Interpreting Company Reports and Accounts

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Edition: 10th
Format: Paperback
Pub. Date: 2008-01-01
Publisher(s): Prentice Hall
List Price: $99.50

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Summary

Interpreting Company Reports and Accounts 9th Edition Geoffrey Holmes, Alan Sugden, Paul Gee " That it is known as ' The Analysts Bible' says much about this book. It shows how to crunch the numbers and what to look for buried in the notes to the accounts and suggests how to read reports for the signs of business turning sour."''We still love it'' 2004Investors Chronicle " The book is wholly successful in its aim of providing a guide for 'anybody with a reasonably enquiring mind' on how to take to pieces a set of company reports."Financial Times "If I wanted to give my mother a book to help her make sense of company accounts I could hardly think of a better book. For business people or potential investors ... I would say this book is ideal."Michael Thompson: University of Ulster Interpreting Company Reports and Accounts guides the reader through the conventions and complexities of company accounts, explaining how to assess the financial and trading position of a company from year to year, how to spot undue risk taking and ''cosmetic accounting'' and where to look for clues on the quality of management. Packed with interesting real world examples, this is a highly practical book which shows readers how to analyse company reports and accounts, both qualitatively and quantitatively. The analysis is illustrated with over 200 extracts/examples from published accounts, ranging from BP and DIAGEO down to smaller companies on AIM. Key Features Key points from company accounts are highlighted and explained throughout the book. Chapter 31: Putting it all Togethertakes readers step-by-step through the reports, accounts and press cuttings of an interesting AIM company. The authors comment as well as inform - previous editions highlighted the serious weaknesses of both Polly Peck and Maxwell Communications Corporation well ahead of their collapse. Very well written, engages students and brings the subject to life. New Features A chapter detailing the differences between International and UK accounting standards, and how the ASB plans to close the gap. New chapter on 'Accounting Practices Cause for Concern?' A critique on Corporate Governance. Interpreting Company Reports and Accountsis suitable for intermediate/advanced undergraduate accounting and finance courses and for MBA courses. The book is recommended reading for several professional examinations and will also be relevant to practitioners. Geoffrey Holmes FCA, FTII was, for more than twenty years, the highly regarded and much respected Editor of Accountancy, the Journal of the Institute of Chartered Accountants. Alan Sugden is a Sloan Fellow of the London Business School and a retired director of Schroder Investment Management. He spent nearly 20 years in the City as an Analyst and fund manager, running the pound;100 million Schroder Recovery Fund for several years.Paul Gee BA (Econ) FCA is Technical Director of Bristol based accountants Solomon Hare, and lectures widely in the UK on financial reporting.

Table of Contents

Preface xiii
Introduction
Company reports and accounts -- an introduction
1(6)
The purpose of this book
The report and accounts
The directors' report
The profit and loss account
The balance sheet
The accounts of a newly-formed company
Financial reporting standards and principles
7(8)
The present structure
The regime prior to 1990
The present regime
The Financial Reporting Council (FRC)
Financial Reporting Review Panel (FRRP)
The Accounting Standards Board (ASB)
The Urgent Issues Task Force (UITF)
Financial Reporting Standards (FRSs)
Statements of Recommended Practice
International accounting standards
Principles of financial reporting
Need for a conceptual framework
Fundamental accounting concepts
FRS 18 Accounting policies
Statement of Principles for Financial Reporting
What financial statements comprise
The need to read the notes
The objective of financial statements
Users and their information needs
What users look for
Recognition
Accounting policies
FORMATION
Forming a company
15(2)
The limited company
Incorporation of a company
Memorandum of Association
Articles of Association
Members' (shareholders') liability
Public company
Private company
Chartered company
Small and medium-sized companies
Admission to listing
17(3)
Stock Exchange listing -- `quoted companies'
Requirements for listing
Listing Particulars (prospectus)
Minimum size of issue
Keeping the public informed
Continuing Obligations
Methods of obtaining a listing
Alternative Investment Market
THE BALANCE SHEET: CAPITAL EMPLOYED
Share capital and reserves
20(14)
Share capital
Authorised and issued share capital
Types of share capital
Preference shares
Golden shares
Ordinary shares
Partly paid shares
Ordinary stock
Non-voting shares
Another substantial shareholder
Deferred shares
Warrants
Exercise rights
Accounting for warrants
Warrant price behaviour
ADRs
Share schemes for directors and employees
Granting of options
Executive share option schemes
Unapproved share option schemes
Enterprise Management Incentives (EMI)
Save-As-You-Earn (SAYE) share options
All employee share ownership plans (AESOPs)
Performance share plans
Phantom share schemes
Summary of schemes
The investor's viewpoint
Effect of inflation
The issue of further equity
Rights issues
Placing and open offer
Scrip issues
Share splits
Scrip (stock) dividends
Further information on shares
Company purchasing its own shares
Reduction of share capital
Arrangements and reconstructions
Reserves
Where reserves come from
Capital and revenue reserves
Share premium account
Revaluation reserve
Capital redemption reserve
Loan capital
34(16)
The advantages of borrowing
The risk of borrowing
Types of borrowing
Security given to the lender
Typical characteristics of debentures and ULS
The trust deed
Accounting for finance costs
Repurchase of debt
Deep discount issues
Sinking funds
Yields
Bonds
Notes and loan notes
Commercial paper (CP)
The amount a company can borrow
Capital and income covers
Convertible loan capital
Terms of a convertible loan
Convertibles with `put' options
Warrants
Mezzanine finance
Complex capital issues
Off balance sheet financing
Substance over form
FRS 5 Reporting the substance of transactions
Quasi-subsidiaries
Sale and leaseback
Linked presentation
Other aspects of FRS 5
Gearing ratios
Financial gearing
Leverage effect
Interest rate sensitivity
Operational gearing
Profit/volume chart
Aggravating the problem
Fixed charges cover
ASSETS: FIXED ASSETS
Intangible fixed assets
50(4)
Intangible fixed assets
Capitalised development costs
Rights
Copyright and similar publishing rights
Licences
Patents and trademarks
Purchased goodwill
Purchased goodwill - old rules
Purchased goodwill - FRSs 10 and 11
Impairment
Tangible fixed assets
54(13)
Tangible fixed assets
Depreciation
Companies Act requirements
Rates of depreciation
Subnormal depreciation charges
Useful economic life
Where depreciation is shown in the accounts
Depreciation methods
The straight line or fixed instalment method
The reducing balance method
The sum of the years' digits method
Comparison of methods
The renewals method
Change in expected useful life
Writing down of asset values
Changing method
Freehold land and buildings
The revaluation of assets
Background
The arguments for and against valuations
FRS 15 Tangible fixed assets
Sales and other disposals of fixed assets
Investment properties
Government grants
Ratios
Fixed asset investments
67(4)
Types of investment
Investment in subsidiaries
Investment in associates
Investments in joint ventures
Other fixed asset investments
Disclosures on significant holdings
Balance sheet presentation
Points to watch
Interlocking holdings
CURRENT ASSETS
Stocks and work in progress
71(10)
Different classes of stock
Subclassification
The matching principle
Dead stock
Consistency
The importance of stock valuation
Problems in valuing stock
Stocks in a large retail business
Stocks in a manufacturing business
Methods of pricing issues from stock
Taxation of stock profits
Requirements of the Companies Act 1985 and of SSAP 9 on stocks and WIP
Consignment stocks
The danger of rising stocks
Long-term contracts
SSAP 9 requirements on long-term contracts
Stock ratios
Stocks/Turnover ratio
Stocks/Cost of sales ratio
Cost of sales/Stock ratio
Debtors
81(8)
Trade debtors and other debtors
Introduction
Bad debts and doubtful debtors
The importance of debtors
Debt collection period
What we would like to know
Factors affecting the debt collection period
Debtors due after more than one year
Assets held for resale
Hire-purchase and credit sale transactions
Definitions
Timing of profit taking
The rule of 78
Hire-purchase information given in accounts
Factoring
The provision of finance
Service charge
Bad debt protection
International factoring
Invoice discounting
Factoring in the accounts
Linked presentation
Current asset investments; cash at bank and in hand
89(3)
Types of investment
Types of current asset investment
Accounting for current asset investments
Current asset investments in practice
Significance of short-term investments
Availability of short-term investments
Cash at bank and in hand
Disclosure requirements
CURRENT LIABILITIES
Bank loans and overdrafts
92(7)
Bank facilities
Overdrafts
The cost of borrowing on overdraft
Fluctuations in amount
Vulnerability
Bank loans
Security
Flexible loan facilities
Bills of exchange
Definition
Primary purpose
Balance sheet presentation
Discounting
Acceptance credits
The big picture
Cash flow statements
Derivatives and other financial instruments
99(7)
Introduction
Derivatives can seriously damage your wealth
Definition of a derivative
Risk management and derivative trading
Disclosure requirements
Common types of derivative
Commodity related derivatives
Reducing the risks of trading in derivatives
Financial derivatives
Currency swaps
Interest rate swaps
Interest rate caps
Numerical disclosures
Counterparty risk
Concern about derivatives
But why bother with derivatives?
Benefits of disclosure
Recognition and measurement
Creditors, provisions, contingent liabilities and contingent assets
106(12)
Creditors
Presentation
Types of creditor
Working capital and liquidity ratios
Comment on The Body Shop's ratios
Liquidity ratios
Current ratio
Quick ratio or acid test
Provisions
Background
Definition
When to make provisions
Annual review and disclosure
Provisioning -- the main areas
Other accounting standards on provisions
Other uses of the term `provision'
What does all this mean to the investor?
Contingent liabilities and contingent assets
Definition
Examples of contingent liabilities
The significance of contingent liabilities
Capital commitments
Other financial commitments
Leases
Operating leases
THE PROFIT AND LOSS ACCOUNT
Profit and loss account
118(20)
Introduction
Turnover
Profit before taxation
The three parts
Additional disclosures
Disclosures required by the Companies Act
Turnover
Other items in the profit and loss account
Parent company profit and loss account
Disclosures required by accounting standards
Disclosures required by the UKLA Listing Rules
Purple Book requirements
Effect of accounting policies on profitability
Accounting policies
What is it reasonable to capitalise?
Research and development
Finance costs
Starting-up costs
Changes of accounting policy
Changes of presentation
Retirement benefits
Types of pension scheme
Defined contribution schemes
Defined benefit schemes
What to look for
Problems faced by actuaries and pension funds
Disclosure of information
FRS 17 Retirement benefits
Exceptional items
Basic purpose of the profit and loss account
Is it extraordinary or exceptional?
FRS 3 definition
`Headline' or `normalised' earnings
FRS 3 Reporting financial performance
Comparative figures
Ratios
Horizontal analysis
Vertical analysis
Operating ratios
Improving the return on capital employed
Massaging the figures
Segmental reporting
Accounting standard
Analysis of profitability
Non-disclosure
Taxation
138(8)
Introduction
Tax in the profit and loss account
Tax in the balance sheet
Tax in the cash flow statement
Example of a timing difference
Advance corporation tax from earlier years
Depreciation and capital allowances
`Pooling'
Tax years
Rates of corporation tax
When corporation tax rates are set
Deferred taxation
Timing differences
Purpose of deferred tax
Accounting for deferred tax
Definition of deferred tax
Other timing differences
Rollover relief
Reasons for `abnormal' tax charges
Adjustments to previous years
Permanent differences
The effective tax rate
Profit after tax, dividends and earnings per share
146(17)
Profit after tax
Profit attributable to ordinary shareholders
Dividends
What is prudent?
What is legally permissible
Preference dividends
Company articles on dividend distribution
Accounting treatment
Interim dividends
Earnings per share
Background
ASB curbs `enhancement' of e.p.s.
Misleading use of the word `basic'
Company's own figures for e.p.s.
Amortisation
Going for growth
The effect of acquisitions on earnings per share
Market rating - the PER
Wonder growth by acquisition
Normalised and company e.p.s.
Investigating trends
Adjustments to basic earnings per share
When the number of shares in issue changes
Shares held by a group member
Diluted earnings per share
Causes of dilution
Calculation of diluted e.p.s.
Growth in share incentive schemes
Share greed
Growth in the complexity of schemes
Further examples of dilution
Points to watch on incentive schemes for directors and senior management
Statement of total recognised gains and losses
Prior period adjustments
Financial statistics in historical summaries
Movements in shareholders' funds
Investment ratios
The Price Earnings Ratio (PER)
What the PER represents
Price earnings growth factor (PEG)
Dividend policy and the PER
Dividend yield
Dividend cover
Payout ratio
CASH FLOW
Cash flow statements
163(12)
Overview of the cash flow statement and related notes
The finance director's viewpoint
A real example
Reconciliation of net cash flow to net debt
Analysis of net debt
Acquisitions and disposals
Non-cash items and restrictions on transfer
The direct and indirect methods
Restrictions on remittability
Limitations of cash flow statements
Borrowing facilities
Cash requirements
Cash shortfall
Cash flow -- definitions and ratios
Free cash flow (FCF)
Authors' comments on free cash flow
Cash flow ratios
`Sherlock Holmes' approach to cash flow
Snippets of information
THE GROUP
Subsidiaries and group accounts
175(9)
Interests in another company
Buying some shares in company B
Making a takeover bid for company B
FRS 6 Acquisitions and mergers
Holding companies, subsidiaries and groups
Some definitions
Group accounts
Additional information
Consolidated Accounts
The consolidated balance sheet
Goodwill on consolidation arising prior to 1998
Goodwill on consolidation arising after 1998
The consolidated profit and loss account
Unrealised profits on stocks
Parent company's own balance sheet
Parent company's own profit and loss account
Accounting periods and dates
Further statutory requirements
Acquisitions and mergers
184(7)
Introduction
Acquisition accounting
Year of acquisition or disposal
Purchased goodwill
Determining fair values
Assets at the date of acquisition
Provisional fair values
Subsequent disposals
Disclosure requirements
Substantial acquisitions
Example of a substantial acquisition
Post balance sheet events
Merger accounting
Introduction
The mechanics of merger accounting
Profits in the year of merger
Comparison of accounting methods
Associates, joint ventures and related parties
191(10)
Introduction
Companies Act definitions
Accounting standards
Joint arrangement that is not an entity
Joint venture
Associates
Definition
The equity method
Interest held on a long-term basis
Significant influence
Joint ventures
Definition
Gross equity method
Proportional consolidation
Related parties
ASB warning
Disclosure rules
Ultimate controlling party
Who is a related party?
Disclosures
OTHER
Foreign exchange
201(9)
Introduction
Accounting problems
The main problem
The UK accounting standard
Individual companies
Group accounts
Hyperinflation
The temporal method
Current UK practice
Mitigating the effect of currency fluctuations
What the analyst should study
Historical summaries, ratios and trends
210(11)
Historical summaries
Variations in form and content
Our comments on Tesco's five-year record 1999--2003
No FRS planned
Inflation
Changes in accounting standards
Accounting changes made by the company
Changes in the business environment
Changes in the composition of the group
Acquisitions
Continuing and discontinued operations
Ratios
Choice of ratios
Why capital-based ratios are unreliable
Earnings per share
How e.p.s. can be `smoothed' a little
Two modern ratios
Fixed chargescover
Total return to shareholders
Trends
Common size statement
Chairman's statement, operating and financial reviews and directors' report
221(10)
Sequence of study of a report and accounts
The Chairman's Statement
Review of operations
Financial Review
Environmental reports
Estimating current year profits
Longer-term prospects
Information on the quality of management
The directors' report
Contents
Statutory requirements
Control of the company
The board of directors
Non-executive directors
Internal controls and looking to the future
Combined Code on Corporate Governance
Post balance sheet events
Adjusting events
Non-adjusting events
Window dressing
Corporate governance and the auditors' report
231(8)
Corporate governance
Background
The Combined Code
Audit committees
Going concern
Auditors' review
Remuneration Report
The auditors' report
Appointment of auditors
Auditors' access to information
Scope of the report
The Auditing Practices Board (APB)
Statement of Auditing Standards 600
Responsibilities of directors and auditors
Auditors' report
The auditors' opinion
Adverse opinion
Disclaimer of opinion
Fundamental uncertainty
Going concern assumption
Interim reports
239(3)
UK Listing Rules
Auditors' review
Accounting policies
Major transactions
Exceptional items
Half year on half year comparisons
Seasonal businesses
Other sources of information
242(7)
Information provided by the company
Prospectuses and listing particulars
Circulars on acquisitions and disposals
Documents issued in a contested bid
Related party transactions
Company newsletters and magazines
Company websites
Form 20-F
Catalogues and sales information literature
Annual General Meeting
Company visits
External information
The Registrar of Companies
Newspapers and journals
H S Financial Publishing
On the Internet
Accounting standards and financial reporting
City and general news
Inflation
249(4)
Introduction
Historical cost (HC) accounting
HC accounting with stable prices
HC accounting with inflation
The impact of modest inflation
The effect of inflation on the investor in fixed-interest stocks
The future if high (over 10%) inflation returns
Accounting practices - cause for concern?
253(5)
Revenue recognition
A good place to start fiddling
No UK accounting standard
Revenue recognition problems
Revenue recognition examples
Pulling out all the stops
Stocktaking
Provisions
Sales
International accounting comparisons
258(5)
Introduction
Progress since 1990
Contents of this chapter
Harmonisation in Europe
European Commission
International Accounting Standards
Impact of IFRS
Comparison of UK GAAP and IFRS
What lies ahead?
Recent developments
Forthcoming projects
What will happen to UK GAAP?
Convergence with US GAAP
Conclusions
Putting it all together
263(6)
Introduction
Charterhouse Communications
Any other information?
Summary
Conclusion
Developments in accounting
269(5)
Introduction
The Accounting Standards Board (ASB)
Too many rule makers
Company law
Corporate governance
Financial Reporting Standards coming into force
2004
2005
FRS 17 Retirement benefits
FRS 20 Share based payment
FRS 21 Events after the balance sheet date
The Accounting Standards Board's work list
Financial instruments
Earnings per share
Capital instruments
2006
Business combinations
Leases
The comprehensive income statement
Main focus
Format
Remeasurements
Appendices
274(28)
Appendix 1 -- Current Financial Reporting Standards and Exposure Drafts
274(2)
Appendix 2 -- Present value
276(2)
Appendix 3 -- Retail Price Indices since 1950
278(1)
Appendix 4 -- Problems and solutions
279(22)
Appendix 5 -- International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS)
301(1)
Index 302

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