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To: Baroness Neville-Rolfe B I S
From: Justin Manson iGR 9 I Richard Callard (GRO I Department for Business
Lad Innovation & Skills
Date: 11 December 2015
Subject: Post Office Limited update
Purpose: To update on issues related to accounting restatement and to IT transformation
programme.
Timing: Routine.
Recommendation: That you note the issues.
A. Background
1. We set out below our views on the proposed accounting restatement and on the
delays in implementation of the IT transformation at POL. These views are based
on discussions in the last few days with the Chairman, the CEO, the CFO and the
original Financial Controller. They represent our best current understanding of the
company’s position as well as a cautious view of what the company may face in
the next twelve months.
B. Context
2. In the first half of 2015, the CEO of POL, working with the Board, moved to
strengthen the executive team to ensure that the business, which is still going
through its full operational separation from Royal Mail, has the right processes and
controls. Three appointments were made to the executive: a CFO, a General
Counsel and a Transformation Director. As the business is transformed, issues are
being identified and resolved: this process is expected to continue for some time,
at least through fiscal year 2016/17.
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C. Understatement of provision for sub-postmaster exit costs
What is the issue?
3. The POL Finance team identified that the provision for making future payments of
compensation to sub-postmasters under the Network Transformation (NT)
programme had been understated. As at 29" March, 2015 (POL’s fiscal year end)
the understatement is estimated at c£86mm. The data sources are complex and the
work to ensure that the number is correct, and fully audited, is nearing completion.
The final figure may vary but the CFO is increasingly confident that it is
substantially correct. The work to date suggests that there has been no cash
impact, no funding impact and that the cost of the Network Transformation (NT)
programme remains as planned. There has been no suggestion of improper
payments, missing payments to sub-postmasters, or any loss to the business.
What is the restatement and what is the impact on BIS and POL accounts?
4. POL’s 2014/5 accounts were signed and published in the summer and will now
have to be restated in the 2015/16 accounts (and interims).
5. HMG, through the Secretary of State for BIS, owns 100% of the shares in the
Postal Services Holding Company, the company that owns 100% of POL. PoSH’s
2014/5 accounts will not need to be restated because they have not yet been
published but might need to be delayed beyond the last filing date of 23"
December.
6. POL’s net assets appear in the BIS Departmental Group accounts (which have
been published for 2014/15), because PoSH is consolidated by BIS. POL’s prior
period error of around £86m is not material to the BIS Departmental Group
position and so BIS’s 2014/15 position would not need to be restated. The
2015/16 accounts will instead recognise a fair value movement to reflect the
understatement. A narrative explanation for that movement would not need to be
disclosed as it is below the disclosure threshold.
When will the provision be finalised?
7. The CFO expects to finalise the number in the next few days and is attending this
Friday’s board meeting of POL’s parent company (Postal Services Holding
Company Ltd (PoSH)) to provide an update. In addition to the calculation and
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auditing of the number, POL is looking to demonstrate and state in its interim
results that there has been no impact on payments to sub-postmasters or on the
overall cost of the programme.
8. The accounting teams are also focussed on the six month period ending 30"
September, 2015 which will be reported in the interim statements in the next
couple of weeks. Applications to the NT programme, by which sub-postmasters
sign up to leave the network, or amend their contracts, will end on 31‘ December,
2015 (possibly with a short grace period thereafter for any late applicants). After
that date, payments to exiting (or modernising) sub-postmasters will continue to be
made as they actually leave the network or refresh their branches. The provision
will reach its peak and the final amounts to be paid over the remainder of the
programme will then become increasingly certain.
How did the need for restatement of POL accounts arise?
9. The need for restatement of the provisioning of payments to sub-postmasters
exiting the transformation programme arose for two reasons. Some data from the
Network Transformation programme did not flow through to the spreadsheets used
as the basis for the financial provisioning. Secondly, some of the data that was
included in the spreadsheets was not being picked up in the calculations used for
the financial reports. Financial reports were therefore based on incomplete data
although the underlying documentation and payments appears to be sound. POL
has sought to confirm the value of the provision by reviewing payments and
agreements either side of the period end and these processes are being tested by
EY. To date, no missing payments or overpayments have been identified.
Provisions were under-recorded from the perspective of the accounts but no sub-
postmasters have suffered financial losses.
What is being done to address the accounting and internal control issues?
10.The weaknesses of the internal accounting controls which gave rise to the under-
provisioning, were identified by the relatively new CFO and are being
addressed. He has replaced the Financial Controller, and has created Finance
Director functions for each of the four business lines. A programme of work is
underway to agree accountabilities. Previously these lines were much less clear.
The internal audit function is being rebuilt from first principles by an external
recruit reporting to the new General Counsel Jane MacLeod. The redesign of
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the internal reporting controls will be substantially finished in 2015/16 but their
refinement, implementation and improvement will continue through 2016/17.
11.The external audit function continues to be performed by EY and a new audit
partner has been assigned. The fee for EY will be reviewed once the work to
correct the sub-postmaster provisioning is completed.
12.POL is putting in place significant changes to the accounting and controls
environment. POL should also benefit from having a new Chairman, a new CFO,
a new external audit partner, new lines of internal accounting responsibility, and a
new Chair of the Audit Committee. As the improved governance and controls
take effect over a full new audit cycle, and as the company continues to actively
manage significant change in its business environment and its operating model, we
expect that issues such as the understated provision will be addressed fully and
openly. By the same token, we expect that any residual accounting and control
issues, if there are any, will become apparent over the next audit cycle. ShEx will
have visibility of these issues through Richard Callard’s membership of the board
and future membership of the audit committee, and will encourage POL to
continue to identify and address these issues in an early and open manner.
D. IT Transformation
Why the delay and cost overrun of implementation of the IT transformation plan?
13.POL’s IT network suffers from significant underinvestment. The Horizon front
office system has been in place for over a decade, POL resorts to having to recycle
kit from old post offices to find replacements, and its back office systems suffer
operational issues most days. The £280m IT transformation programme aims to
address these issues and POL has been running a series of IT procurements over
the last two years.
14.POL had originally wanted to use its existing front office software provider
Fujitsu, which would have reduced the operational risk (and cost) of the
replacement software significantly. Despite being pressed by POL, Fujitsu refused
to participate in the public procurement process. POL therefore had to use a
different supplier, which has involved added complexity and cost. The current IT
transformation plan involves four suppliers to cover front office software,
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hardware, network, and back office, plus a fifth supplier co-ordinating their
integration. This is a challenging task, particularly in rolling out the front office
software and hardware in all 11,600 post offices whilst ensuring that all financial
ledgers are reconciled during the changeover.
15.The new Director of Transformation (David Hussey), who was appointed six
months ago, has recently conducted a detailed review of POL’s wider
transformation programme which encompasses IT, the Post Office network,
separation from Royal Mail, and other projects such as cost reduction plans. He
has found that there is now likely to be a delay of eleven months and an additional
cost estimated, on a preliminary basis and if unmitigated, at c£60m. The CFO does
not expect to seek additional funds in the current spending period (through to
2018). Detailed funding discussions for post-2018 are scheduled to begin next
year.
An alternative solution to the current IT transformation plan?
16.In an effort to mitigate the time and cost challenges, POL has confidentially re-
engaged with Fujitsu, who with new management seem more inclined to consider
supporting POL. Fujitsu’s involvement would make the upgrade of the software
much simpler from the perspectives of the front office and upgrades to the network
and hardware. However, simply re-appointing Fujitsu presents challenges,
primarily from a procurement law perspective. POL is working through these
issues and will update the Board on 17" December.
E. Next steps
17.ShEx will have weekly calls with the CFO and ad hoc calls with the Chairman and
CEO as necessary. ShEx will continue attend board meetings and audit committee
meetings as a member.
18.We will also hold discussions with the Chair, and incoming Chair of the
Remuneration Committee, Ken McCall, about any further actions that need to be
taken by the Board and/or the shareholder.
19.ShEx will continue to keep the Minister updated.
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Copied to: Minister’s office; Mark Russell, ShEx
Advice received from:
Finance SpAds Press Legal Analysts
N/A N/A N/A N/A N/A
Devolution Issues Post Office is not a devolved
matter.
Equality Analysis N/A