Carillion’s banks, Santander, revealed that the "early payment facility" was actually reverse factoring. The arrangement with Santander was that suppliers could get payment from Santander earlier than Carillion’s notorious 120-day waiting period if the suppliers accepted a reduction in money owed.

S&P believes that, on its public financial results, Carillion tucked the cash managed through reverse factoring into the box labelled "trade and other payables", to which it had added "other creditors".

This, believes S&P, allowed it to show a modest increase in working capital from 2012 to 2016, because "working capital" does not usually include trade payables.

After 2012, the growth in money owed under trade payables ballooned from £263m that year to £761m in 2016. Reverse factoring, said S&P, allowed Carillion to "hide a substantial part of its debt from view".

Moody’s claimed that Carillion misclassified as much as £498m.

Santander got burned. When it was forced into liquidation on 15 January, Carillion owed the bank £91m for overdue invoices. It was one of several banks operating an "early payment facility" for Carillion’s hard-pressed supply chain.

Duping the market

Some investors could see the writing on the wall.

Aberdeen Standard Investments at one point held 12% of all Carillion’s stock, but in 2015 it decided to begin selling it off because it was suspicious of Carillion’s growing debt and of the amount of cash it was burning without showing increased profitability.

It managed to close its position before the July 2017 profit warning, but others were duped.

Scottish asset manager Kiltearn Partners increased its stake in Carillion from 5% to 10% in February 2017, becoming the company’s main shareholder, and its principal victim when its true position was revealed that July.

A report by the Reuters news agency said it had lost £70m in a matter of hours.

"We rely very heavily on the historic accounting record of the companies we invest in, and typically that is a very good guide to what is going on," Murdo Murchison Kiltearn’s chairman, told the MPs’ inquiry. "We would argue that in this case it clearly was not a good guide to what was going on."

Also duped were the companies in Carillion’s vast supply chain, who effectively donated their services to prop up the company.

Image: Richard Adam, Carillion’s finance director from 2007 to 2016, was "the architect of Carillion’s aggressive accounting policies", MPs claimed. Photograph from Countryside Properties, where Adam was a non-executive director until he announced his resignation in October 2017.

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  1. The article is entitled “Accounting tricks” and later “Aggressive accounting” but a better label is FRAUD-as in declaring profitability when there wasn’t is clearly fraudulent reporting to satisfy Shareholders, Bankers and by virtue of the Bonus provisions for Directors & Management; a means to improve personal gain. The practice of taking ” Uncertified Claims and uncertified variations” to INCOME is a well known NO NO in the Industry and should have been easily picked up by the Auditors when comparing CERTIFIED INCOME to RECOGNISED[booked] INCOME.Equally not recognising COSTS [ ie liabilities due to defective works as in the case of the Liverpool Hospital] is again a practice adopted by less scrupulous Contractors and once again uncoverable in a decent AUDIT of known troublesome projects. Had I been in charge of questioning the DIRECTORS /SENIOR MANAGEMENT I would have first interviewed all the Regional Middle Management -in particular the Commercial Managers who prepare and submit the PROJECT MONTHLY COMMERCIAL REPORTS [comparing COST to VALUE]- because for sure they would have known the real forecast profitability of all projects.Once the full enquiry is public for sure the practice of engineering project profitability will become clear it was a policy for a number of years-since the Crash of 2008/9 !

  2. Greed of this type will always happen when ” employees ” of a company have no vested inherint interest in it, they want as much out as fast as they can.

  3. I have no claims to be an accountant, but I read the 2016 annual report and find £1.669b in intangible assets, with net assets of £730m. Where is the surprise? it doesn’t take a big four firm to spot the problem does it?

  4. The article says ““working capital” does not usually include trade payables.”

    Is this a mistake? Trade parables are always part of working capital. What I thought Carillion did was to reduce trade payables by including the bank debt for SCF under “other payables”.

    This trick doesnt change the total current liabilities, but working capital usually doesn’t count the “others”, but does count the “trade”.

    But as others have said, this total liability was visible, along with a growing pension deficit, all balanced by all that “goodwill”. It was all there, but you had to read the accounts, not just do tick-box due-dilligence.

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