Under Section 490 of the UK’s Companies Act 2006, the business secretary has the power to appoint an auditor for a public company if the firm itself fails to do so.
A failure to notify the government will result in the company and all of its directors receiving an initial fine as well as subsequent daily penalties until a new auditor is appointed.
While the process seems straightforward, it has never actually been employed by the government against a company, let alone a FTSE 250 firm such as Sports Direct.
The government may also have issues appointing a new auditor for the firm, as all of the so-called ‘Big Four’ auditors have so far refused to take up the job, mostly on the grounds of conflict of interest.
KPMG has claimed it cannot audit the firm due to its role as auditor of competitor JD Sports Fashion PLC (LON:JD.), Deloitte has recused itself as it advises on SPD’s tax affairs and EY has claimed a conflict after managing the sale of department store chain House of Fraser to the firm last year.
The only remaining major auditor, PwC, has also ruled itself out of the running due to what Sports Direct said in its annual report was “a reluctance to engage based on [its] ownership structure”.
“Significant” audit risk
So why is Sports Direct so toxic at the moment? According to John Stevenson, analyst at Peel Hunt, the problem lies not in the scale of the job but the perceived client risk following several distressed acquisitions by the company over the last year.
“The audit risk is absolutely significant…you’re taking businesses out of administration where there are concerns about their longevity” he says, adding that an audit for House of Fraser, the department store chain Sports Direct rescued from administration last August, would be a huge undertaking by itself.
However, since buying House of Fraser, Sports Direct has also acquired Evans Cycles, GAME Digital and Jack Wills, adding yet more layers to its empire.
Sports Direct’s issues also come at a time when auditors are actively trying to purge their books of risky clients following several high-profile scandals that have called their impartiality into question.
The collapse of outsourcing firm Carillion and cake shop chain Patisserie Valerie among others have made auditors “very careful” when taking on new clients, Stevenson says.
As a result, Sports Direct has turned to medium-sized ‘challenger’ auditors, although this presents its own set of problems relating to their resources and global reach on top of the perceived client risk.
What does an auditor do?
An independent (or external) auditor is given the task of judging whether a company’s accounts are presented in a way they deem to be fair and in accordance with financial reporting laws.
The auditor will do this by compiling evidence and testing it until they are reassured that the financial statements are free of any misstatements, either due to error or fraud.
Auditors do not compile the financial statements they evaluate, rather they rely on the company to compile its figures in line with accounting standards and then evaluate whether it has done so.