Introduction
This Financial Review covers the period of 1 October 2016 to 30 September 2017 and addresses the material events subsequent to the Reporting Date up to the date of this Annual Report.
Prior period restatements due to accounting irregularities
On 5 December 2017, the Company announced that its 2017 Consolidated Financial Statements could not be released when expected as it had identified potential accounting irregularities and questionable transactions.
As a result of these concerns, PwC was upon instruction of the Supervisory Board retained by the Group's legal advisors to conduct an independent forensic investigation. The audited 2016 Consolidated Financial Statements could no longer be relied on and had to be restated and publication of the 2017 Consolidated Financial Statements was postponed.
The initial Investigation Report was produced on 11 March 2019. The investigation is ongoing. The Investigation Report is confidential and legal professional privilege inheres therein. Consequently, the Investigation Report will not be published.
Reference to the investigation identified adjustments to the financial results, and the Investigation Report in these consolidated and separate financial statements and notes thereto is made without waiving the privileged nature of the Investigation Report.
A number of accounting irregularities were identified by the Management Board:
• A small group of the Group’s former executives and other non Steinhoff executives, led by Senior Management, structured and implemented various transactions over a number of years which had the result of substantially inflating the profit and asset values of the Group.
• Complex, fictitious and/or irregular transactions were entered into that involved many entities over a number of years, including parties said to be, and made to appear to be, third party entities independent of the Group and its
executives, but which now, appear to be closely related to and/or have indications of control by the small group of people mentioned above.
The Management Board determined that certain other transactions, which were not part of the investigation, required further consideration, and were also assessed by the Management Board to have been inappropriately recognised in the consolidated financial statements and required correction.
The Management Board identified a number of transactions with four principal groups of corporate entities which were not necessarily on an arm’s length basis. The four principal groups are: Campion and/
or Fulcrum Group, Talgarth Group, TG and/
or TG Management Group and Fihag Group and certain individuals; Schmidt, Evans, Pasquier were purportedly independent, but were in substance closely related and/or controlled by the Group or its employees and certain key management.
The Management Board have considered the nature and substance of the Group’s relationships with these respective parties. The Management Board have considered whether Schmidt, Evans and Pasquier were related parties and have considered whether they controlled entities in the principal groups above.
The entities linked to these groups at some point in time have been summarised below:
Campion and/or Fulcrum Group
• Campion Capital
• Fulcrum UK Group
• Fulcrum FS Group
• GT Branding Group
• SSUK
TG or TG Management Group
Fihag Group
• Geros B
• Geros FS
Talgarth Group
• Talgarth Capital
• Top Global
• Triton B
• Triton V
• Genesis Group
The transactions entered into between the Group and entities within the Campion Group and Talgarth Group included, amongst others, the facilitation of business acquisitions and transactions that involved the trading of Ordinary Shares. Funding in respect of such transactions was mostly provided for by the Group. It appears that all, or the majority of these transactions, were concluded on a non-arm’s length basis. The Management Board considered whether the Group controls the Campion Group, Talgarth Group, TG Group and Fihag Group.
Certain of the Group’s former executives and other non-Steinhoff executives, who have subsequently resigned, were assessed to have a degree of influence over the structure of the entities and the outcome of these transactions and the Group is exposed to variable returns resulting from the recoverability of the funding provided and the manner in which the transactions were structured for the benefit of the Group.
However, although there are some indicators suggesting that the Group might control the Talgarth, Campion, TG and Fihag Groups, no conclusive information exists to confirm that the Group does in fact control any of these Groups. In addition, the Management Board does not have access to the financial information of either the Talgarth, Campion, TG or Fihag Groups to be able to consolidate these entities. The Management Board therefore accounted for the transactions with the respective entities on a transaction by transaction basis to reflect the substance of the underlying transactions and the Group’s exposure. The Group did not identify any direct transactions with Fihag or direct loans outstanding during the period from 1 July 2015. Where transactions were entered into within specific entities in the respective groups it was considered whether the Group controlled the specific entity it was transacting with, which has led to the consolidation of certain entities within those groups. The recoverability of any loans and assets with such counterparties has been assessed and where there is no security on the loans in the entity with the liability or where the Group does not have sufficient information to perform a recoverability
test, the Management Board has deemed it appropriate to impair these assets.
The Management Board have also considered their relationship with the following
individuals: Schmidt, Evans, Pasquier:
• Schmidt was the financial director of the European division of the Company until his resignation on 28 November 2011.
Despite his resignation, shares allocated to him continued to vest in respect of the Steinhoff share scheme for the 2013 and 2014 financial years. Since resigning from the Group, Schmidt was not a director or key management personnel of the Group and did not have a relationship with the Group that would indicate the legal form of a related party in terms of IAS 24 Related Parties (“IAS 24”).
• Evans and Pasquier have never been key management personnel of the Group and there are no legal relationships that indicate that they are related parties in terms of IAS 24.
The 2016 Consolidated Financial Statements and its statement of financial position as at 1 July 2015 have been restated to correct prior period errors. As a result of the extent and complexity of the restatements required to correct these errors, the Management Board has grouped the restated transactions according to type and impact on the consolidated financial statements. A brief explanation of each grouping is discussed below with the detail of the restatements contained in this note and the relevant section of the consolidated financial statements.
Categories of restatements:
1. Property transactions
Property should be recognised at depreciated cost, where cost is measured at the date on which the Group acquires the property either through acquisition or through gaining control of the entity owning the property. The carrying value of the property should not be affected if properties are transferred between Group entities.
Information that is now available has been used to reassess the control of entities
owning properties and the substance of property related transactions. A number of transactions in which properties were transferred between entities are now considered internal to the Group and therefore should not have impacted the consolidated financial statements. This has resulted in the reversal of some significant step ups in the cost of properties.
2. Intangible asset transactions
There are strict requirements under IFRS in relation to the recognition of internally generated intangibles as assets. In the past, the Group purportedly sold internally generated intangible assets (or entities owning these assets) to so called independent parties, which were then reacquired resulting in the recognition of the internally generated intangible as a purchased intangible measured at fair value.
In certain instances the sale and repurchase of certain intangible assets acquired from third parties were also stepped up. As a result profit and assets were overstated, since the risks and rewards of ownership of the intangible assets always remained within the Group.
3. Accounting for Group or related entities The appropriate recognition of investments in consolidated financial statements depends on the nature of the holding.
Controlled entities should be consolidated, jointly controlled entities should be equity accounted on the same basis as entities over which the investor has significant influence, with all other investments being recognised at fair value. Where investments are recognised at fair value, adjustments to fair value may only be recognised in profit or loss if specific criteria are satisfied, failing which they are recognised in other comprehensive income. The determination of the correct accounting treatment is therefore dependent on correctly understanding the relationship between the two entities as there are many other factors, in addition to the size of the shareholding, that are relevant. As a result of new information emerging, relating to loan financing, previously undisclosed agreements, and more insight into the way in
which decisions relating to the investments were made, management has revised its assessment of the appropriate method of recognising some of its investments.
4. Contributions and 'cash equivalents' Any contributions received from independent third parties in relation to trading activities should be recognised either as income or as a reduction in expenses, with a receivable recognised to the extent that payment has not been received at the time of the transaction. The Group previously recognised certain contributions arising from the so-called sale of Know-how and supplier volume rebates that lacked economic substance and did not result in cash flows in to the Group, which in turn resulted in an overstatement of profit.
A restatement is therefore required to reverse the aforementioned contributions recognised in profit together with the related debit, which in some cases had been incorrectly classified as “cash and cash equivalents” instead of a receivable.
5. Share transactions
Where the acquisition of Ordinary Shares is funded by loan finance from the Group that has no recourse to any asset other than those shares, the borrower does not carry the risk of a decline in the share price but will benefit from any increase in the share price above the loan balance. The borrower’s exposure is therefore effectively the same as a purchased call option on the shares.
The substance is therefore that the funded shares are only treated as issued share capital once the related loan financing has been settled. Any shares that are issued prior to the settlement of the loan are therefore reflected as treasury shares i.e.
as a debit to equity. The optionality granted to the borrower is in substance an equity settled share-based payment, which results in an IFRS 2 related expense.
6. Consequential effects of accounting irregularities
The restatements as a result of the accounting irregularities has consequential impacts on various other assets and liabilities of the Group. The most material impacts related to; the impairment of
goodwill and brands due to the revision of inputs used in value-in-use calculations of CGUs as a result of incorrect forecast information and revised WACC rates, the taxation impact of fictitious income and expenses; the reassessment of vesting criteria based on restated financial information relating to employee share grants, the classification of external debt as short term as a result of the technical breach of financial covenants and the recognition of adjustments not previously considered material to the Group.
The following table summarises the effect of restatements recognised by the Group in order to correct prior period errors in respect of the 15 months ended 30 September 2016 and at 1 July 2015. Details relating to the nature and amount of the restatements are provided below.
Financial impact:
30 September 2016 Financial impact:
1 July 2015 Equity
Categories of restatement Asset
decrease Liability
Property transactions (429) – 41 (18) 406 (406) –
Intangible asset transactions (5 801) 703 1 013 (19) 4 104 (3 778) (326)
Accounting for Group or related entities (1 376) 802 240 153 181 (348) 167
Contributions and 'cash equivalents' (1 179) 11 288 35 845 (845) –
Share transactions (241) – 62 (40) 219 (219) –
Consequential effects of accounting irregularities (2 406) 41 35 (209) 2 539 (2 600) 61
Total impact relating to accounting irregularities (11 432) 1 557 1 679 (98) 8 294 (8 196) (98)
Restatement due to finalisation of provisional post-combination accounting of acquisitions The post-combination accounting of the following acquisitions was finalised and the affected assets and liabilities were retrospectively restated:
(i) Mattress Firm acquisition: effective acquisition date 30 September 2016;
(ii) Poundland acquisition: effective acquisition date 30 September 2016; and (iii) Other small acquisitions
Refer to note 1.1 to the 2017 Consolidated Financial Statements for further details on the restatement. These restatements are not as a result of the accounting irregularities.
Change in reportable segment information As a result of restatements arising from the correction of prior period errors, the Management Board had to reconsider the Group presentation of its segments.
Historically, the Group presented three aggregated segments, but in the interest of transparency and in compliance with IFRS, the Group has restated its segments as eleven segments, details of which are contained in
note 2 to the 2017 Consolidated Financial Statements. This presentation is aligned with how the Management Board views the business and with historical operational reports.