3Role of professional services
71.Between 2013 and 2015, the Cabinet Office used the work of auditors, accountants and consultants to inform its decision making in relation to Kids Company. However, none of these reviews delivered a meaningful assessment of the charity’s effectiveness, quality of services, outcomes or value for money. They were therefore inadequate in providing a useful picture of the charity’s operations or reassurance to potential donors.
Kingston Smith LLP
72.Kingston Smith audited Kids Company 2011–2013, and signed off the charity’s accounts as a going concern each year.130 Mr Nick Brooks, the partner responsible for the audit, stressed that “responsibility for signing the accounts is firstly with the Trustees” but explained that Kingston Smith was content to sign off the accounts on the basis of “a letter of representation signed by a Trustee on behalf of the Board”.131 Mr Brooks also clarified that Kingston Smith checked the assumptions of this letter, examined the charity’s budgets and cash flows and “assessed reliability based on history and previous matching to budgets and cash flows,” before confirming that the charity was indeed a going concern.132
73.However, despite an overall agreement that the charity’s accounts represented a going concern, the accounts included identical warnings each year: the charity was continuing to grow very fast, had low reserves relative to its size, and activity in the next financial year would “depend almost entirely on its ability to secure continuing grant income”.133
74.The auditors raised these concerns directly with Trustees. Management letters sent to Kids Company between 2009 and 2013 consistently repeated two warnings: about the charity’s low levels of reserves, and Kids Company’s extensive use of contracted and self-employed workers.134 Kingston Smith received a response from Kids Company in 2011 but the charity failed to respond in both 2012 and 2013. Mr Brooks stated that many charities do not “formally respond to auditors”.135
75.There is a striking contrast between the language used by Kingston Smith and that used by the previous auditors, MacIntyre Hudson, in management letters to Trustees. MacIntyre Hudson called Kids Company’s “history of spending over budget…a very risky strategy,” and warned that the “deficit in free reserves currently puts the charity in a potentially insolvent position.” When Kingston Smith took over as auditors, the charity’s free reserves were still in deficit (-£10,125 in 2011, compared with -£32,464 in 2010) but Kingston Smith’s management letters warned instead of “an impact on Kids Company sustainability…negative publicity and reputational damage” rather than insolvency. Mr Brooks explained that this was simply a case of “different firm, different language,” and stated that Kingston Smith “probably agreed” with MacIntyre Hudson’s assessment that Kids Company’s business model put them at risk of insolvency: “Nothing had changed…it has always been living on a knife edge, which is in my view portrayed quite clearly through the notes to the accounts.”136
76.Section 156 of the Charities Act 2011 places a duty on the auditors of both a non-company charity and a company charity to report matters of “material significance” to the Commission.137 Amongst matters considered to be of “material significance” are “failure(s) of internal controls, including failure(s) in charity governance, that resulted in a significant loss or misappropriation of charitable funds, or which leads to significant charitable funds being put at major risk”.138 However, Kingston Smith did not notify the Charity Commission about the charity’s failure to address its precarious funding situation - which ultimately led to the charity’s folding, the loss of significant charitable funds and the collapse in the support framework of a large number of vulnerable people. Mr Brooks acknowledged that he “had not considered whether that would be an area [of interest to the Charity Commission] and going forward I would think about that”.139 We respect Mr Brooks’s honesty in this matter.
77.Kingston Smith has offered no credible explanation for changing the warnings of insolvency from those issued by the preceding auditors. Mr Brooks stated that Kingston Smith’s softer language still indicated that Kids Company was “living on a knife-edge.” It is surprising that Kingston Smith did not consider its duty to alert the Charity Commission to the extremely high risk of failure in this charity, in accordance with its duty as charity auditors under Section 156 of the Charities Act 2011. We note that this is a lesson that Mr Brooks appeared to accept under our examination, but this lesson should be learned by the audit profession as a whole.
Assessment of internal controls
78.The International Standard on Auditing (UK and Ireland) 530 dictates that “the higher the auditor’s assessment of the risk of material misstatement, the larger the sample size needs to be,” and that auditors should assess the risk of material misstatement by considering the “inherent risk and control risk”.140 Mr Brooks confirmed that Kingston Smith’s judgements about the charity were based on samples selected by a computer as “there were thousands of documents and we can only test a sample,” but stated that Kingston Smith felt that the charity’s internal financial controls “as we checked them were more than adequate for an organisation of that size”.141 This assessment of the charity’s internal controls would have influenced Kingston Smith’s decisions about what constituted an appropriate sample size.
79.Mr Brooks stated that PwC and PKF Littlejohn’s reviews had “much more of an internal audit nature, where you look in much more detail at a lot more invoices”.142 When asked about the “miscellaneous pieces of paper” that PwC stated Ms Batmanghelidjh used to document distribution of her float, Mr Brooks stated that he was “unaware” of this practice and that Kingston Smith “might or might not have chosen one of her expenses from the sample that we undertook”.143 He also said that Kingston Smith’s samples did not uncover the examples of excessive spending highlighted by a number of witnesses throughout the inquiry.
80.Mr Brooks clarified that, as the charity’s auditor, Kingston Smith was concerned with checking payments were “properly authorised and correctly treated through the system” and did not assess whether the charity’s spending was in line with charitable objectives, or whether clinical assessments justified the expenditure.144 Mr Brooks stated that:
if a therapist or one of the case workers felt that money should be spent on that individual, it is very difficult for us as auditors to say, “We don’t believe that is right’… I think that comes down to the overall management of the organisation, the governance and how it is run.145
81.Mr Brooks also stated that he would not “be in a position to make [an] assessment” about whether therapists employed by the charity were appropriately qualified.146
82.It is regrettable that, in over three years of auditing the charity, Kingston Smith’s sampling method failed to uncover any of the issues that have since emerged regarding the charity’s expenditure and internal controls. Kingston Smith appeared to be over-confident in the charity’s internal controls. This in turn may have influenced the sampling process and the level of scrutiny to which the charity was subject. For a charity that the auditors acknowledged was “unorthodox”, particular vigilance in identifying the audit risks and sampling size should have been especially important.147 In addition, the failure of Kids Company’s Trustees to respond to recommendations repeatedly laid out in management letters suggest that Kingston Smith’s confidence in the charity’s management was misplaced.
83.Kingston Smith did not consider it part of its remit to assure the public of whether Kids Company spent money in line with its charitable objectives. Ultimately, discretion over appropriate spending rests with the charity’s Trustees, not the auditors or the Charity Commission. This inquiry provides a reminder to all who use charity accounts that a set of audited accounts do not provide assurance that charitable funds are being used wisely or that a charity is well run.
84.Ms Batmanghelidjh’s use of the fact that the charity had 19 years of clear audits, while true, is also disingenuous. Each time the charity’s accounts were signed off as a going concern, the auditors issued significant warnings to the charity about the precariousness of its demand-led operating model and the dependency of the charity upon future grants and emergency funding. However opaque the language, the meaning should have been clear enough to the Trustees and CEO. Such repeated warnings should have led to a change to the reserves policy, contingency planning for insolvency and substantial downsizing many years before the final crisis.
PKF Littlejohn
85.In December 2013, PKF Littlejohn LLP was engaged by the Cabinet Office to review the financial and governance controls of Kids Company because it was “nervous about the charity’s financial controls and governance” and wished to “work out whether the charity was being badly run”.148 Correspondence between Nick Hurd, the then Minister for Civil Society in the Cabinet Office, and Kids Company shows that the Cabinet Office held £500,000 of an early £1 million grant payment contingent on the outcome of PKF Littlejohn’s review.149
86.Overall, the report concluded that the charity’s governance system “appears to be appropriate for its size and complexity. Board and Committee responsibilities are well documented and, more importantly, understood. We have no recommendations to make in terms of improvements to the governance systems and risk assessment processes”.150 The Cabinet Office subsequently released the remaining £500,000 as agreed.151
87.In the tender documents for the contract to complete the review, the ‘Scope of Requirement’ required the successful bidder to use “appropriate methods…to assess the effectiveness of the charity’s governance and controls”.152 However, in written evidence, PKF Littlejohn stated that “an assessment of the effectiveness of these policies and procedures was outside the scope of our review”.153 Instead, it claimed that the review was limited to “establishing the policies and procedures in place and assessing whether these policies and procedures were appropriate for a charity of similar size and complexity to Kids Company”.154
88.As Alastair Duke, Partner at PKF Littlejohn who oversaw the review of Kids Company, acknowledged: “what must be made clear is that good financial controls and good governance controls will not necessarily result in the correct decisions being made”.155 When asked to explain why the final report did not deliver the requirements outlined in the tender document, Mr Duke stated that PKF Littlejohn “worked throughout the planning stage with the Cabinet Office explaining the work that we were going to do and agreed the work programme”.156 Evidence from Mr Letwin, however, has indicated that Cabinet Office did in fact treat the report as if it offered the assurances of the original scope (see paragraph 159). Mr Duke stated that “how the report was used subsequently by the Cabinet Office is not something I can answer”.157
89.The Cabinet Office’s tender for the contract to review Kids Company required the successful bidder to provide the Government with assurances about the effectiveness of Kids Company’s governance. PKF Littlejohn now says that the original scope was narrowed, in agreement with Cabinet Office, to establishing whether the policies and procedures in place were appropriate. PKF Littlejohn asserts that Ministers took assurances from the report that were outside the scope of the review. The Cabinet Office should have identified that the PKF Littlejohn remit had altered and communicated this message clearly to future users of the report. This would have minimised the weight Ministers placed upon the very limited assurances the report offered.
90.However, it is not acceptable that a report commissioned to provide a professional assessment of a charity’s governance and controls looked only at systems and processes; as Mr Duke acknowledged, good controls can be overridden. PKF Littlejohn’s review did not assess the organisation’s sustainability in financial and reputational terms and proved to be of little value in assessing the effectiveness of the organisation’s governance. Without reviewing, for example, decision-making, attitudes and habits of behaviour, risk-management and strategic objectives in the organisation, a contractor could not assess the effectiveness of the charity’s governance and controls and deliver upon the tender’s requirements.
PricewaterhouseCoopers
91.On 16 July 2015, the Charity Commission met former employees of Kids Company, who made a number of allegations about financial practices at the charity. These included allegations of possible unlawful trading, non-charitable expenditure and employment irregularities. At the direction of the Charity Commission, Kids Company commissioned PricewaterhouseCoopers (PwC) to investigate the allegations.
92.PwC’s investigation began on 23 July, with the agreement that “initial findings” would be shared with Kids Company and the Charity Commission three days later. The preliminary investigation cost Kids Company £26,300 in time costs, and £1,000 for expenses.158 PwC reported spending 100 hours conducting this stage of the investigation.159
93.Mr Will Richardson, Partner at PwC who oversaw the investigation, stated that, initially (on 21 July), the charity requested “an answer to the allegations by that Thursday (23 July) evening” but “pragmatically that was not possible”.160 Instead, PwC worked with Kids Company to decide which allegations to investigate in the short period of time available. Of the eight allegations reported to the Charity Commission, five were selected for preliminary investigation on the basis that progress could be made in the few days available.161 Mr Richardson noted that PwC covered as much ground as possible in the time available, but stressed that the investigation had only been under way for three days and that the work was not complete. The preliminary report emphasises “the very limited nature of the work” undertaken by PWC and makes clear that “we have not carried out anything in the nature of an audit.”
94.The Cabinet Office delayed payment of the £3 million grant until the competition of PwC’s preliminary investigation, but Mr Richardson said that he was unaware “that the Cabinet Office was waiting to see our report before any decision was taken” about whether to release funds. 162 He was, however, “aware that the charity was in financial difficulty” and that it “wanted an answer” to serious allegations. He was unsure “how those factors interplayed to create a very short timescale”.163
95.When asked what assurance a reader should take from PwC’s preliminary report, Mr Richardson said that he “would not use the term assurance”.164 He said that he was aware that the Charity Commission wanted to know “whether there was any substance to the allegations,” and stated that the preliminary report had “determined that there was no basis for one of the allegations and started to give a sense of direction of travel in relation to the other four.” He added, however, that the fact that “there was no direct evidence at that point in time, with the very specific work that we had undertaken in relation to those specific allegations” came with the “big caveat” that the investigation was not complete.165
96.Phase Two of the investigation, which never took place, would have required PwC to examine “the documentation trail, to see that those beneficiaries had gone through the normal clinical acceptance procedures” as well as to cross-reference the clinically assessed needs of relevant individuals with the payments made in relation to those needs and to corroborate some of the explanations given for the expenditure. Explanations requiring corroboration included those offered by Ms Batmanghelidjh, whose responses to each allegation were published in the report. Mr Richardson explained that PwC “had not had time to corroborate Ms Batmanghelidjh’s answers” but nevertheless felt that it was “important to put the fact that we received those explanations into the report”.166
97.PwC’s preliminary report was of little value to Kids Company, the Charity Commission or the Cabinet Office. Although investigation into one allegation had been completed, the remaining reports were subject to such heavy caveats in consequence of the very short timeframe that no conclusions could be drawn. Nevertheless, the report was cited by supporters of Kids Company as proof there was no substance to the allegations. Kids Company’s rush to complete the investigation resulted in a report that offered no real assurances for the considerable costs incurred.
98.All three professional firms identified matters of concern relating to Kids Company, yet not one of them reported the scale of risk carried by the charity to the Trustees, the Cabinet Office or Charity Commission. This is a salutary warning about the use of professional advisers. They are no substitute for the exercise of judgement. They tend to limit the scope of the terms of their investigation in order to limit their own exposure to risk. In this case, they were able to avoid making any examination of the wider issues that threatened the charity’s existence. In the partial assurances they offered, the resulting reports may actually have obscured more than they revealed to those who read them.
130 Kingston Smith was only in the very early stages of the 2014 audit when the charity closed.
131 Q492 oral evidence 17.11.2015 and KCI 24 (Kingston Smith)
133 Kids Company’s Annual Reports. The Annual Reports for 2010–2013 are available on the Charity Commission’s website.
134 Kingston Smith, and the previous auditors MacIntyre Hudson, warned that HMRC may judge these to be full time employees and therefore demand PAYE and National Insurance contributions from the charity.
135 Q500, oral evidence 17.11.2015
136 Qq485, 492 oral evidence 17.11.2015
138 Charity Commission Guidance for Auditors and Independent Examiners
139 Q503, oral evidence 17.11.2015
141 Qq430, 465, oral evidence 17.11.2015
142 Q430, oral evidence 17.11.2015
143 Q448, oral evidence 17.11.2015
144 Q415, oral evidence 17.11.2015
145 Q416, oral evidence 17.11.2015
147 Q411, oral evidence 17.11.2015
148 Qq30, 100 , [Richard Heaton] oral evidence to Public Accounts Committee 02.11.2015
149 The review was carried out at Kids Company’s offices 15–24 January 2014, and the report was issued on 3 March 2014.
150 Kids Company Review of Financial and Governance Controls, PKF Littlejohn report (March 2014)
151 Ms Batmanghelidjh claimed that Cabinet Office attempted to “tamper with the independent audit carried out by PKF Littlejohn in order to make it more negative (KCI58).” Mr Duke explained that there were “minor amendments,” following input from both Kids Company and the Cabinet Office, but that “nothing of substance changed from the draft one to the final draft that I signed.” He stated that Cabinet Office asked PKF Littlejohn to move the warning about the charity’s cash flow to the beginning of the report, and confirmed that he “thought it was a good idea, to bring that upfront to the very first page,” because the charity’s cash flow and low reserves represented the biggest risk to the charity.
155 Q316, oral evidence 17.11.2015
156 Q321, oral evidence 17.11.2015
157 Q324, oral evidence 17.11.2015
158 Q274, oral evidence, 17.11.2015
159 Q250, oral evidence, 17.11.2015
160 Q251, oral evidence, 17.11.2015
161 Q499, [Michelle Russell] oral evidence 03.11.2015
162 Q254, oral evidence, 17.11.2015
163 Q253, oral evidence, 17.11.2015
164 Q261, oral evidence, 17.11.2015
166 Q285, oral evidence 17.11.2015 Investigation would also begin into the three allegations that had not been covered in Phase One: allegations of trading while insolvent; making payments outside of its objects and; whether there were any implications in relation to a beneficiary on state benefits also receiving benefit payments. Although PwC’s letter of engagement was sent to the charity on 4 August, the charity closed down the following day and Phase 2 did not begin. The preliminary report noted a number of expenses incurred buying individual items purchased for beneficiaries. These included £80 blankets from John Lewis; men’s outerwear costing £149; designer shoes for £305; and over £4,700 spent on clothing for one client in one year. Mr Richardson confirmed that these payments were “irregular” within a charity but stated that PwC was unable to pass a judgement on whether this was appropriate without “connecting clinical assessed needs and payments made in relation to those needs,” which would have formed Phase 2 of the investigation.
© Parliamentary copyright 2015
Prepared 28 January 2016