1.STUDENTS CASE A THOMAS COOK

tHOMAS cOOK A going concern story

“…we are looking at a world where risk is huge. Brexit is approaching and there are potential recessions in other parts of Europe. Travel patterns were very disrupted by weather and terror. Those were real, living challenges that you faced. If you strip away all the assets, you have an incredibly volatile business. It fails the common-sense test that you would look at that environment, strip away the only bit of the business that has assets and say with your hand on your heart, “This is a business that is still going to be trading in a year’s time, or 10 years’ time.”Peter Kyle, MP Peter Kyle, Member of Parliament (UK), Member of the BEIS1 Select Committee2 October 2019

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Conclusion

Introduction

Appendix

Background to the collapse

Bibliography

What is Going Concern?

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Introduction:

A brief history 3: Thomas Cook was born in the North of England in 1808. He left school at 10 years old but the company that he created is synonymous with the tourism industry.In 1841, Thomas Cook organised his first excursion – a rail journey from Leicester to a temperance meeting in Loughborough, a journey of no more than 15 minutes today. According to the Encyclopedia Britannica, this was the first publicly advertised excursion train in England4.Later, Cook conducted excursions from Leicester to Calais for the Great Exhibition of 1855. By the early 1860s, he changed his business model. Instead of conducting tours himself, he became an agent for the sale of travel tickets, and opened his first shop in London in 1865.In 1872, he organised the first round-the-world tour – a trip that took 222 days! In 1886, his son, John-Mason Cook, launched a fleet of luxurious steam-boats that cruised the Nile. In 1919, just sixteen years after the Wright Brothers made the first powered flight, Thomas Cook was the first travel agent to advertise "pleasure trips by air". When he died in 1892, the business passed to his son, and in 1899, it passed to his grandsons. It was a family run business until 1928.

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Introduction:

But Thomas Cook’s long history came to an abrupt end on 23 September 2019, with the news that it had ceased trading. Two weeks later, the UK Civil Aviation Authority announced that it had completed the largest peacetime repatriation plan, code-named 'Operation Matterhorn' that had brought more than 140,000 people back to the UK. Meanwhile, a Committee of members of the UK Parliament had begun an inquiry to understand the train of events leading to the collapse5. This Parliamentary Committee had been hugely influential in provoking the Government to commission a series of reports that recommended a wholesale reform of the UK audit market and of the regulator, the UK Financial Reporting Council (FRC)6.In the case of Thomas Cook, the Minister responsible for UK businesses wrote to the regulator asking it to consider investigating the conduct of the past and present directors of Thomas Cook and the auditors. On 1 October 2019, the regulator announced it had opened an investigation into Ernst & Young's (EY) audit of the financial statements for year ended 30 September 2018. Later on 19 December 2019, there was a further announcement that the scope of the investigation would be extended to include EY's audit of Thomas Cook's financial statements for the year ended 30 September 2017. To date, the investigation is still open.

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Introduction:

Meanwhile, the Parliamentary Committee had held a series of hearings to obtain evidence for its inquiry into the collapse of Thomas Cook.In addition, a UK Parliamentary Committee comprising MPs from different political parties. The first hearing was on the 15 October 2019; it saw former Thomas Cook Board7 members including Chairman, Chief Executive Office, Chief Financial Officer, and non-executive chairs of the audit committee and remuneration committee appearing in front of the Select Committee. A week later, auditors from EY and Price Waterhouse Coopers (PwC) appeared in front of MPs to answer their questions. EY had performed the audits for 2017 and 2018, and a review of the half-year 2019, while PwC had audited Thomas Cook from 2007 to 2016. Quotes below are taken from the verbatim reports of the hearings that are available on the Committee's website8.The Committee's inquiry into Thomas Cook finished sooner than expected when all Parliamentary Committees ceased to exist on the dissolution of the Parliament prior to the UK election on 12 December 2019.

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Background to the collapse:

Despite its illustrious past, Thomas Cook plc had experienced many difficulties in its long history. Investors became increasingly worried about its financial state from late 2016 through to 2019, and the press was reporting the group's problems in refinancing itself. However, the group had faced similar worries about its financing and profitability in 2012 and had seemingly turned itself around. What was the source of its problems, and why had they become impossible to resolve?In the first hearing of the BEIS Select Committee, former Chief Executive Officer, Peter Fankhauser apologised for Thomas Cook's collapse saying on behalf of the Board:

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Background to the collapse:

In 2007, Thomas Cook Group (the Group) had acquired My Travel, which came saddled with debt. In the following two and half years, the Group had made 11 other acquisitions. However, in 2010, the Group was forced to issue two profit warnings prior to its final results announcement for year ended 30 September 2010. This was the year that the Icelandic volcano scattered ash, creating clouds all over Europe, which forced airlines to cancel most European flights. In 2011, there was a further profit warning. The Group's annual report for that year was delayed as the Group sought further support for its financial position, which it was eventually able to secure. Its debt level was close to £900 million, and it reported a record loss. The following year, a new CEO, Harriet Green was appointed to turnaround the Group. She set out restructuring the Group to reduce its costs base and to bring it into the digital age. While the Group was reporting heavy restructuring costs, in May 2013 it had an injection of equity capital. Despite this apparent progress, Ms Green resigned in 2014, and Mr Fankhauser took over the process of trying to transform the Group. The turnaround seemed to be working; the Group reported profits in 2015, and in 2017 paid down £100 million of debt.

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Background to the collapse:

quote

Mid-way through 2018, things began to go wrong. In Mr Fankhauser's words:

Uncertainty about the effects of Brexit9 had also affected customers' holiday decisions. In short, many sun-loving Brits had decided they would be better off staying at home than booking a package trip to Spain or Greece. In September 2018, the Group issued another profit warning that full year profits would be 15 % lower than in 2017, which turned out to be the case; there was no dividend for shareholders.The Board then began to consider its options. Notably, it was considering selling off some assets, and it decided to focus on its airline10 for which it invited offers. Subsequently, the Board decided that the bids they had received were insufficient to resolve its difficulties. It then focused on a fundamental recapitalisation plan involving its investors and bankers. Fosun Conglomerates11, a company based in Shanghai, which already had a significant holding (18%) in Thomas Cook, was the key stakeholder. By late August 2019, believing there was an agreement with Fosun and some banks for a feasible recapitalisation and new lending totalling £900 million, the Board announced this positive news to the market. However, they had been too hasty. Soon after, some of the banks indicated that Thomas Cook would need to find an additional £200 million funds to meet a possible downside scenario of further difficulties in 2020.

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Background to the collapse:

the endgame:

In early September, the CEO, Mr Fankhauser, contacted British Government officials explaining the situation and setting out alternative ways in which the Government could provide support. It appeared to Mr Fankhauser that the Government was inclined to help, though no firm commitments were given. However, there had been a number of leaks to the press about the difficulties and the lack of agreement on the recapitalisation. Press reports about the difficulties undermined public confidence in the company. As the Group's position looked increasingly precarious, customers cancelled bookings, and key suppliers (including of fuel) demanded up-front payments placing further strain on Thomas Cook’s liquidity position. Late afternoon on Sunday 22 September, the Board received the news that Fosun and the banks had expressed concerns about the impact of recent media coverage on the business. To protect themselves, they sought to impose new provisions in the arrangements making their support conditional on these being met. These included a requirement that the Group had the support of the British Government. However, minutes later, there was a telephone call from the department concerned to say that the Government would not support the proposed recapitalisation, which was soon confirmed by letter. Later that evening, the directors submitted a petition for the liquidation of the Group companies. The court heard the petition at 1.00 am on Monday 23 September, and three-quarters of an hour later, Thomas Cook plc and twenty-five subsidiary companies were put into insolvent liquidation.

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what is going concern?

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Thomas Cook plc as a listed group was required by EU law to prepare its consolidated financial statement under international financial reporting standards (IFRS).One of the most fundamental concepts in IFRS is that of going concern. The standards are developed on the basis that the reporting entity will continue as a going concern for the next 12 months. This affects the extent to which assets and liabilities are recognised, and how they are measured. The principle is often known as the going concern 'assumption' even though the status of a company as a going concern cannot be simply 'assumed' but must be rigorously assessed by the Board of directors. Moreover, since the assessment of an entity's ability to continue as a going concern underpins the basis of preparation of the audited financial statements, there must be adequate evidence to support the assessment so that auditors can determine whether they agree with the directors.

IFRS specifically requires that management: "make an assessment of an entity's ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity's ability to continue as a going concern, the entity shall disclose those uncertainties.” Thus, it is the directors' responsibility to assess whether a company is a going concern; they are required to take into account all available information about the future, which is at least but is not limited to, twelve months from the end of the reporting period.

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When did Thomas Cook stop being a Going Concern?

Thomas Cook had already run into difficulties over its going concern position in the years before its final year of trading. MPs heard that PwC auditors had raised concerns that they required further evidence to support the directors' opinion that Thomas Cook was a going concern for the year ended 30 September 2011. In order to rectify this situation, the Board had entered into financial arrangements to secure additional financing of £200 million.

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When did Thomas Cook stop being a Going Concern?

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This refinancing had caused a delay in the signing and publication of the 2011 financial statements.In September to October 2018, going concern problems recurred. Thomas Cook advised its lenders that it needed relief from certain banking covenants13 for the first 6 months of the financial year (Oct-Mar)14 of both 2019 and 202015. The bankers agreed to this relief, which gave EY auditors evidence of the lenders' ongoing support for the group. Nevertheless, as with many areas of forward-looking assumptions in the financial statements, the auditors used a range of scenarios to test the directors' assessment. In applying the scenarios which EY audit partner, Richard Wilson, described as "severe but plausible" for the year ahead, the auditors found that the Group could pass the covenant test in the second half of 2019, but the position would be very tight. This fact was highlighted in the firm's audit report for that year16.By March 2019, when the Group was considering its interim report for six months ended 31 March 2019, there was further lack of clarity over whether Thomas Cook was a going concern. During the Parliamentary hearing, Mr Wilson explained the position:

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When did Thomas Cook stop being a Going Concern?

Finally, the interim report for six months ended 31 March 2019 did include an explanation by the directors of the uncertainties facing the group.During the hearing, at least one of the MPs considered that these facts meant that Thomas Cook had not been a going concern on 31 March 2019. Mr Wilson reiterated that the evidence meant the position was uncertain, rather than that the company was not a going concern. In the hearing with the directors, it had been explained that when the offers for the airline had come in, it was apparent that it was not going to raise sufficient cash to resolve the problems. Therefore, the directors had looked for other solutions. Nonetheless, the MPs asked how EY could have believed that the sale of the airline could have been a feasible solution. Mr Wilson responded to these concerns about Thomas Cook's ability to survive without the airline by explaining that, as auditors, they had looked at the indicative bid process from a range of buyers at the time of reviewing the interim accounts. It was only later when the final bids had come in that the directors had dropped the idea. Nevertheless, MPs were not convinced:

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When did Thomas Cook stop being a Going Concern?

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When did Thomas Cook stop being a Going Concern?

With hindsight, this exchange seems significant because it could point to potential failures: of the auditors in their challenge of management's assessment that the group was a going concern, and also to a potentially incorrect judgement by the directors. Moreover, the issue has a broader significance than its corporate reporting implications since in the UK it is illegal for insolvent companies to continue trading.However, it is important not to rely on hindsight, but to consider facts and circumstances as they were, when the auditors and directors made their assessments on going concern.In the Parliamentary Committee hearing with the directors of Thomas Cook, their judgements about Thomas Cook’s ability to continue as a going concern were not explicitly called into question. However, it seems the directors maintained their confidence up until the end:

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When did Thomas Cook stop being a Going Concern?

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When did Thomas Cook stop being a Going Concern?

Later in the same hearing, the MPs challenged the directors’ continuing belief that they would reach a deal with Fosun and the banks for the £900 million, which would have secured Thomas Cook’s future. As above, the banks had asked Thomas Cook to find an additional £200 million funds to meet a possible downside scenario. The directors did not believe it would be necessary, but sought support from the UK Government and other stakeholders such overseas Governments and hoteliers.

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Conclusion

Give us your opinion after the class discussion:

Thomas Cook was liquidated on 23 September 2019. In the words of Ms Reeves MP "The final collapse of the business resulted in misery and uncertainty for staff and customers, and brought a significant hit to the taxpayer"17

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Appendix

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appendix

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Appendix: timeline

Peter Fankhauser CEO from 2014 until 2019Harriet Green CEO from 2012 to 2014Mr Wilson Auditor with EYAntoinette Sandbach Member of Parliament (MP)Peter Kyle Member of Parliament (MP)

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Bibliography

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Bibliography

TEAM

Maria RUIZ

Enseignant(e) sénior, Département Finances

Dawn ROBEY

Clinical Professor, Département Comptabilité, Contrôle et Affaires Juridiques

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