Harvard Case - Accounting Fraud at Tesco Stores (A)
"Accounting Fraud at Tesco Stores (A)" Harvard business case study is written by Jonas Heese, Suraj Srinivasan, Julia Kelley. It deals with the challenges in the field of Accounting. The case study is 22 page(s) long and it was first published on : Sep 3, 2019
At Fern Fort University, we recommend a comprehensive overhaul of Tesco's accounting procedures, policies, and corporate governance structure. This includes implementing robust internal controls, strengthening the role of the audit committee, and fostering a culture of ethical behavior throughout the organization. Furthermore, we suggest a shift towards activity-based costing to improve cost analysis and allocation, leading to more accurate financial reporting and better decision-making.
2. Background
Tesco, a leading British multinational grocery and general merchandise retailer, faced a significant accounting scandal in 2014. The company overstated its profits by '250 million through aggressive accounting practices. This manipulation involved manipulating the timing of revenue recognition and improperly accounting for supplier rebates. The scandal led to the resignation of several senior executives, including the CEO, and resulted in a significant loss of investor confidence.
The main protagonists of the case study are:
- Philip Clarke: CEO of Tesco during the period of the accounting fraud.
- Dave Lewis: Appointed CEO after the scandal to lead the company's recovery.
- The Audit Committee: Responsible for overseeing the company's financial reporting and internal controls.
- The Board of Directors: Responsible for the overall governance of the company.
3. Analysis of the Case Study
The accounting fraud at Tesco can be analyzed through the lens of several frameworks:
- Corporate Governance: Tesco's governance structure was weak, allowing for a culture of aggressive accounting practices to flourish. The audit committee lacked independence and the board of directors failed to adequately oversee the company's financial reporting.
- Management Control: The company's management control system was inadequate, lacking sufficient internal controls to prevent and detect accounting fraud. This was exacerbated by a lack of transparency and a culture that prioritized short-term profits over ethical behavior.
- Financial Analysis: The manipulation of financial statements through aggressive accounting practices resulted in an inaccurate picture of Tesco's financial performance. This distorted the company's true profitability and misled investors.
- Cost Accounting: Tesco's use of traditional cost accounting methods, which allocated costs based on volume, led to an inaccurate understanding of the true costs associated with different products and services. This contributed to the company's aggressive accounting practices as it struggled to meet profit targets.
4. Recommendations
To address the accounting fraud and prevent future occurrences, Tesco should implement the following recommendations:
- Strengthen Internal Controls: Implement a comprehensive system of internal controls to prevent and detect accounting fraud. This should include:
- Segregation of duties: Ensure that no single individual has complete control over a financial transaction.
- Independent reviews: Establish independent reviews of financial data and accounting practices.
- Regular audits: Conduct regular internal and external audits to ensure compliance with accounting standards.
- Enhance Corporate Governance: Strengthen the company's corporate governance structure by:
- Independent Audit Committee: Ensure the audit committee is truly independent of management and has the necessary expertise to oversee financial reporting.
- Board Oversight: The board of directors should actively oversee the company's financial reporting and internal controls.
- Ethical Culture: Foster a culture of ethical behavior throughout the organization, emphasizing the importance of integrity and compliance.
- Implement Activity-Based Costing (ABC): Transition to ABC to gain a more accurate understanding of the costs associated with different products and services. This will enable Tesco to make more informed decisions about pricing, product mix, and resource allocation.
- Improve Financial Performance Measurement: Focus on long-term sustainability and profitability, rather than short-term gains. Develop key performance indicators (KPIs) that reflect the company's long-term goals and align employee incentives with these goals.
- Transparency and Communication: Increase transparency with investors and the public regarding the company's financial performance and accounting practices. This will help restore trust and confidence in Tesco.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: The recommendations align with Tesco's core competencies in retail and its mission to provide value to customers. By strengthening internal controls and corporate governance, Tesco can ensure that its operations are conducted ethically and transparently.
- External Customers and Internal Clients: The recommendations will benefit external customers by ensuring the accuracy and reliability of Tesco's financial information. Internal clients, such as employees and investors, will also benefit from a more transparent and accountable organization.
- Competitors: By implementing these recommendations, Tesco can regain its competitive edge by demonstrating its commitment to ethical business practices and sound financial management.
- Attractiveness - Quantitative Measures: The recommendations are expected to lead to improved financial performance, increased investor confidence, and a stronger brand reputation. These benefits are difficult to quantify precisely, but the potential for positive impact is significant.
6. Conclusion
The accounting fraud at Tesco was a serious breach of trust and a significant setback for the company. By implementing the recommendations outlined above, Tesco can restore investor confidence, improve its financial performance, and ensure that similar scandals are avoided in the future.
7. Discussion
Other alternatives not selected include:
- Merging with another company: While a merger could provide some benefits, it might not address the root causes of the accounting fraud and could lead to further complications.
- Focusing solely on cost reduction: While cost reduction is important, it should not come at the expense of ethical behavior and sound financial management.
Key assumptions of the recommendations include:
- Commitment from leadership: The success of these recommendations depends on the commitment of Tesco's leadership to implement the changes.
- Employee buy-in: Employees must be fully engaged in the effort to change the company's culture and practices.
- Effective communication: Effective communication is essential to ensure that all stakeholders understand the changes being made and their rationale.
8. Next Steps
The following timeline outlines key milestones for implementing the recommendations:
- Month 1: Form a task force to develop and implement a plan for strengthening internal controls and corporate governance.
- Month 3: Begin the transition to activity-based costing.
- Month 6: Implement a new performance management system that aligns employee incentives with long-term goals.
- Year 1: Complete the implementation of all recommendations and begin monitoring progress.
By taking these steps, Tesco can emerge from the accounting scandal as a stronger and more ethical company, regaining the trust of its stakeholders and achieving long-term success.
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Case Description
This case describes the accounting fraud at Tesco Stores Limited (TSL), which was discovered by a senior accountant in TSL's finance department. The accountant was concerned about TSL's handling of commercial income, which, according to the accountant, overstated Tesco's profit by an estimated £246 million. Beyond the accounting issue, the case describes Tesco's organizational and cultural shortcoming causing this problem, how Tesco's new CEO Dave Lewis responded to the allegations, and how the court held the Tesco accountable for its fraudulent accounting. In September 2014, Amit Soni, a senior accountant in Tesco Stores Limited's (TSL) finance department filed a report with Tesco's legal team. Soni was concerned about TSL's handling of commercial income. According to the accountant's allegations, TSL employees had been inflating commercial income to meet the division's financial targets, causing Tesco's projected trading profit for the six months ended August 23, 2014 to be overstated by an estimated £246 million. Tesco's legal team had quickly referred the issue to CEO Dave Lewis, who had started in the role just a few weeks earlier, on September 1. Lewis had to decide how to respond to these allegations. Did the allegations have merit and what are the causes for the accounting violations? Should managers be removed if Tesco determined that the allegations had merit? What were the legal consequences for Tesco and how should Tesco's organizational structure and culture evolve?
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