The U.K.’s accounting watchdog on Friday imposed non-financial sanctions on KPMG related to its audits of the financial statements of investment firm Foresight 4 VCT.

The Financial Reporting Council (FRC) announced it imposed an official reprimand and an order that KPMG monitor compliance with revised audit procedures on company capital and distributions and report on this to the FRC’s Executive Counsel. The sanctions relate to audit failures concerning the financial statements of Foresight 4 VCT for fiscal years ending 2013, 2014, and 2015.

According to the FRC’s final decision notice, KPMG admitted shortcomings in its audits of figures relating to the company’s distributable reserves. “These failings may have led to misstatements relating to distributable reserves in the company’s financial statements, which were later restated in 2016 and 2018,” the FRC said.

“There is no requirement under accounting standards, or in law, for financial statements to distinguish between realized profits and unrealized profits or between distributable and non-distributable reserves,” the FRC noted. The FY2013 and FY2014 financial statements of Foresight 4 VCT “did not include any breakdown of distributable and non-distributable reserves,” but the FY2015 financial statements disclosed that the “realized and distributable” amount of the profit and loss reserve was £4.95 million (U.S. $6.2 million) as of March 31, 2015, (out of a total of £14.45 million [U.S. $18.12 million]) and £12.32 million (U.S. $15.45 million) as of March 31, 2014, (out of a total of £7.34 million [U.S. $9.2 million]).

“This disclosure was incorrect,” the FRC said.

In 2016, following a restatement, the financial statements disclosed realized and distributable profits of £20.95 million (U.S. $26.26 million) and £37.67 million (U.S. $47.21 million) for 2016 and 2015, respectively. The financial statements for FY2018 disclosed a further restatement, increasing the amount disclosed as of March 31, 2017, by £3.44 million (U.S. $4.31 million) to £17.49 million (U.S. $21.93 million), the FRC said.

“The financial statements disclose that the restatement arose from ‘a misallocation in the historical records between realized and unrealized gains on investments,’ ” the FRC said in the final notice. The FY2018 financial statements further explained that this misallocation had also caused the realized and distributable reserves as of March 31, 2015, and March 31, 2016, to be “incorrectly disclosed by the same amount.”

Inspection failures

The FRC also found the audit team did not inspect documents that were submitted to Companies House in November 2012, “choosing instead to perform alternative procedures for the audit of share capital movements.” As a result, KPMG “did not identify the cancellation of the share premium account and capital redemption reserve and the fact that this cancellation had not been correctly accounted for in the FY2013 financial statements,” the FRC said.

There was also “no evidence that the audit team performed any testing of whether the disclosure of distributable reserves in the FY2015 financial statements was correct,” the FRC said. “There is no evidence as to whether or how the disclosure in the FY2015 financial statements was audited.”

Audit breaches

Accordingly, the FRC said, KPMG breached ISA 230 (audit documentation) regarding fiscal years 2013 and 2014, because the audit documentation was insufficient to enable an experienced auditor, having no previous connection with the audit, to understand:

  • The nature, timing, and extent of the audit procedures performed to comply with the ISAs and applicable legal and regulatory requirements;
  • The results of any such audit procedures and the audit evidence obtained; and
  • The conclusions reached by the audit team on these matters.

KPMG also breached ISA 500 (audit evidence) concerning FY2015 “because it failed to obtain sufficient appropriate audit evidence to support the figures disclosed in the FY2015 financial statements in relation to realized and distributable reserves,” the FRC said. Had KPMG sought to obtain sufficient appropriate evidence to support these figures, the error resulting in the FY2018 restatement might have been identified earlier, the agency said.

In November 2019, the board of Foresight 4 VCT approved the appointment of Deloitte as its auditor, following the resignation of KPMG. Deloitte’s reappointment will be subject to shareholder approval at an annual meeting in September 2020.

Sanction context

In considering the penalty, the FRC cited KPMG’s “poor recent disciplinary record,” for being sanctioned in five cases in the last four years. “[T]wo of these cases relate to a failure to obtain sufficient appropriate audit evidence,” the FRC noted.

The determination not to issue a monetary penalty reflects the steps KPMG has taken to improve its audit procedures on distributions and acknowledges the breaches “were not intentional, dishonest, deliberate or reckless.” Additionally, the FRC said, “there is no suggestion that there were insufficient distributable reserves to cover distributions made by the company; and the misstated figures for the company’s reserves did not affect the company’s profits or net asset value.”

The FRC is currently investigating both KPMG and PwC concerning the audits of U.K. logistics company Eddie Stobart Logistics, which suspended trading of its shares last year after a review conducted by former Chief Financial Officer Anoop Kang found the company’s 2018 adjusted operating profit was overstated by about £2 million (U.S. $2.46 million).

Also, in April, the FRC reprimanded and fined KPMG £455,000 (U.S. $564,225) and one of its former senior partners £29,250 (U.S. $35,905) for failure to exercise “sufficient professional skepticism” and for failure to obtain “sufficient appropriate audit evidence” concerning the fiscal year 2016 audit of an unidentified company.