Financial Report Analysis free essay sample

Incitec Pivot Limited (IPL), is leading global chemical manufacturer supplying agricultural fertilisers and industrial chemicals to the Australian and overseas markets. The objective of this report was to analyse and understand how the accounting policies and strategies implemented by IPL impacted their financial performance. The analysis is based on IPL’s annual report which outlines the selected accounting policies, business strategy and performance. Firstly, the report summarises IPL’s activities and strategies during the financial years ending 30th September 2009 and 2010. Secondly, the report identifies the key accounting policies and assesses management’s flexibility in selecting them. Also, the report evaluates the quality of disclosure in IPL’s annual report, identifies potential questionable numbers and attempts to undo any possible distortions in the numbers. Finally, the report examines the financial press discussion of IPL’s performance and accounting numbers. The absence of any impairment [write-down] of intangible assets [13 per cent of Goodmans total asset base, and included in the covenant gearing calculation] was a surprise, Deutsche Bank said. Read more: http://www. smh. com. au/business/writedown-is-not-a-dirty-wordjust-look-at-goodman-group-20090227-8kb1. html#ixzz1YvZOrW5P 1. Summary of IPL’s activities and strategies Incitec Pivot Limited is a leading global chemicals company which has nitrogen-based manufacturing as its core activity. (Incitec Pivot Limited, 2009) The company is involved in the manufacture, trading and distribution of fertilisers, industrial explosives and chemicals. It was formed as a result of the merger between Incitec Fertilizers and Pivot in 2003 and 2006 and expanded by purchasing Southern Cross Fertilizers. IPL owns a portfolio of recognised and trusted brands and is the number one supplier for fertilizers and the number three supplier of explosives in Australia as well as being the prime supplier of explosive products and services in North America. (Incitec Pivot Limited, 2009) The company operates in Canada, USA, Mexico and Australia and has 4500 employees worldwide. The company has grown due to international demand for the four F`s: food, feed, fibre and fuel. IPL supplies 50% of Australia’s agricultural nutrient needs and also assisted Australian farmers to develop sustainable farming. The volatility of the market during the global financial crisis had an adverse impact on IPL. NPAT (excluding individually material items) decreased by 46% from $647. 5m in 2008 to $347. 8m in 2009. IPL’s Velocity efficiency program enabled it to make a significant return to the market in 2010 with a NPAT of $442. 8m (excluding individually material items), which was an increase of $95m. (IPL, Annual report, 2010). 2. Key accounting policies and Accounting Standards 2. 1 Revenue Recognition – AASB 118 Revenue is measured at the fair value of the consideration received or receivable. Trade allowances, amounts collected on behalf of third parties and net of returns comprise the revenue. Revenue is recognised as sales revenue, interest income and dividend receivable. Sales revenue is recognised when the considerable risks and rewards of the ownership have been transferred to the buyer. Interest income is recognised on an accrual basis, while dividend receivable recognition occurs when it is declared or received. 2. 2 Foreign Currency Translation – AASB 121 Items presented in the financial statements of each of the Group`s entities are measured using the functional currency. IPL’s presentation currency is the Australian dollar, the currency used to present its consolidated financial statements. Foreign currency transactions are translated into the functional currency at the exchange rate on the day the transaction occurs. Foreign exchange gains and losses are recognised in the statement of comprehensive income, except when they are `deferred in equity as qualifying cash flow hedges`. These have been calculated following the AASB 121 `The effects of changes in Foreign exchange rates` and AASB 139 `Financial instruments – recognition and measurement`. 2. 3 Income Taxes – AASB 112 The current and deferred tax constitutes the income tax expense which is shown in the statement of comprehensive income. The current tax comprises tax that has to be paid on the taxable income for that period at tax rates as of the reporting date. It also includes adjustments of the past period’s tax payable relating to deferred tax assets and liabilities. The balance sheet method is used to calculate deferred tax. . 4 Consolidation – AASB 127 According to AASB 127, â€Å"consolidated financial statements shall include all subsidiaries of the parent† the financial statements of IPL adhere to this. Furthermore, all inter-company transactions, unrealised gains and losses (unless they occurred as a result of impairment of assets) and balances are eliminated. Investments in subsidiaries are recorded at cost. 2. 5 Impairment of Assets – AASB 136 The impairment test of goodwill is conducted annually or more frequently, if events or changes in circumstances indicate that it might be impaired. Assets subject to amortisation are tested for impairment when events demonstrate that the carrying amount cannot be recovered. Where the asset’s carrying amount exceeds its recoverable amount, an impairment loss would be recognised. 3. Management’s flexibility in selecting key accounting policies If management can be flexible in selecting accounting policies, they can significantly influence financial performance. As per the 2010 Annual Report, the managers of IPL had various levels of flexibility with the items below: 3. 1 Foreign currency transactions – Low Flexibility Foreign currency transactions are a crucial element in the development of IPL as a multinational company, because every movement in the exchange rate has an impact on its performance. As stated in the Annual report 2010, any gains or losses from the settlement of the transactions and the translation of the exchange rates of the assets and liabilities denominated in foreign currency are recognized in the income statement. The flexibility of management regarding this accounting policy is low, because the transactions are translated at a functional currency using the exchange rates valid at the date of the transaction. . 2 Derivative financial instruments – Low Flexibility Derivative instruments have been used by the Group in order to hedge its exposure to foreign exchange, commodity price and interest rate risks occurring as a result of the operational, investment and financing activities. While hedging motivates management’s flexibility to lock in company profits and pro tect them from the volatile exchange rates, it subtracts the profits made under the falling exchange rates. 3. 3 Interest Bearing Liabilities – Medium Flexibility The current interest bearing liabilities decreased significantly from $432. m in 2009 to $108. 5m in 2010. This was a consequence of the company’s issue of the US$800m 144A Bond in December 2009, which increased the diversity and tenor of their debt. During the year ended 30 September 2010 interest of $25. 2m was capitalised relating to interest bearing liabilities used specifically to fund qualifying assets as defined in AASB 123 Borrowing costs. 3. 4 Intangible Assets – Goodwill – High Flexibility As per the 2010 Annual Report, intangible assets represent the largest item of IPL’s total assets at 56%. They consist predominantly of Goodwill at 85%. Adjustments made to goodwill include additions, acquisition of business, impairment of assets and foreign exchange movement. IPL does not amortise goodwill but impairs it annually and as a result in 2010, the company recognised a non-cash impairment charge of $nil compared to $490. 6m in 2009. 4. Accounting strategy employed by management and incentives The accounting strategy management chooses will have a positive or negative impact on financial performance and business operations. The managers at IPL implemented accounting policies that enhanced financial performance in the long term. . 1Evaluation of accounting strategy employed by management Management implemented a strategy to reduce debt levels and improve the gearing ratio of Net Debt/EBITDA by issuing a 10 year bond worth $800m in December 2009. The proceeds from this bond issue were used to repay and cancel the Working Capital Facility with the remaining proceeds used to partially repay the Syndicated Facility. (IPL, Annual report, 2010). The gearing ratio was 1. 39 in 2010 and 1. 97 in 2009. As per the 2010 Statement of Financial Position, Net debt decreased by $366. 3m from $1,463. m in 2009 to $1,097. 1m in 2010. This was as a result of improved operating cash flows and the benefit of carrying the debt in US dollars rather than the Australian dollar which appreciated during 2010. 4. 2 Evaluation of incentives strategy employed by management IPL’s aim is to generate competitive returns for its shareholders through its strategy, and their philosophy is that the remuneration strategy should support the objectives of the business. The majority of the Executives remuneration is â€Å"at risk† and linked to performance and the creation of sustained shareholder value. For example, the Long Term Incentive Plan measured in 2010 Plan was established in 2007 and the Plan required IPL’s total shareholder returns (TSR), measured over the three year period to 30 September 2010, to be greater than 10% per annum compounded over the period. The Company’s TSR was 2. 64% per annum and, accordingly, no awards were made to Executives under the 2007/10 LTI Plan. (Annual Report , 2010) Refer Appendix 1 for table of % of Total Remuneration Annualised. This incentive is related to the strategy to improve financial performance. 5. The quality of the disclosure made in the accounts IPL Limited is listed on the Australian Securities Exchange (ASX) and is therefore subject to continuous disclosure obligations (corporate governance statement, remuneration report, shares, etc) under the ASX Listing rules and Corporations Act 2001. IPL’s Board has implemented the proper and timely disclosure of information to shareholders and the market. IPL uses its website (as well as) other sources to communicate via annual/half yearly reports, share price movements, sensitive and other relevant announcements to ASX. The financial report of IPL Limited highlights its business strategy. It is well structured and informative and in accordance with AASB 101 â€Å"Presentation of Financial Statements†, International Financial Reporting Standards and the Corporation Act 2001. The disclosure quality in the IPL annual report was adequate and informative and complied with ASX, the Corporation Act 2001, IFRSs, IASB and AASB. Table 1: Examples of IPL’s high and low quality disclosures Quality| Disclosure| High| â€Å"Restatement of prior year tax benefit† clearly describes the reason for the change and varied result in terms of Net Profit After Tax for 2009. Refer Appendix 2. High| Operating Segments AASB 8 replaces Segment Reporting AASB 114; this disclosure clearly outlines the change of IPL’s composition from 2 main businesses to four segments. Refer appendix 5. | Low| Deferred Tax Assets and Liabilities Notes 19 and 24 are circular and less than transparent. As these numbers are not explained, it is very difficult to understand how the numbers were calculated. | 6. Potential questionable numbers 6. 1Deferred Tax Assets amp; Liabilities In 2010 financial report both deferred tax assets and liabilities decreased by 80% and 65% respectively. The quality of the disclosure is low and questionable. (see table above) Like other companies listed on ASX, IPL could have an exclusive arrangement with the ATO that they are unable to disclose. As a result, DTA and DTL balances would be questionable in almost all annual reports. Refer appendix 3. 6. 2 Cash and cash equivalents In the year from September 2009 to 2010, the amount of cash and cash equivalents decreased 157% which is significant. Currently, the company has $48. 7m which represents 39% of the cash and cash equivalents in 2009. For a company whose business strategy focuses on growth, financing the acquisition of Nitromak with cash is a questionable decision. An alternative strategy could have been to finance the acquisition with debt, preserving cash resources. 7. Undoing distortions in the numbers On thorough review of 2010 annual report, IPL did not have any obvious areas of distortion. However, the acquisition of Nitromak is a possible area of distortion with regard intangible assets. When reviewing the stated fair value of the 50% equity interest held before acquisition, the consideration amount paid of $97. 1m is $22. m higher than the fair value amount of $74. 8m. Refer appendix 5. Considering IPL held the original 50% interest at fair value it is interesting that the remaining 50% would attract such a premium, hence intangible assets could be overstated. As per note 18, goodwill allocated to Nitromak is $142. 9m, considering the total consideration was $171. 9m, it is very high at 83% and it may have been fair to recognise an impairment loss in 2010. We can support this assumption that asset values may be distorted in the reports due to the write down in 2009 in the carrying value of the Dyno Nobel goodwill of $490. m, the year after acquisition. Table 2: Possible distorted items and adjustments | +/- adjustment| Notes| Intangible Assets| -$22. 3m (overstated)| | Cash amp; Cash Equivalents| +$22. 3m (understated)| The amount IPL paid for the remaining 50% should have equalled the fair value being 74. 8m. | 8. Summary of financial press discussion of IPL’s performance and accounting numbers During the GFC, IPL reported a full-year loss of $179. 9m to September 30, 2009 compared with a profit of $604. 6m in the prior year. IPL wrote down $490. 6m in the non-cash mark to market carrying value of Dyno Nobel goodwill. In 2009, net profit excluding material items slumped 46% to $347. 8m, as sales from the fertiliser business fell 32% to $1. 59 billion due to the challenging conditions in Australia and seasonal conditions in North America. The company is quoted as stating it would also benefit from its Velocity program, with $US60m ($A65. 05m) of savings targeted for fiscal 2010. (SMH, 2009) In 2010, IPL bounced back into profit despite the surging Australian dollar. The company announced a $412m profit compared with a loss of $179. 9m that was restated upwards to $221m in 2009.