The Carillion Scandal & Financial Statement Fraud


Carillion plc was a construction giant in the U.K. that collapsed in 2018. It did so under the weight of a £2.6 billion pension liability and approximately £2 billion debt to its suppliers, sub-contractors and short-term creditors (Bishop). The liquidation was abrupt and from a publicly-declared position of power. Carillion’s accounts in 2016 presented virility, with the company paying a personal best dividend of £79 million-£55 million, and awarding generous performance bonuses to its top management. However, in July 2017, four months after the publication of the 2016 annual report, the company declared a profit warning that delineated a decrease in the value of its contracts by £845 million (Bishop). Later, in September 2017, this amount increased to £1,045 million. Carillion was liquidated in 2018, with liabilities totaling to about £7 billion, with just £29 million in cash (Bishop).

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Red Flags for the Fraud

Financial statement accounting is significantly reliant on estimates. As a result, management can easily manipulate these estimates, hence, overstating a company’s net income and net worth. The red flags of the Carillion financial fraud case include:

Aggressive Revenue Recognition Practices

Carillion exploited its supply chain finance scheme in which it used nearly £500 million. It then used aggressive accounting strategies efficiently to window dressing financial statements to flatter the cash-flow conversion ratio, heighten net cash and decrease debt, and increase cash generated from operations. In all of Carillion’s annual reports in the past three years since its liquidation, cash conversion had been used as a key performance indicator, and as a factor influencing upper-level management remuneration (Carillion, Annual Report and Accounts 2016 18; Carillion, Annual Report and Accounts 2015 4). However, from 2014 to 2016, the “other creditors” grew by £355.9. This phenomenon was caused by Carillion’s reverse factoring arrangement to finance cash flow; therefore, it affected the computation of cash conversion.

Utilizing the Reverse Factoring Technique

Carillion was using the reverse factoring technique that is also referred to as a “hidden debt loophole”. This practice made Carillion seem healthier than it was. For instance, Carillion recorded having £115 million worth of operating cash flow of and an operating profit of £145 million, in 2016 that yielded a reasonable cash conversion (Carillion, Annual Report and Accounts 2016 94). Nevertheless, it is essential to note that this operating cash flow was amplified by the £200 million rise in “other creditors” in 2016. In the absence of finance obtained from “other creditors”, the operating cash flow would have decreased. By December 2016, Carillion’s debt to equity ratio was 5.3, which significantly exceeded the widely considered acceptable ratio of 2.

Pension Deficit in Relation to Poor Dividend Policies

Dividends were a central financial signal in Carillion, in which in 2016, they were estimated to be approximately 64% of the reported £124 million earnings. Moreover, in the past years, Carillion has taken pride in disbursing significant dividends to its shareholders. Zafar Khan, the Group Finance Director, boasted that “the board has increased the dividend in each of the 16 years since the formation of the company in 1999” (Carillion, Annual Report and Accounts 2016 43). The growing dividend was supported by a concurrent increase in share price. However, in 2016, it was seen that Carillion’s pension fund had attained a deficit of -£811 million, which was significantly more than £701 million equity in the balance sheet (Carillion, Financial Results for the Six Months 22). Therefore, this suggested that upper-level management had opted to disburse dividends to shareholders instead of utilizing the finances to pay for its pension commitments to past and current employees. Furthermore, this insinuates that there is a high probability that management was aware of the company’s default. Between 2014 and 2016, Carillion’s working capital ratio was at 1.0, in which any value less than 1.2 signifies financial difficulty.

Disproportionate Incentive to Maintain the Goodwill Value in Accounts

Based on the past annual reports, it is evident that Carillion’s balance sheet had been greatly reinforced by goodwill. For instance, in 2016, the company recorded a goodwill of £1.6 billion, which was more than double the £730 million net assets and approximately 35% of Carillion’s gross assets (Carillion, Annual Report and Accounts 2016 110). Goodwill, which is the disparity between the book value of the company procured and the amount Carillion paid, was obtained through acquisitions. This was meant to embody the future profits of a business that Carillion had acquired in the previous years. Due to the significance of goodwill in the balance sheet, any material misappropriations would have a substantial impact on reported results. Hence, it can be contended that the disproportionate incentive to maintain the value of the goodwill in accounts is alarming.

Moreover, the IFRS standards require that assumptions utilized in estimating goodwill be subjected to annual tests to assess whether they are impaired or have reduced value. Carillion never recorded an impairment in its annual accounts, thus, suggesting that the management was confident that the price paid for each acquisition was rationalized because of the continuing economic benefits it expected to reap from them. However, it was difficult for Carillion to justify some of its purchases. For instance, in 2011, Carillion recorded a goodwill of £330 million when it purchased Eaga. Nonetheless, after five years of consecutive losses, the amount remained constant, in spite of Philip Greene, the former Carillion Chairman, acknowledging that the acquisition was a blunder (Greene 2). Overall, regardless of the high value of the goodwill, the cash flow was significantly less than the amount implied by the net income.

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Low Margin Contracts Combined with Excessive Debts

Carillion’s business model was centered on bidding low margins to win contracts, then utilizing high levels of debt to report profits in its accounts. Moreover, the company was operating in an industry characterized by slender margins. Such kinds of low margin contracts are highly likely to create risks since minor changes in revenue and cost can easily impact the overall profitability of that specific contract. Moreover, these low margins will have a ripple effect through the supply chain. For instance, Carillion’s operating margin in the last eight years was between 1-4%, while its earnings margin was in the range of 2-3%. It is essential to note that Carillion was often engaging in long-term contracts, and with the previous IFRS accounting standards that gave companies discretion over when to report the revenues of the contract. Carillion financial statements gave no clue on how the company accounted for long-term contracts.

Alternative Versions of Key Profit Numbers

For instance, in just a single page of Carillion’s 2017 interim report, in the key results page, the company mentioned ‘underlying’ numbers more than ten times (3).

How to Approach Financial Statement Fraud Examination

Financial statements are designed to reflect the true position of a company, however, with regards to true accounting, they are in fact highly subjective. The collapse of large companies like Carillion does not just occur overnight. It is stems from poor business decisions that were made over a number of years and concealed in the financial statement. Therefore, in the case of a large company like Carillion, the shocks of the financial misappropriations are felt after several years. As a result, when examining financial statement fraud, an auditor should review the past financial statements or annual reports of a company. There is a given set of steps that have to be followed when investigating financial statement fraud to extensively evaluate and generate accurate results indicating whether or not the company has committed fraud. Furthermore, during the auditing process, the auditor needs to have in mind that it is relatively easy for large corporations like Carillion to hide financial statement fraud. This is because the misinterpretations can be concealed through the reliance on the various interpretations of accounting standards used in preparing financial statements. The procedure of conducting a fraud examination constitutes:

  1. Ascertaining whether the behavioral conditions of the organizations are disposed to fraud. This is achieved by determining whether there is a strong incentive for the management or employees to participate in fraudulent financial reporting. In Carillion’s scenario, the upper management wanted to showcase the company’s virility through the increasing amounts of dividends it gives shareholders.
  2. Identifying the existence of red flags or fraud risk indicators – symptoms that are present when particular financial reporting frauds take place.
  3. Evaluating the existence of weaknesses in internal controls, which could easily facilitate the performance of financial reporting fraud with minimal or no detection in the normal course of business.
  4. Performance of analytical procedures aiming at the identification of financial statement fraud. These analytical procedures comprise trend and ratio analysis. This is followed by the calculation of a series of financial ratios and examination of specific historical economic trends to facilitate the identification of areas on the income statement or balance sheet that have been subjected to material statement due to fraud, primarily, the revenue section of the income statement.
  5. Evaluate particular sections of the annual report, for instance, the Management’s Discussion and Analysis (MD&A), which offer further insight and details into the value of financial statements.
  6. Evaluating whether the information collected exhibits clear signs of fraudulent financial reporting.
  7. Evaluating whether the financial statements are fraudulently reported due to non-compliance to several acceptable basis of accounting in the U.K.
  8. Identifying the individuals involved in the scheme and the duration that it has been going on.
  9. Evaluating whether external parties have liability or have willingly participated in the scheme. In large corporate fraud schemes, financial fraud is often committed by upper-level management. This has also been mirrored in some of the historical financial statement frauds, such as at WorldCom and Enron. Therefore, it is essential to investigate the activities of upper management.


Based on the information presented by the auditors in the annual reports, there was no implication of Carillion committing outright financial statement fraud. The company was mainly using the supply-chain finance scheme, a legitimate financing tool, which benefits Carillion and the participating suppliers. However, it was abused by Carillion as the upper management inappropriately used to window-dress financial statements. Therefore, a superficial analysis of the company’s financial report would not have yielded any red flags – operating income seemed to have covered interest expenses. However, intense scrutiny exposes signs of financial fragility. It indicated that Carillion had issues with its accounting strategies, pension remuneration policies, goodwill, and key profit numbers used in financial statements.

Works Cited

Bishop, Phil. “The Decline and Fall of Carillion.” The Construction Index, Web.

Carillion. Financial Results for the Six Months Ended 30 June 2017: Strategic and Operational Review Update. 2017, Web.

Annual Report and Accounts 2016. 2016, Web.

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Annual Report and Accounts 2015. 2015, Web.

Green, Philip. Carillion – Joint select Committee Hearing Evidence. 2018, Web.

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