Multinational companies BP Amoco and Royal Dutch/Shell have been operating in dollar-dominated environments for quite some time, and this month both have chosen to publish their accounts in dollars rather than sterling.
BP Amoco discloses that its merged operations are substantially dollar-based, while Royal Dutch/Shell tells us that the dollar is the underlying currency in which it operates.
FRRP defends FRS 7’s aims
While it is common for companies to restate comparative figures following ‘discussions’ with the Financial Reporting Review Panel, aerospace company AIM goes one step further and publishes a supplementary note revising its 1998 accounts – seven months after the original set was published.
In the original set of accounts, AIM disclosed that it had made an acquisition and intended closing part of the acquired operations. As the decision was taken by AIM, FRS 7 ‘Fair values in acquisition accounting’ required the related costs to be treated as a post-acquisition charge to profit.
AIM invoked the true and fair override and included within net assets acquired a £1m provision for the costs of closure, arguing that it was an integral part of the acquisition decision. Although many commentators will sympathise with this argument, as did many respondents to the exposure draft that evolved into FRS 7, the Accounting Standards Board rejects it unequivocally.
Predictably, the FRRP was not willing to let such a high-profile rejection of FRS 7 go unchallenged, and ensuing discussions have resulted in AIM publishing a supplementary note revising its 1998 accounts. The provision is charged now to the profit & loss account as an exceptional item, increasing the loss for the year by £1m and reducing goodwill by an identical amount.
One of the most controversial aspects of FRS 12 ‘Provisions, contingent liabilities and contingent assets’ is its prohibition of the long-standing and accepted ‘unit of production’ method of providing for decommissioning costs. Controversial or not, FRS 12 will soon be effective and companies are beginning to change policy accordingly.
BG has adopted early FRS 12, making full provision for the net present value of decommissioning costs and recognising a corresponding asset in its balance sheet. A note to the accounts discloses that the interest charge for the year includes £56m in respect of the unwinding of the discount arising from the npv calculation. Previously, BG provided for the estimated costs of decommissioning on a ‘unit of production’ basis, calculated on proven reserves and price levels as at the balance-sheet date.
Non-amortisation of goodwill
FRS 10 ‘Goodwill and intangible assets’ requires companies not to amortise goodwill deemed to have an indefinite economic life. As we reported last month, this runs contrary to the Companies Act, so the true and fair override has to be invoked.
This month, both Cadbury Schweppes and business support company Capita invoke the true and fair override for this reason. Companies in this position state usually that they cannot estimate the effect of their departure from the Companies Act, but Cadbury Schweppes discloses that this year’s operating profit would have been reduced by £5m had goodwill been amortised over 20 years.
It is a different story with intangibles other than goodwill, which are required by the Companies Act to be depreciated only if they have limited economic lives. Newspaper publishers Newsquest and Johnston Press both acquired publishing rights during the year and used fair-value adjustments to increase their value.
Following FRS 10, neither company amortises these assets on the grounds that they have an indefinite economic life. Unlike the situation with goodwill described earlier, however, no true and fair override is necessary as the Companies Act has not been breached.
Choosing a discount rate
Under FRS 11 ‘Impairment of fixed assets and goodwill’, impairments are calculated with reference to the net present value of future cash flows.
Selecting a discount rate is crucial to this process, as even small differences in the rate applied can lead to enormous differences in end result.
FRS 11 requires companies to use ‘the discount rate that the market would expect on an equally risky investment’, leaving companies to select (and justify) appropriate rates depending upon their knowledge of the operations under review. Analysis shows that the range of rates being used is proving to be very wide.
For example, Rank uses a pre-tax rate of 16% while BG selects a far lower rate of 7%.
Selective disclosure of effect
For most companies, adopting FRS 10 reduces reported profit, thanks to the introduction of goodwill amortisation charges. For manufacturer Epwin, however, the opposite is the case, with its £99,000 amortisation charge being offset by a £177,000 credit in respect of negative goodwill.
Not that it seems keen to inform analysts. A note to the accounts discloses that adopting FRS 10 has reduced profit by the amortisation charge, but neglects to mention the boost given to income by its treatment of negative goodwill.
Last of a dying breed?
Proponents of merger accounting appear to be fighting a losing battle as international accounting standard setters continue to plot its down-fall, motivated by fears that it is being used in inappropriate circumstances to avoid goodwill arising.
Company Reporting’s analysis, however, shows that less than 1% of companies with evidence of business combinations make use of merger accounting, which is hardly a sign of widespread abuse.
The latest company to join this select group is BP Amoco, owned 60% by former BP shareholders and 40% by those of Amoco. Unfortunately for the newly merged group, its planned takeover of Arco is not expected to meet the merger criteria of FRS 6 ‘Acquisitions and mergers’ and a reputed $20bn goodwill could arise on the transaction.
This feature is an edited version of the review published in ‘Company Reporting’ magazine, a monthly title monitoring financial reporting practices in the UK. Details from: 0131 558 1400.
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