Fonterra defends audit despite $34m mistake

By PHILIPPA STEVENSON agriculture editor

Fonterra has admitted an embarrassing $34 million mistake in its end-of-year financial reporting but has defended the auditing procedures that caused it.

Fonterra director Graeme Hawkins, who chairs the board audit committee, moved to clarify the $14 billion dairy giant's auditing process after contradictory statements from chief financial officer Graeme Stewart and KPMG partner Joanna Perry, who is responsible for the Fonterra audit.

But Hawkins' explanations have not satisfied some accounting and audit experts, who remain concerned that New Zealand's biggest company risks "financial timebombs" going undetected in its 200 or more subsidiaries.

The $34 million discrepancy emerged in the earnings of Fonterra subsidiary NZ Milk after the co-op released its annual report last week.

When Fonterra reported its full-year result on July 19, NZ Milk's earnings before interest and tax (ebit) were reported as $336.2 million but the figure reduced to $302 million in the annual report.

NZ Milk's reported revenue also dropped from $5.6 billion to $5.58 billion.

Neither change altered Fonterra's overall financial position.

Hawkins said Fonterra acknowledged NZ Milk's higher ebit was a mistake in the July 19 accounts.

He said there was a lot of subjectivity about where costs and revenues fell within the group. When the company came to write the annual report commentary, KPMG auditors had raised questions about figures relating to a joint venture with Arla in Britain that had been allocated to NZ Milk. The amounts were re-allocated, changing both the ebit and revenue figures.

"It's just the shuffling of an activity from one pot into another," Hawkins said.

"What we weren't bright enough to do was change the website at the same time ... or the printout that everyone received [on July 19].

"It's a mistake. We are embarrassed by it. It shouldn't have happened and I guess we were trying to be too quick off the mark. Probably what would have helped is if we had acknowledged the difference in the reported figures from the earlier release. So we accept the rap for that."

The error has raised concerns about the auditing of Fonterra's subsidiaries. Stewart told Weekend Business that NZ Milk's audit was not completed until after July 19, but Perry said Fonterra had chosen not to audit the wholly owned subsidiary.

However, Hawkins said KPMG had audited Fonterra's subsidiaries by July 18 "in as full a way as if we produced audit certificates by subsidiary". But the auditors were not required to produce audit reports.

It saved money if auditors did not produce audit reports for each individual company "with views on the rightness of that company in relation to the rest of the group".

"For example, on the trading accounts they would get in to all sorts of issues on the appropriateness of inter-company and head office charges for each individual subsidiary which, from a group point of view, is irrelevant. It all comes out in the wash whether we charge someone - it's all consolidated out in consolidation [of group accounts]."

Hawkins said no one cared what the accounts showed for Fonterra's 200 or so subsidiaries in which it was the only investor.

By law, a company could not make a subsidiary off limits to the auditors. "If they are forming a group of consolidated set of accounts they audit the lot."

The audit was on consolidated accounts, not an individual subsidiary's, but the "difference was a highly technical one", he said. "It doesn't mean there is a lesser audit."

Hawkins said the operations of NZ Milk and Fonterra's other main business unit, NZMP, were still entwined in some subsidiary companies. Fonterra, not the auditors, decided how to split allocations between the two business units and their parent.

The mistake has sparked calls to Fonterra from concerned farmers, one describing it as shabby stuff. Another said he could not believe a company as big as NZ Milk was not audited.

It has become a hot discussion topic in accounting circles where debate is being led by Canterbury University senior accountancy lecturer Alan Robb.

He is concerned that Hawkins said some sales revenue and costs were allocated within the group by management. Bonuses paid to executives - understood in some instances to range between 20 per cent and 50 per cent of their remuneration - if based on sales or ebit could vary depending on how things were allocated within the group by management.

The reported cost of milk to the New Zealand consumer was a number that could vary materially depending on how management allocated costs.

And it was a concern that some key figures were being, in Hawkins' words, "shuffled from one pot to another", Robb said.

Fellow Canterbury financial accounting lecturer Dr Sue Newberry said Fonterra's situation highlighted an unrealised consequence of changes in 1993 to the Companies Act and to the Financial Reporting Act.

If a company's subsidiaries, especially ones the size of Fonterra's, were not audited there was a greater likelihood that mistakes or intentional wrongdoing would go undetected, she said.

For shareholders' benefit the issue could immediately be addressed by auditors voluntarily disclosing which of a group's companies had, or had not, been audited. Long-term, the situation could be dealt with by changing the legislation.

An auditing authority, who declined to be named, said the Fonterra auditing process was Mickey Mouse.

It was appropriate to claim an audit had been done only if a report was written, and it was farcical to suggest not writing one was a significant money-saver when it involved a small amount of time in the auditing process, he said.

"An audit implies that they [auditors] can put their hand on their heart to say these accounts are true and fair. Anything less than that is not an audit."

A company's management and directors should be responsible for deciding where allocations to accounts lay, and the auditor had to form a view whether they had been properly accounted for.

"There seem to be limitations on the coverage of the audit and how much of the activity and the transaction base of this large organisation is available for audit or examination by the auditors. I would be concerned if it is less than 100 per cent."

While important subsidiaries should be routinely audited, even Fonterra's smaller ones should eventually be scrutinised to be sure none contained a "financial timebomb" or an embarrassment that could cost the company money.

Chartered accountant Elizabeth Hickey, a member of the Accounting Standards Review Board and the Securities Commission, said an auditor did not need to split a group "into individual bits" to audit the consolidated accounts. "It can just audit the consolidation."

Asked whether auditing the consolidation would be sufficient to know whether the subsidiary was being operated appropriately, Hickey said: "The auditor is not asked to make that comment.

"The auditor is asked to say that the financial statements comply with generally accepted accounting practice and give a true and fair view."

Hickey said the review board did not consider auditing standards or the Companies Act. "That is for Parliament. It is a legislative matter."