The Hatfield rail tragedy last year not only claimed the lives of four passengers but also it led to the ultimate demise of the company that caused the disaster. Earlier this month, the government announced that Railtrack plc, owners of Britain’s railway infrastructure, had been placed in Railway Administration under the 1993 Railway Act.
But there is another serious and related issue involved. Just why didn’t the auditors raise a danger flag at a much earlier stage in the company’s troubles?
Questions need to be asked just why Railtrack’s directors, its shareholders and auditors were seemingly surprised by the company’s sudden and fatal collapse. It is not as if the patient suffered an unexpected death. The railway patient was fatally ill long before its recent collapse. It had long-standing and serious cash flow problems that had become progressively worse over the last twelve months.
Railtrack’s eventual demise was becoming self-evident from the evidence in this year’s financial statements, six months before it failed. At this stage, the company’s auditor, Deloitte & Touche, should have known that the company was facing a number of serious problems.
Analysis of the 2001 accounts reveals the precarious nature of Railtrack’s financial position. This year’s financial statements, ending on 31 March, highlighted the growing cash flow crisis. The mayhem to train services following Hatfield was massive. The upheaval caused the most extensive disruption of train services since the second world war.
The resulting costs, compensation and damages were colossal. The group accounts showed a staggeringly high exceptional item of #733m, including penalties to train operators for rail disruption of over #644m. The overall net result was that Railtrack reported a pre-tax loss on ordinary activities of #534m.
The balance sheet was just as dire as the income statement. Railtrack also disclosed nearly #2bn of net current liabilities on a net asset base of only #2.6bn. The company’s indebtedness reflected its acute liquidity problems. Even short-term borrowings soared by nearly #1bn compared with the previous year. In total, the company’s level of indebtedness approached #3.5bn, a daunting amount for a company capitalised at just over a third of this value.
The Hatfield accident revealed that Railtrack had been cavalier to the point of recklessness in maintaining its existing asset infrastructure.
Its incompetence was typified by its utter mismanagement of its flagship projects. The cost over-runs of the desperately needed upgrade to the West Coast Main Line had become an industry joke. The crass ineptitude over managing the development costs of both the cross-London Thameslink extension and the Channel Tunnel Rail link had also become legendary.
By this spring, the company was running into cash flow problems, and fast.
It was obvious now that the company was more than just ill. It appeared in danger of imminent collapse.
Most sections of the rail industry, the Treasury and the Department of Transport, Local Government and the Regions realised a crisis was inevitable.
Everybody seemed to be concerned. But on 23 May this year, Deloittes signed off the accounts. Nothing in the firm’s report gave any indication that they were in any way concerned about the company’s future trading prospects. In short, Deloitte’s report was unqualified.
In fact the financial plight of Railtrack plc, the main infrastructure subsidiary company, was even worse than the group accounts of Railtrack Group plc suggested. The combined assets of the parent company at least put a slightly better gloss on the overall group picture.
In the interval between the 31 March year-end and 23 May, the date when the auditors actually signed their report, the company was seriously floundering.
It was questionable whether, by now, the company was a going concern. Even so, in the auditors’ opinion there were no post balance sheet events to report.
But there was already some evidence emerging of the extent of Railtrack’s problems in the notes to the accounts. Reference was made to the existence of contingent liabilities. Comment was made about possible large-scale claims and damages arising from most of its major rail development projects including the ill-fated west coast line. The note warns that if these contingencies materialised they would ‘seriously prejudice the Group’s financial position’.
Unfortunately it was becoming increasingly likely that project delays and arguments would cause these contingencies to materialise.
The alarm bell was sounding again; detailed audit probing was essential.
Additionally, at 31 March, Railtrack and its auditors assumed that the government would keep contributing indefinitely to the company’s cash stream. After all, the company had received billions of pounds of handouts before – so why should this year be any different? But different it was.
Though its bungling and sheer inept management the company had no friends left. It had long since alienated its customers and the public but now it had now foolishly picked a fight with the Treasury paymasters. Advance payment of subsidies would now cease.
Certainly the government was not going to forgive or forget. The company’s insistence on paying a #88m final dividend (on 3 October this year) whilst still pleading for more state aid was just too much for the transport secretary.
So when the company sought yet another payment of #1.5bn, and ahead of schedule, its fate was sealed.
The crucial questions remain: by March, why did the auditors not warn that it was all going wrong (even by 23 May, when the report was signed, the company’s financial position was still deteriorating)? There was absolutely no firm public evidence that the government would continue the funding at the levels then being sought. Since the company was so obviously heavily dependent on its government backers the auditors should have been put on enquiry.
If the government turned the funding tap off the company would fail – it was as simple as that. In cases where, for example, other companies are dependent on the successful outcome of loan renegotiations, a company’s auditors will be rightly concerned. Such alarm is normally reflected in the wording of the auditors’ report.
On the surface, Deloittes seems to have assumed or accepted that the government funding would continue to flow. Did the auditors seek explicit assurances from the government that funding at the level required would continue?
If not, or if assurances were not received, there exists a prima facia case for this critical fact to be reported. The distinctly unhealthy financial position of Railtrack in March combined with the high degree of dependence on increasing state funding should have caused the auditors deep concern.
There are important issues of public and private accountability at stake.
In addition to shareholders, taxpayers have suffered major losses. Railtrack’s 255,000 shareholders and the public have every right to ask whether the company’s auditors were too complacent.
Deloittes received an audit fee of #500,000 and other related services of #2.4m. For these sort of sums, shareholders and indeed, taxpayers have every right to ask whether Deloittes provided them with the quality service they deserved.
– John Stittle is principal teaching fellow and transport analyst at the University of Essex.
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