Company Reporting – Sugaring the pill

Company Reporting - Sugaring the pill

Few companies quantify unfavourable items in their annual report. It is the bane of analysts' work.

Analysts need more than financial figures to assess the performancet is the bane of analysts’ work. of a business. Unfortunately, a lack of quantified information and a tendency to disclose only favourable items means that non-financial sections of the annual report often resemble little more than glossy advertising brochures.

Blue Circle publishes a report on health and safety matters, including details of a strategy to reduce significantly its accident frequency rate.

While it discloses a variety of achievements (including percentage reductions in both the accident frequency and severity rates in two business divisions), Blue Circle does not join the 2% of companies on our database, including BG and Zotefoams, that quantify their accident rates.

In the wake of allegations of malpractice at its dog toxicology department, Huntingdon Life Sciences produces an animal safety and welfare statement that outlines policy in this area. Although it trumpets a policy of using the minimum number of experimental animals, the statement quantifies neither the number of animals experimented on at present, nor any target reductions.

The practice of disclosing non-quantified goals in annual reports is common, and makes it hard for analysts to measure change or assess performance.

Joint ventures increasing

When a new accounting standard is published, companies take initially differing views as to how its requirements can best be met, although practice settles down quickly into dull uniformity. FRS9: ‘Associates and Joint Ventures’ has yet to become effective and responses to it offer interesting variety.

If any one trend stands out, it is the reclassification of associates as joint ventures. Henlys, Kingfisher, aerospace company Cobham, and construction company Taylor Woodrow all reclassify past associates as joint ventures, without reporting significant changes in their relationships with them.

FRS9 was developed following a review by the Accounting Standards Board of SSAP1: ‘Accounting for Associated Companies’, a reason for its instigation being that SSAP1 does not cover the identification of, and accounting for, joint ventures. Now that FRS9 has plugged this hole and introduced a definition of joint ventures, companies will have to investigate whether or not any of their existing associates will have to be reclassified.

Goodwill capitalised

Inevitably, with the effective date of FRS10: ‘Goodwill and Intangible Assets’ creeping ever closer, there is much movement on the goodwill front this month. Pet food manufacturer Pascoe’s joins the band of companies that have adopted early FRS10, as does construction company Britannia.

In Britannia’s case, the change in policy leads to a rare event – the capitalisation of negative goodwill.

In a note to the accounts, Britannia discloses that, after fair-value adjustments, goodwill arising on acquisitions was a negative amount of #1.2m. Its fixed asset note to the accounts shows this has been capitalised as an intangible fixed asset, with a related #150,000 amortisation being credited to the profit & loss account as a reduction in operating expenses.

Cause for concern

It is a fundamental principle of accountancy that businesses are assumed to be going concerns, but sadly that is not always the case. Occasionally, a company will draw up its accounts under this assumption but draw attention to circumstances that cast doubt on its validity.

Print company Wace discloses in its chairman’s statement that disappointing trading has led to the breaching of banking covenants. Renegotiated facilities with its lenders require a reduction in borrowing which is unlikely to be achieved this year through trading, so the company has agreed to dispose of some businesses, subject to shareholder approval at an egm.

The auditors draw attention to these matters but, following SAS600: ‘Auditors’ Reports on Financial Statements’, do not qualify their opinion in this respect. Not that we would expect them to; in 1992, 5% of auditors’ reports were qualified, but in the last 12 months not one of the companies we have analysed has carried a qualified auditors’ report.

Similarly, Huntingdon Life Sciences mentions circumstances surrounding its going-concern assumption. As with Wace, there are concerns surrounding the company’s ability to meet its finance arrangements, but it remains confident that current restructured banking facilities should suffice.

The auditors’ report does not mention this situation – perhaps not much of a surprise given 99% of all auditors’ reports contain no special comments of any type.

Segmental p&l accounts

The style and format of p&l accounts evolve over time, with major changes in presentation driven usually by new accounting standards – a notable example being FRS3: ‘Reporting Financial Performance’.

In a break from the norm, Kingfisher discloses separately on the face of its p&l account the operating profit of each of its businesses. This proves to be an unusual but informative presentation, which combines an element of segmental reporting with a standard p&l account.

Asset no longer tangible

Publisher Cassell reclassifies a tangible fixed asset as an intangible fixed asset this month, although when FRS10 becomes effective, the item may well have to slide down the evolutionary scale and be removed from fixed assets altogether.

Initially, Cassell capitalised the external costs of establishing a dictionary database and recognised it as a tangible fixed asset. It can be argued that the asset did not meet the definition of tangible fixed assets as proposed by FRED 17: ‘Measurement of Tangible Fixed Assets’ (specifically that they should have ‘physical substance’). This year it has been transferred to intangible fixed assets, being increased in size by the addition of identifiable internal staff costs.

As from next year, Cassell will have to be satisfied that this asset meets the recognition criteria of FRS10, that allow an internally developed intangible asset to be capitalised only if it has a readily ascertainable market value. Further, in order to recognise any intangible asset, the company must have control over the future benefits that will flow from it.

Disclosing effects of changes

The publication of UITF 17: ‘Employee Share Schemes’ is expected to generate an increase in the number of companies using prior year adjustments. Such is the case with pharmaceutical company Chiroscience that provides an excellent example of how to report the effects of accounting policy changes.

A note to the accounts discloses clearly the effect of both the adoption of UITF 17 and the reclassification of certain costs on the face of the p&l account. Analysts looking for evidence of prior year adjustments turn to the reserves note, as reserves brought forward will have been adjusted accordingly.

In cases such as Chiroscience’s, however, where total reserves brought forward remain unaffected, this approach is a welcome addition to the norm.

When it comes to the recognition and accounting treatment of intangible assets, in the light of the requirements of FRS10, many companies describe intangible assets as being carried ‘at cost’ less amortisation, when the original value was in fact calculated as part of a fair-value exercise on acquisition.

It would be helpful if companies identified clearly those intangibles that have been valued in this subjective manner, not just in the year of acquisition but for as long as it remains on the balance sheet. This is an edited version of the review published in Company Reporting, a monthly publication monitoring financial reporting practices in the UK. Company Reporting is available on subscription. Details from 0131 558 1400.

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