Lessons To Be Learnt From Abc Learning's Collapse
Sydney Morning Herald
Friday January 2, 2009
Executives are running for cover after the child-care operator's failure, but they are not the only ones in the firing line, reports Colin Kruger.THE ABC Learning child-care nightmare has now been put to bed for the majority of parents whose children attend its centres and the Government is addressing the policy blunders that allowed ABC to get too big to fail.But amid the heartfelt pleas of embattled parents, reports of Eddy Groves and his gilded lifestyle and a blizzard of law suits waiting to be unleashed, the fate of the company's accounts - and the role of the corporate bodies responsible for policing them - has been pushed into the background.That will soon change.The last detailed financial statements from the failed child-care operator were delivered on February 19 last year when ABC Learning made available its accounts for the half year ending December 31, 2007. This statement would, for the first time, lift the lid on the social, political and financial disaster that was to come.It pays to remember that all of those high-octane profits that supercharged the company's shares - and put Groves top of the BRW Young Rich list - began to combust in these accounts under the scrutiny of a new audit team from Ernst & Young.Statements from ABC Learning just before it finally collapsed in November indicated losses for the year ending June 30 would easily wipe out any profits the company ever made.In simple terms, ABC Learning has wiped out its dubious claim to having ever made a profit.When it came to the treatment of revenues and earnings in those fateful half-year accounts, Ernst & Young's Brian Long took a very different view from ABC's previous auditors from Pitcher Partners - who were happy to endorse the interpretation provided by the company's management.Payments from developers that subsidised loss-making centres - and hid the fact that ultimately a quarter of them were losing money hand over fist - were included as normal revenue, hiding the fact that the Government's child-care largesse was no El Dorado for ABC Learning shareholders. This got the OK from Pitcher Partners along with valuations on billions of dollars worth of now discredited intangible assets that made up most of ABC's balance sheet.Dr Philip Ross, the head of the school of accounting at the University of Western Sydney, describes it as a "failure of regulatory and accounting processes" and says that despite changes to corporations law and accounting standards ABC Learning's situation is not that different to the One.Tel and HIH collapses."All three sought rapid expansion of market share which carried significant risks clearly not reflected in [their] financial statements," he says.He notes that ABC Learning's profits increased rapidly through acquisitions, which should have raised questions about the underlying valuation of assets it acquired - especially given that 70 per cent of its assets were intangibles."The inherent risk associated with the valuation of the assets was enormous and should have been a red flag," Dr Ross says.Embarrassingly for the Australian Securities and Investments Commission, this issue was pointed out to it in 2006, but the regulator could find no fault with ABC Learning's massive intangible assets, which would go on to play a crucial role in the expansion that brought the company undone.The ASIC complainant said: "It's suggested that the methods of financial reporting being employed here are designed to artificially create apparent shareholder value, when, in fact, that shareholder value associated with the child-care licences (91 per cent of net assets) is based entirely on the future net cash flows of the company, which may or may not be realised. It's also suggested that this may be misleading to potential investors in the company."An ASIC official replied to the complainant in September 2006 stating it had "made a number of inquiries into the issues" raised. "However, after carefully considering the results of these inquiries, ASIC will not be taking any further action in relation to the issues you have raised." ASIC is now having a close look at the ABC Learning collapse and is expected to be a little more active this time around. Conflicting public statements from the child-care operator provide an embarrassment of riches that even the corporate watchdog can't ignore.ASIC won't be the only one in the doghouse. The roles of the auditors won't be ignored and the repercussions may go well beyond ABC Learning.Ernst & Young's audit appears to have generated a more accurate picture of ABC Learning's perilous position but events before the company's collapse show the case against Pitcher Partners may not be so clear-cut.From the end of the 2007 calendar year, it took just seven weeks for ABC Learning to produce its interim financial report despite its new auditor, Ernst & Young, having to make its fateful changes.These two parties failed to produce audited accounts for the year ending June 30 despite having nearly four months before ABC Learning went into administration.When the board woke up to just how drastic Ernst & Young's changes would be - including the restatement of prior year accounts - KPMG was brought in as a neutral third party to adjudicate between the current and previous auditors.The findings have not been made public but Groves made it clear KPMG could not find fault with either auditor's opinion.Put simply, three different audit firms - including two of the biggest names in the business - looked at ABC Learning's account practices. KPMG could not find fault with two materially divergent opinions provided by different auditors, one of which correctly diagnosed what was ultimately a fatal condition.With many other companies and their accounts coming under scrutiny amid the most volatile of financial markets, many investors may be wondering what exactly it is they are reading.Experts interviewed by the Herald point to two issues: one is the "audit expectation gap" - the misperception that beancounters go through the accounts with a fine-tooth comb and check every detail.Auditors are required to do only enough checking to assure themselves that the accounts are OK. It is only if enough "red flags" pop up that they are forced to review the accounts, as Ernst & Young's four-month slog demonstrates."The audit doesn't certify anything. [Auditors] don't guarantee anything, they express an opinion," Dr Ross says.The auditors are given guidelines but, as the ABC Learning trio showed, there is plenty of room for divergent opinions."What it comes down to is accounting policy choice and this is where you can get differences in interpretation," Dr Ross says."A lot of people ask whether we should have so much choice available because of the distortions it can bring."He says it also raises questions about how well-equipped directors are in enforcing their corporate governance roles "given the complexity and given the choice of accounting approach in this situation".Ian Ramsey, director of Melbourne University's Centre for Corporate Law, says it comes down to a move towards principle-based accounting standards that allow auditors and accountants more latitude to address unique situations they face rather than strict standards that "try and cover everything and fail"."In a fast-moving market it's impossible to draft accounting standards to cover every contingency," Ramsey says.The trade-off for this flexibility is that "strong enforcement" is needed to keep the auditors honest, he says.This is the avenue that will no doubt be explored by the administrators and various litigation funders who already have Pitcher Partners in their sights and who must prove the auditors breached the standard of care owed to ABC Learning and its investors and that this negligence was responsible for the losses they suffered.Ramsey says the preference for targeting auditors may not necessarily be a reflection of their guilt in a company collapse. "Auditors are sometimes sued because often they are the last ones standing."The Pitcher Partners responsible for the audits have stood by their work."The Pitcher Partners Brisbane firm stands by its audit of ABC Learning and notes that the application of accounting standards is subject to interpretation and professional judgment," it told the Herald in a statement in September.Since then the Queensland branch of Pitcher Partners has broken from the national body. The accounting partners have joined Vincents Chartered Accountants. The partners who conducted the audit, and who are the only ones legally liable for it, have signed on with yet another firm.
© 2009 Sydney Morning Herald