Carillion: Going Concern Failures and Auditor Responsibility

What happened at Carillion

Carillion plc was the UK’s second-largest construction and outsourcing firm. At its peak, the company held around 450 public sector contracts, employed 43,000 people globally, and worked on projects ranging from hospitals to HS2 railway construction. The business model relied on winning low-margin public sector contracts through aggressive bidding, then funding operations through high levels of debt.

Between 2009 and 2016, Carillion paid out £554 million in dividends while its total borrowing rose from £242 million to approximately £1.3 billion. In 2016 alone, the company paid a record £79 million dividend on reported earnings of £124 million. The dividend payout ratio was 64%. Operating margins across the preceding decade sat between 1% and 4%.

On 10 July 2017, Carillion issued its first profit warning: an £845 million provision for contract losses, primarily from three UK PPP projects and operations in the Middle East and Canada. The CEO resigned on the same day. By September 2017, the half-year financial statements revealed a total hit of £1.2 billion, wiping out eight years of cumulative profits. A third profit warning in November 2017 disclosed that Carillion would breach its banking covenants the following month, with full-year debt reaching £925 million.

Rescue talks with banks collapsed over the weekend of 13–14 January 2018. PwC and EY both declined to act as administrator. On 15 January 2018, Carillion entered compulsory liquidation (not administration, because there were effectively no assets to administer). The company had £29 million in cash and owed approximately £2 billion to its 30,000 suppliers.

Where the going concern assessment failed

ISA 570.10 requires the auditor to evaluate whether events or conditions exist that may cast significant doubt on the entity’s ability to continue as a going concern. This isn’t a check performed once at the end of the audit. It runs throughout, and ISA 570.11 requires the auditor to remain alert to audit evidence of such events or conditions.

Carillion’s financial statements from 2014 through 2016 contained multiple indicators that ISA 570.A3 lists as examples of events and conditions requiring evaluation.

On financial indicators: Carillion’s cash conversion ratio had been declining. The company paid out more in dividends than it generated in operating cash flow during the five-and-a-half years from January 2012 to June 2017 (a cumulative £333 million shortfall, per the House of Commons Library analysis). Total debt rose continuously. Net debt appeared manageable at £219 million in 2016 only because the company held £470 million in gross cash, much of it potentially inaccessible in overseas operations.

On operating indicators: Carillion used a supply chain finance scheme (also called reverse factoring) that shifted supplier payment obligations to banks. This artificially improved reported operating cash flow by reclassifying what was effectively short-term debt as trade payables. The “other creditors” balance owed within one year jumped from £212 million in 2009 to £761 million in 2016. The company squeezed suppliers by making them wait over 120 days for payment.

On borrowing indicators: by December 2016, Carillion’s debt-to-equity ratio stood at approximately 5.3. Goodwill of £1.57 billion (accumulated through acquisitions including Mowlem, Alfred McAlpine, Eaga, and John Laing’s facilities business) was more than double the balance sheet equity of £701 million. Any goodwill impairment would have been devastating to reported equity.

The 2016 annual report (strapline: “Making tomorrow a better place”) gave no going concern qualification. KPMG issued an unqualified opinion.

What the FRC found in KPMG’s files

The FRC opened its investigation on 26 January 2018, eleven days after Carillion entered liquidation. The investigation covered the statutory audits for the 2014 through 2016 financial years, plus additional audit work in 2017. A separate investigation covered a 2013 IT outsourcing contract.

In October 2023, the FRC imposed a combined £30 million fine on KPMG (reduced to £21 million for cooperation), the highest penalty in FRC history. The FRC’s executive counsel, Elizabeth Barrett, stated that the deficiencies in the Carillion audits were “exceptional” and that their breadth and severity undermined public trust in audit.

The FRC’s findings fell into four areas.

On going concern specifically, the FRC found that KPMG’s 2016 audit work was “seriously deficient.” KPMG failed to respond to numerous indicators that Carillion’s core operations were loss-making and that it relied on short-term, unsustainable measures to support cash flows. The audit team did not adequately evaluate indicators that ISA 570.10 and ISA 570.A3 require the auditor to consider.

On professional scepticism, the FRC found that lead audit partner Peter Meehan and his team had, at times, approved audit reports before completing all necessary work. They accepted the presentation of financial information that suited Carillion’s management narrative without sufficient challenge. There were findings of a lack of integrity in Meehan’s record of his review of the 2016 audit, along with four findings of a lack of objectivity.

On evidence gathering, KPMG failed to gather sufficient appropriate audit evidence (ISA 500.6) to conclude that the financial statements were true and fair. The FRC noted failures to consider the implications of evidence suggesting that Carillion’s accounting “might have been incorrect or unreliable.”

On the 2013 outsourcing contracts, KPMG and partner Darren Turner failed to question accounting treatment for IT outsourcing transactions that distorted reported profit. Turner was fined £70,000 (reduced from £100,000). Meehan was fined £350,000 (reduced from £500,000) and banned from ICAEW membership for ten years.

The parliamentary Business and Work and Pensions Select Committees published a joint report in May 2018 describing Carillion’s collapse as “a story of recklessness, hubris and greed.” The report called the FRC “toothless” and recommended replacing it with a more powerful regulator. Three government-backed reviews of UK auditing followed (the Kingman Review on FRC reform, the CMA market study on audit competition, the Brydon Review on audit scope, plus the Redmond Review on local audit). Legislation to create ARGA (the Audit, Reporting and Governance Authority) as the FRC’s successor was promised but, as of January 2026, the UK government scrapped the Audit Reform Bill entirely, citing improvements already made.

How Carillion’s accounting masked the problem

Carillion’s financial statements presented a picture of stability while the underlying cash position deteriorated. Two accounting practices deserve attention.

The first was aggressive revenue recognition on long-term construction contracts. Under the accounting standards applicable at the time (IAS 11, later replaced by IFRS 15), Carillion declared revenue and profit based on optimistic forecasts for contract outcomes. When actual costs exceeded forecasts (because of delays, defects, or scope changes), expected profits became actual losses. But those losses only appeared when management revised the estimates downward, which it had strong incentives to delay. July 2017’s £845 million provision proved that contract profit estimates had been overstated for years. Under ISA 540 (now ISA 540 Revised), the auditor’s job is to evaluate the reasonableness of those estimates along with the method, assumptions, data, and significant judgments used to make them. The FRC’s findings suggest KPMG did not sufficiently challenge management’s contract completion estimates.

The second was the use of reverse factoring (supply chain finance) to inflate operating cash flow. Carillion would extend supplier payment terms to 120+ days, then offer suppliers early payment through a bank-intermediated scheme. In the financial statements, these arrangements were classified as trade payables rather than financial debt. This treatment moved what was functionally bank borrowing out of the net debt calculation, making Carillion’s leverage appear lower than it was. ISA 570.A3(a) lists adverse key financial ratios as a going concern indicator. If the reverse factoring had been reclassified as financial debt, Carillion’s reported net debt in 2016 would have been materially higher than the £219 million management presented.

Worked example: going concern on a construction group with thin margins

Client scenario: Van der Berg Bouw B.V. is a Dutch construction and facilities management company with €95M revenue, operating margins of 2.1%, net debt of €14M (per management’s classification), and a pension deficit of €8M. The company uses a supply chain finance programme through ING Bank. Average supplier payment days are 95. You are signing the 2025 audit.

1. Identify events and conditions (ISA 570.10, ISA 570.A3)

Operating margin of 2.1% on €95M revenue yields approximately €2M operating profit. With net interest costs of €0.9M and pension contributions of €1.1M, free cash flow before working capital movements is close to zero.

2. Evaluate the supply chain finance programme (ISA 570.A3(a), IAS 32)

Van der Berg’s supply chain finance programme through ING involves €6.2M in outstanding balances classified as trade payables. Suppliers receive payment at 30 days from ING. Van der Berg pays ING at 95 days. ING charges Van der Berg 1.8% above EURIBOR on the outstanding balance.

3. Assess management’s going concern evaluation (ISA 570.12)

Management’s board paper projects 3% revenue growth and stable margins. It does not model a downside scenario. Two fixed-price contracts (€34M combined) are at preliminary stages with cost estimates subject to revision.

4. Evaluate disclosure requirements (ISA 570.19–20)

Even if you conclude that no material uncertainty exists, ISA 570.19 requires you to evaluate the adequacy of disclosures about going concern. Given the thin margins, pension deficit, supply chain finance dependency, and concentration of fixed-price contract risk, the financial statements should include disclosure of the principal risks even in the absence of a material uncertainty conclusion.

A reviewer would see that you independently verified the substance of the supply chain finance arrangement, recalculated key ratios on an adjusted basis, stress-tested management’s forecasts, and documented the disclosure assessment. Carillion’s auditors accepted management’s net debt figure and contract profit estimates without this level of independent work.

Practical checklist

1. Identify whether your client uses supply chain finance, reverse factoring, or similar programmes. Evaluate whether the substance is trade payable or financial liability under IAS 32.11, and recalculate ISA 570 financial ratios on both bases.
2. Obtain and review the board’s going concern assessment. If it does not include a downside scenario, prepare your own independent stress test (ISA 570.16(b)).
3. Compare reported operating cash flow to reported operating profit over at least four years. A persistent gap (profit exceeding cash) indicates aggressive revenue recognition that affects ISA 540 estimate reliability.
4. For construction and outsourcing clients, review the five largest contracts individually. Assess whether management’s percentage-of-completion estimates are supported by independent evidence (cost-to-complete reports, project manager assessments, client correspondence).
5. Check whether dividend payments are sustainable against actual operating cash flow (not reported profit). Carillion paid £554M in dividends over eight years while debt tripled.
6. Document your evaluation of familiarity risk if you are beyond year four of the engagement, referencing IESBA Code Section 540 and your firm’s policies on key audit partner rotation.

Common mistakes that echo the Carillion findings

• The FRC’s 2022–23 inspection cycle found going concern deficiencies in 38% of Tier 2 and Tier 3 audit files, making it the most frequently flagged area for non-Big 4 firms. The most common deficiency was insufficient evaluation of management’s assessment and failure to consider contradictory evidence.
• The AFM’s 2023 thematic review on going concern found that auditors frequently accepted management’s base-case cash flow forecasts without performing independent sensitivity analysis, particularly on clients in sectors with volatile margins (construction, hospitality, retail).
• KPMG’s lead partner on Carillion approved audit reports before completing all necessary audit work. The FRC’s enforcement action confirmed this as a breach of ISA 220.18 (direction, supervision, and review). On your own engagements, the completion checklist exists for a reason. Sign it last.

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Source references

• FRC enforcement action – £30 million fine (reduced to £21 million) on KPMG, October 2023
• House of Commons Business and Work and Pensions Select Committees – Joint report, May 2018
• House of Commons Library analysis – Carillion cash conversion and dividend analysis
• ISA 570 – Going Concern, IAASB
• ISA 540 (Revised) – Auditing Accounting Estimates and Related Disclosures, IAASB
• IAS 32 – Financial Instruments: Presentation, IASB
• Kingman Review, CMA market study, Brydon Review, Redmond Review – UK government-commissioned reviews of audit regulation