Covey Instruments: a cut-off dispute, an undisclosed interest and a weak board

Fundamental principles engaged: integrity - the December entry is not straightforward or honest; objectivity - pressure from a senior colleague; professional competence and due care - transactions must be recorded in the period to which they relate; professional behaviour - the accounts go to a lender.

Threats: self-interest (job security, loyalty to founders) and intimidation (a direct instruction from the sales director).

Actions, escalating:

1. State the objection in writing: despatch on 2 January means no performance obligation was met at 31 December; the sale is 20X6 revenue, and the £96,000 margin (240,000 × 40%) is what converts £830,000 into an apparent £926,000 - i.e. the entry is the only reason the covenant appears to be met.
2. Escalate to the finance director and then the board, recording the advice given and the response.
3. Because the board is entirely executive and implicated, press for an independent non-executive director or external advice; use CIMA's ethics advisory service.
4. Never sign or approve the accounts and never mislead the auditor.
5. If the misstatement proceeds, consider resignation, and note that a protected disclosure to a prescribed regulator may be appropriate; confidentiality does not prevent reporting where there is a legal or regulatory obligation.

Weaknesses: no separation of ownership from control - the two founders are the board; no independent oversight, so no one can challenge an executive instruction; no audit committee, hence no independent scrutiny of cut-off, estimates or covenants; no conflicts register or declaration procedure; no procurement or tender policy; no whistleblowing channel; and no evidence that the bank covenant is monitored by anyone other than the person being pressured.

Recommendations:

• Appoint at least one genuinely independent non-executive director and form an audit committee chaired by that NED, meeting the auditor without executives present.
• Adopt a written conflicts of interest policy and register; directors should declare interests in proposed transactions (Companies Act 2006 s.177) and existing ones (s.182), and avoid conflicts (s.175) - the supplier arrangement should be reviewed, minuted, and disclosed as a related party transaction in the accounts.
• Require competitive tender above a set threshold, with a documented evaluation and a second approver.
• Adopt a whistleblowing policy with a named independent route.
• Report covenant compliance to the board quarterly. The UK Corporate Governance Code does not bind a private company, but its principles are the benchmark a bank or future investor will apply.

Cut-off. Revenue is recognised when control passes, which is despatch on 2 January. Posting the invoice to December overstates revenue and profit by £240,000 and £96,000 respectively and misstates receivables and inventory.

• Directors who approve accounts they know do not comply with the Act, or are reckless as to compliance, commit an offence under Companies Act 2006 s.393. The accounts must give a true and fair view.
• Deliberately presenting the figures to the bank to obtain or retain facilities may amount to fraud by false representation (Fraud Act 2006 s.2), and knowingly being party to carrying on business with intent to defraud creditors is an offence under s.993 of the Companies Act 2006.
• Directors owe duties under ss.171–174; misleading a lender is unlikely to promote the success of the company and is not the exercise of reasonable care.
• Knowingly or recklessly misleading the auditor is an offence under s.501.

The covenant breach must be disclosed, not disguised; early negotiation is lawful, deception is not.

Supplier contract. Failure to declare an interest breaches s.177/s.182; the company may be able to avoid the contract and recover any benefit. A 30% family holding makes the supplier a related party, requiring disclosure in the accounts. If any inducement was received, the Bribery Act 2010 is engaged.