As you may know, there are public and private companies. Public companies can sell shares to members of the public, normally through a broker or exchange, private companies cannot. Both must prepare accounts though, and must also file certain accounting information which in turn becomes available to the public. So what accounting data can Joe Blogs get? The answer is it depends, but I will give you a good idea on this post.
In most European countries there is a central register of all companies – as far as I am aware the US does not have such a register, and the SEC focuses on public companies only. In Ireland and the UK, a small fee via an online portal gets me at least a balance sheet of a company – an abridged version for small companies – and an annual return which shows the directors and shareholders and their details (such as address). To give another example, in Germany I can download a free app called the Bundesanzeiger and search for details of any company – again for smaller companies I can get a summarised balance sheet.
For larger companies, including public a lot more information is available of course. But even with a balance sheet, or more of the company is medium or large, I can obtain quite a good picture of the financial position of a private company, and quite detailed information of directors and shareholders. Such information can be very useful to prospective investors, suppliers, customers and even employees. Why not search for a private company you know and see what you can find.
When I teach accounting to students with no prior accounting knowledge, I usually cover some of the regulatory framework around financial reporting. One commonly adopted set of regulations are the International Financial Reporting Standards, or IFRS.
One question often posed to me in class is what countries use IFRS? The quickest answer is lots of countries, and I often mention the big economies that don’t require the use of IFRS for public companies- the US, India and China. Recently then IFRS organisation has created an interactive map showing which countries use IFRS. The link is here, and its a very useful resource.
So, I was looking through Google News search to find something to quickly write for this post.
I found this article about the differences between IFRS and GAAP. I don't know much about the website, but the article has two incorrect statements. First IFRS does classify assets as current and non-current. Second, the term GAAP is more widely used that just referring to US rules. So, we could say UK GAAP or German GAAP.
Okay, so it's not fake news, but it's incorrect 🙂
This blog post appeared in my LinkedIn recently. Have a read. It’s basically claiming that British accountants are worse than their American counterparts because they don’t use technology as much as. Now, I’m a big fan of technology, but I’m also old enough to have worked before the internet and all other things which make our life easier (supposedly). The author of the blog should know that all technology is a series of instructions in some or other code, and that code is only as good as the person writing it! We are becoming way too reliant on technology and it’s no harm to do it the old way, or use less technology from time to time. If I were recruiting an accountant tomorrow, while their grasp of technology would be something I’d look out for, it’s not the only thing.
And to end, Irish accountants are best 😀
Probably my favourite (spectator) sport is motor cycle road-racing. There aren’t too many places it still happens – doing 180mph on public roads is not for everyone – but thankfully it still happens here in Ireland, the Isle of Man (IOM) and a few other places.
The IOM TT is probably the pinnacle of road-racing – it’s two weeks of fund each June. imagine my delight when I read an article featuring news on the 2016 TT and creative accounting! The article notes the number of TT visitors for 2016 to be similar to 2015 – based on data from the IOM government. The article also suggested a revenue of £738 per visitor for the economy, based on this same data. In the comments beneath the article, the fun starts.
One comment notes:
“This year’s TT races in June brought a £4.1 million benefit to the island’s exchequer, according to government figures just released.” OK, so that is the claimed revenue, now let’s see the total costs. And by total, I mean the total cost to the island not just the cost of TT preparations. How much for a fatality or serious injury involving medevac? How much for the road closures and effects on businesses as well as the public? These are real costs and the list goes on.
I note the total expenditure of £738 pp is not broken down into for example travel costs and monies spent on island. Therefore that figure is meaningless If the figures of £31.3M, £22.5M and £4.1M are based on the £738pp they are also meaningless. Creative accounting it is for sure. In addition, if the government can come up with a figure for the benefit to the island they must be in possession of all costs, such as DOI, medical, policing, helicopters etc. So why do they never produce such figures?
These two sharp commentators highlight many things -the subjective major of accounting, where costs and revenues are attributed, and what are the relevant costs, for example. I’ll be using this example in my teaching at some future point.
As you are probably aware, the United Kingdom (UK) is leaving the European Union. This will have many effects on business, and in Ireland we are likely to experience the effect quite early on due to our close business ties.
Will any effects on business be revealed in the accounts of Irish (or other) businesses? The simple answer is yes, as if a company has close business ties with the UK then there is very likely to be a contingent liability or provision in the accounts. IAS 37 defines a contingent liability as:
- a possible obligation depending on whether some uncertain future event occurs, or
- a present obligation but payment is not probable or the amount cannot be measured reliably
As noted in an article in The Sunday Business Post, the outcome of Brexit is as of now uncertain, and looking at the definition of a contingent liability above, it would seem the financial statements of companies may have contingent liabilities (or even contingent assets) disclosed for some years to come. Only time will tell.
On July 14th last, it was reported on the BBC website that the total cost to BP of the Deepwater Horizon oil spill back in 2010 was totalling $61.6 billion – quite an amount. If you look back at the media websites/newspapers over the years you will see the amount rising over time.
Just out of curiosity, I had a look at the most recent financial statements of BP to see what they include on this. Two things came to mind before I looked at the accounts 1) the amounts involved here are material and 2) it spans many reporting periods, so IAS 10 Events after the Reporting Period would probably kick in. Looking at the accounts to 31.12.2015, they contain a separate note which itemises the events of the event on each of the three financial statements. You can see the accounts here – look at note 2. It is quite detailed and I do like how they have shown the effects, and the note is quite detailed. It is not very often such significant events occur, and as far as I can see BP have done a good job on this note. It certainly should provide an investor with enough information to decide whether to invest in the company or not – a key criteria of what financial statements should do.
Regulation of charities in Ireland is not as good as it could be – we have some legislation waiting to be enacted since 2009 as far as I know. But laws cannot prevent what happens within an organisation from happening; they can only penalise after the event.
So what bugs me? Well, the title of this post really – it is something I picked up from the print media in recent weeks. I am sure I have said somewhere on this blog that accounting is the language of business, so what about accounting for charities? My own opinion is that charities must have proper accounting, and there are accounting standards already in place for charities. But I often wonder should we be careful and not allow charities to become too much like a business? For example, we should be using accounting in charities to drive efficiencies, not necessarily monitor revenue and costs like in a business. Nor should we be using accounting just to get funding for a charity. In short, what I am trying to say is that we need to be careful and try to not let accounting (and other commercial sector notions) detract from what a charity should be.
On a recent research project I read an article from 1914 which was written by an “old” accountant of the time. On testing accounting students knowledge through examinations (s)he notes “we see interesting problems set out in symmetry and order”. This made me think about what has changed today.
Indeed we still use examinations in university and in professional bodies. They are a good tool to test knowledge, and increasingly examinations draw on methods such as case scenarios which are less structured in an effort to imitate real life scenarios. However, no matter what we do as teachers, we cannot replicate the real world. This is of course where professional development and on the job training come in. I do hope we at least provide the basic knowledge to help students hit the ground running when they start their careers. We can only improve the value of this basic knowledge by trying to get students to use their knowledge in an unstructured way. In an examination scenario, this means we need to use fresh ideas and new ways to ask standard material – this can be tricky sometimes, but it helps both students and us teachers to apply ourselves in a more real world fashion.
My colleague Michael Farrell has written a nice post explaining the dodgy accounting transactions at Anglo Irish Bank – the bank that was a big part of the Irish financial crisis in recent years.
Former executives from Anglo Irish Bank (“Anglo”) and Irish Life and Permanent (“ILP”) are alleged to have conspired to mislead investors by setting up a €7.2bn circular transaction scheme to bolster Anglo’s balance sheet in 2008.
The simplified debits and credits (from Anglo’s perspective) for the “circular transaction” as it’s being called are as follows:
1) Amount put on deposit with Anglo by ILP:
Dr Cash €7.2bn
Cr Customer Deposits €7.2bn (shown as a liability)
2) Amount “lent” to ILP by Anglo:
Dr Loans and Advances to Banks €7.2bn (shown as an asset)
Cr Cash €7.2bn
Per the above, the transaction is cash neutral, so what’s the big deal? The issue is that the €7.2bn recorded as a customer deposit with the bank would be (and was) incorrectly interpreted by the bank’s wider stakeholders as a measure of customer confidence in the bank.
So where do the accounting rules stand on…
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The question of accounting for spare parts for assets (i.e. plant and equipment) is one which needs some judgement on the part of an accountant. Before outlining some options, let me describe one experience I had. I worked for a global paper company in the past and the policy to deal with such spares was as follows:
- spares bought with machinery were capitalised as items of plant/equipment and depreciated with the asset
- all spares bought at other times were treated as inventory.
Then, the company merged with another and they had a different policy in that only spares valued over $1000 per unit were inventory, all others were expense. I can recall the month this policy changed, the accounts had a few hundred thousand dollars extra expenses as the lower value inventory items were written off to the income statement.
In IFRS terms, there may be two standards at play, IAS 2 on inventories and IAS 16 on Plant, Property & Equipment. So how is it decided whether a spare part is inventory or treated as an item of PPE? The general consensus, although not specifically stated in any IFRS, is to treat higher value items as an asset and lower value items as inventories. If an asset, then the question arises if the spare should be depreciated. There is a good logical argument that a spare should not be depreciated until it is put in use, so it remains on the books at cost value with adjustment for any impairment. Whatever is chosen, the accounting policy probably should disclosed if the value of spares is material – and in large manufacturing concerns it can be.
Just to complicate things further, from my experience, maintenance staff may still want to have an inventory of some low value, but critical spares even if expensed. I have seen SAP being used to track the quantity of spares held, but with no value attached (as they have been expensed). A good example might be a control panel for a machine. It may be for example a small touch screen worth $300, and expensed in the accounts. But the machine cannot work without it, so it is good to know if a spare is in stock and where it is – the latter being important when perhaps another plant in the group has a spare on hand.
Finally, here is a nice tutorial on accounting for spares.
Working capital is defined as current assets less current liabilities. Current assets are inventory, receivables and cash, while current liabilities are amounts owed to suppliers, bank overdraft and other short term liabilities such as taxes due.
Managing working capital is very important. Tie up too much money in inventory and the business is in trouble. A recent report by PWC suggests companies are still not managing working capital as best they can. Read about it and some suggestions to improve working capital here.
Ryanair made a profit of €865 million in 2014. The Irish Times reports this figure and also notes “operating profits rose 65 per cent to €1 billion from €658 million”. Great news for Ryanair. The main reasons for increased profit seem to be a combination of lower fuel costs and increased passenger numbers. What sort of annoys me about such media reports – and all media seem to do this, not just the Irish Times – is that such reporting of numbers does not tell the full story.
Let’s take a brief look at more detail. In this example from Ryanair (or any company) on profits, we also need to consider the level of investment in assets. Forgetting about accounting for a moment, it is logical to think that if Ryanair for example acquired more aircraft, then it should be able to generate more profits due to increased passenger revenue. But, if we just make a statement like “profits rose by 65%”, this does not reveal the underlying assets.
The same Irish Times article reports that net assets (assets less liabilities) did in fact rise from €3.3 billion to €4 billion in the year. If we do a simple return on assets calculation (using operating profits), then for 2013 the return is 658/3300 = 19.9% and for 2014 it is 1000/4000, or 25%. This is a year on year increase in the return on assets of about 26%. This is a long way off the 65% reported increase in operating profit, and a lot more meaningful as it reflects the net assets (or capital) used. It is still a great improvement, but perhaps not so sensational a 65%!
You may know the gross profit margin ratio, which is:
Gross Profit x 100
Gross profit is: Sales – Cost of Sales
Cost of Sales = Opening inventory + Purchases/cost of production – Closing Inventory.
In this short post I would just like to share some of my experiences on the versatility of this simple ratio. If we look at the elements of the ratio, it is easy to see that if each element remain stable, the answer should also be stable. So for example, if I buy something for €40, sell it for €100, then my GP margin is 60%. If my sales price or purchase price changes, then the GP margin changes. Then, if we think about inventory levels, if these fluctuate the GP margin changes too. Taking all this together, it’s easy enough to see how any business typically knows what its GP margin should be. Thus, if it varies considerably, there may be something wrong.
Here are two things I know the GP margin is used for. One, from my own experience, is in pubs/bars. Most pubs/bars are susceptible to fraud and controls typically put in place by owners. One such control is monthly stock-takes and monthly accounts. A fall in the GP margin could indicate “lost” stock or unrecorded cash receipts – which further controls may reveal. Another use is to spot inflated revenues. Businesses may want to make their profits look better and thus do things like invoice for goods early, before the end of a financial year. These good may not even be bought/made yet. Thus, the GP margin may be lower. Again further investigation is needed to find the issue.
There may of course be more simple reasons for changes in the GP margin – costs and sales prices may simply change and affect the ratio. But once these have been ruled out, it is a useful indicator.