Financial Reporting for SABMiller PLC - Essay Example

?I - Financial Reporting: SABMiller PLC Introduction SABMiller Plc formerly known as The South African Breweries is a multinational company in brewing and beverages business with its renowned international brands such as Pilsner Urguell, Miller Genuine Draft and Grolsch and several strong local brands with over 200 brands in its portfolio. The company has its operations in more than 75 countries with about 70,000 employees. The company is listed on London Stock Exchange. SAB Plc has changed its name to SabMiller Plc after acquiring Miller Brewing Company. The growth of the emerging economies with increasing disposable income of the middle class augurs well for the development of the business. The opportunities are growing due to the trends and life style changes in the emerging markets with youngsters as consumers. The consolidation taking place in the industry over the period of time and the innovative market development activities undertaken by the company with its strong brands and wider geographical expansion portrays a good future outlook for the company as well as the industry in the long run. Evaluation of the company’s Performance The consolidated financial statements include the financial information of the subsidiaries, associates and joint venture entities owned by the company. For evaluating the company’s performance, its performance over a period of time needs to be compared. Figure 1SABMiller Financial Highlights Return on equity Revenue growth and return on equity over the period of time is impressive considering the financial crisis faced by the world and slowdown in economies internationally. There is all-round improvement in performance. In spite of the increasing competition in the industry, the company has been able to maintain its revenue growth. Maintaining EBITA margin with the increase in revenues over the period of time resulted into robust growth in gross profit and profits attributable to equity shareholders. The retained earnings added to the shareholders’ equity during 2012 is 11,863 (2011: 8,991) whereas the other components of the equity shareholders’ funds such as share capital, share premium, merger relief reserve and other reserves are more or less at the same levels. This is reflecting in earnings per share (EPS) and continuously increasing dividends per share from 58.00? in 2008 to 91.00? in 2012. With the acquisitions like Foster’s, expansion into emerging markets like China and India and revival of the global economy the revenue growth is expected to be good in future as well subject to the risks identified by the company. The other important ratios are given bellow. 2012 2011 2010 2009 2009 Interest cover (times) 11.4 10.8 9.3 6.7 9.2 Total borrowings to total assets (%) 34.5 21.6 25.1 30.4 26.8 Revenue per employee (US$000’s) 305.9 280.4 256.9 272.5 309.8 Interest cover is at healthy level which indicates the company’s ability to borrow more, if necessary. The increase in borrowings is due to acquisitions which include Australian beverage business of Foster’s in December 2011. The efficiency in operation is reflected well in the key performance measure ‘revenue per employee’. Cash generating ability, uses of cash and financial adaptability As per the data available in Annual Report, 2012 summary of free cash flow can be worked out as below. Cash flow 2012 2011 Net cash generated from operating activities 3937 3043 Net cash used in investing activities -11600 -517 Net cash generated from/(used in) financing activities 7495 -2327 Net cash (outflow)/inflow from operating, investing and financing activities -168 199 The cash flow on account of financing activities and dividends have been considered in this summary. It could be observed from the above analysis that the company has maintained its cash generating ability and shrewdly ploughed back the funds into the business for investment purposes. In this process, in spite of the increased level of activity in the business, the company is also able to maintain the liquidity ratio more or less at the same level, though Liquidity Ratio from the following figures works out to 0.698 (2011: 0.705) which is less than the generally accepted level of 1. With the good cash generating ability, the company could improve this ratio in due course of time. Also, the cash generating ability increased the financial adaptability of the group by diverting the accrued funds for the growth and development of the business. 2012 2011 Current Assets 4742 4244 Current Liabilities 6790 6018 Interim Report 2012 and the important changes Adjusted EPS is at 118.1 US cents and free cash flow at $1,684 m both up 14% during the period 6 months to Sep. 2012. The acquisition of Fosters, pricing and product mix contributed to strong volumes, revenues and profits and the gearing ratio is at 65.0% (31 March 2012: 68.6%) with its business capability programme progressed in line with the expectations. Net exceptional charges during the period are at US$127 (2011: US$210 million). According to SABMiller plc Interim Report 2012 prepared as per the Disclosure and Transparency Rules of the Financial Services Authority, and with IAS 34 ‘Interim Financial Reporting’ “the effective rate of tax for the half year before amortisation of intangible assets (excluding software) and exceptional items is 27.5% compared with a rate of 28.5% in the prior year period.” This is caused partly by the changes in taxable profit due to geographical changes. The acquisition of Cerveceria Argentina SA Isenbeck (CASA Isenbeck), Foster’s Group Ltd (Foster’s) and the Pacific Beverages Pty Ltd (Pacific Beverages) and the International Breweries plc necessitated adjustments to provisional fair values in the Interim Report 2012 and an important post balance sheet event is the acquisition of 49.9% interest in Foster’s USA LLC by MillerCoors LLC on 7 November 2012. The segmental information as per the report includes the reconciliation between the income as per GAAP and non-GAAP used by management. The future outlook is bright in view of its growth in emerging markets and acquisitions / business combinations. “Performance will continue to reflect progress in the development of our brands, product portfolios, distribution and sales effectiveness. We expect input cost pressures to continue...” (Interim Report 2012) Industry comparison Key performance indicators are useful in measuring the company’s relative position in the industry. An important KPI, the market share in lager volume during the years 2010, 2011 and 2012 have been 94%, 94% and 93% respectively. The company maintains its No.1 or No.2 market positions in various markets. Organic growth in lager volume is at 0%, 2% and 3% respectively during 2010, 2011 and 2012 respectively confirms this position. Similarly, revenue growth in premium brands is an important KPI with reference to profitability which are 7%, 7% and 14% respectively during 2010, 2011 and 2012 respectively. As shown in the Annexure - I, the EV/EBITDA ratio of SABMiller is significantly higher than the other leading players in the industry. Principal risks There are various types of risks such as company specific, industry specific, economic and other internal and external environmental risks associated with the business as identified by the company. These risks are related to industry consolidation, changes in consumer preferences, management capability, successful integration on acquisition of Foster’s and execution of business capability program introduced and regulatory changes. Conclusion The company has consolidated its position in the markets through strategic acquisitions and business combinations. However, the company is facing competition from the local players in various markets. The global operations of the company involve economic, political and other risks related to the industry. There are regulatory hurdles in the industry for the growth and development of the business. The company’s foray into emerging markets is expected to yield good results in the long run. II – Financial reporting & Earnings Management Introduction Earnings management has been traditionally used for smoothing out the fluctuations in earnings with the aim of providing stability and growth in the reported earnings by way of conservatism and prudence. But, ‘earnings management’ is frequently used in connection with the manipulation of the results through various accounting and reporting practices with the aim of rigging up the stock prices. Earnings management could be defined in several ways. Jackson and Pitman (2009) define it as “purposeful intervention in the external financial reporting process with the intent of obtaining some private gain.” This is a very grey area which needs to be approached with caution and as per the definition by Ventureline (2012) “EARNINGS MANAGEMENT occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers.” The methods adopted for earnings management are multifarious which include scenarios such as changing the method of valuation of inventory from FIFO to LIFO, change in the depreciation method say, from straight line method to diminishing balance method or method in making provision for bad and doubtful debts, depending upon the nature and size of the business and the motives behind the strategy. In the corporate world there have been evidences to suggest that net income earnings are subjected to manipulation for various purposes through several methods which make the reported earnings misleading. In many cases, corporate failures have taken place due to manipulation in accounting and reporting practices and Enron scandal is a classical case in this regard. The companies may adopt accrual earnings management which can be discretionary as well as non-discretionary, real earnings management or both in varying degrees. Accrual earnings management by creating accruals, say through credit sales for increasing or decreasing volumes is non-discretionary. Provision for bad and doubtful debts could be increased or decreased, and it is a good example of discretionary earnings management. By timing the real activities or transactions, say postponing the execution of an order to the next quarter to achieve the desirable level of production or sales in the current quarter (or next quarter) could be considered as real earnings management. Methods/techniques used by firms to manage earnings Employing specific accrual methods for the earnings management is restricted to some grey areas where there are scopes for revision and discretion. There are various specific accruals which are likely to be managed in view of the accounting choices available or methods of estimations which cannot be precise or can vary. Usually, the companies would engage in real earnings management as it is safe and there are very little risks attached. When the company is under pressure to meet the earnings guidelines already given, increasing or decreasing the earnings for taxation or various other purposes they exercise the option of non-discretionary accrual earnings management in addition to real earnings management. When the company is aggressively pursuing earnings management while facing difficult situations, and if the aforesaid options offer limited scope for earnings management, they engage in discretionary accrual earnings management. Depending upon the size of the company, multitude of its operations, geographical diversification or complex management structure involving several subsidiaries or divisions, the management could follow several methods of earnings management and therefore, the methods or techniques given below are not exhaustive. Valuation of property Valuation of property, especially revaluation of property is used by the companies when the book value is unreasonably low due to the depreciation policies adopted or increase in the value as in the case of land and properties over the period of time, in order to portray the true picture of the balance sheet. The companies usually adopt this method for earnings management when there are financial difficulties or continued poor performance. Restructuring charges Certain expenses could be clubbed together and shown under restructuring charges and the reasons attributable could be achieving efficiencies through changes in reportable segments or reorganization of the business. The real purpose of capitalizing it for future amortization and thereby reducing the burden of expenditure in a particular period is sought to be hidden in this process. Cost allocation Cost accounting is not completely reflected in financial accounting. The cost accounting is mostly used for the internal management accounting purposes or for taking managerial decisions. The manipulation in the area of administrative, selling and distribution overheads is very difficult to infer and establish. In a study on selling, general and administrative costs Anderson et al (2003) observe “Developing a greater understanding of the managerial decision-making processes and the forces that lead to sticky cost behavior will be an important step in improving cost analysis.” By changing the basis for allocation or apportionment of administrative, selling and distribution overheads relating to the group over the various divisions or businesses, the expenses pertaining to a division, unit or subsidiary could be increased or decreased. Also, there are fixed or period costs and variable costs. For example, treating variable costs as fixed costs or vice versa could increase or decrease the cost of production during the period. Also, variable nature of the costs could be used to achieve the desired stock valuation by the company. Income shifting The companies may shift incomes from one period to another period through shifting of sales, valuation of stock or shift income from one company to another related company by differential pricing. This will be very difficult to detect if these companies have different accounting periods and the position could be reversed in the subsequent period without affecting the results of the other company. Hedging through derivatives In hedging through derivatives, accrual earnings management could be done by shifting the liability to the next period. Both the original transaction and hedging transaction are excluded by treating their effect as notional in view of hedging by way of prudence. Transactions within the group Transactions within the group take place in the normal course of business. However, real earnings management could be easily handled in the case of transactions within the group. Also, there are several areas such as price differentials, the discount structure, commissions for the consultancy services provided and charges for the technical services provided which are difficult to be proved with reference to earnings management. Fee for use of brands, management fees, fees for technical advices and marketing advices are some of the methods which are adopted within the group for shifting the incomes or costs. Transfer pricing In transfer pricing adopted within the group for the products, by-products or secondary products, reasonableness of fixing the prices for the purpose of transfer is very difficult to ascertain. Value addition is an important part related to productivity in manufacturing. As it is directly related to profitability, any manipulation in transfer pricing would affect the profitability of the concerned businesses. The allocation or apportionment of cost for the purpose of transfer pricing in the case of a main product and its by-product(s) is a question of judgment rather than cost parameters. Provisions for bad debts or other liabilities In fact provision for bad and doubtful debts or any other provisions or reserves created in any name to meet the contingent liabilities or decrease in values are only estimates and the company can effectively engage in accrual earnings management in such cases. According to Nelson et al (2003) the plethora of reserves include Inventory reserve, Loan loss reserve, Bad debts reserve and Insurance reserve and they also state “Other frequent expense- and loss-related attempts were more focused on long-term assets”. The impacts of earnings management on stock markets The CEOs usually would like to meet the earnings guidelines already given to prove that their forecast about the business is correct after taking into account various contingencies involved in the business. Any failure in meeting the forecasts is reflected in the subsequent movement in the stock prices. A study by Bartov et al (2001) shows that the “investors reward firms whose earnings meet or beat analysts’ estimates. After controlling for the quarterly forecast error (measured relative to analysts’ earnings forecasts made at the beginning of the quarter), the quarter’s abnormal returns are positively and significantly associated with the earnings surprise for the quarter (measured as the difference between reported earnings and the most recent earnings estimate at the time of the earnings announcement).” The reaction in the stock market varies depending upon the situations. The stock markets are efficient in discounting the future events and the current prices are adjusted to the expected impact of the future events on the performance and profitability of the business. Abranell & Lehavy (2003) have found in their study “a tendency for firms rated a sell (buy) to engage more (less) frequently in extreme, income-decreasing earnings management, indicating that they have relatively stronger (weaker) incentives to create accounting reserves especially in the form of earnings baths than other firms. In contrast, firms rated a Buy (Sell) are more (less) likely to engage in earnings management that leaves reported earnings equal to or slightly higher than analysts’ forecasts. When the results of the previous year are expected to be poor, for example a new CEO makes it look worse through shifting of the income to the current year by blaming the previous CEO for poor performance in the previous quarter. This big bath will enable him to paint a very rosy picture for the current year in comparison and this will also fetch greater dividends to the executives by way of performance bonus and increase CEO’s reputation for efficiency in performance. The companies seek to improve their future outlook in the stock market before they embark on big capital investment programs involving initial public offerings or rights issues. Teoh et al (1997) state “We document that discretionary current accruals grow before the offering, peak in the offering year, and decline thereafter. This accruals pattern causes net income to grow before, peak in, and decline after the offering year, despite low pre-issue and improved post-issue cash flow from operations.” Also, in some cases the information, i.e. increase or decrease in profit not in accordance with the analysts’ estimates, will be useful in insider trading or manipulation of the stock prices with some ulterior motive. Other motives behind earnings management Earnings management involves risk and therefore people use their discretion and judgment carefully to mitigate the risks involved. Apart from the reputation of the company, earnings management might also lead to litigations and regulatory sanctions. The companies engage in earnings management using the loopholes in the standards, accounting choices available and the discretionary powers entrusted to the executives. Healy and Wahlen (1999) state “Earnings management for contracting reasons is likely to be of interest to standard setters for two reasons. First, earnings for any reason can potentially lead to misleading financial statements and affect resource allocation. Second, financial reporting is used for communicating management information not only to stock investors, but also to debt investors and to investors’ representatives on board of directors.” The motives for earnings management are not apparent. Inefficiency in the operations The executives are likely to engage in earnings management to hide the inefficiency in the operations. Kim and Yi (2006) state “as the control-ownership disparity becomes larger, controlling shareholders tend to engage more in opportunistic earnings management to hide their behavior and avoid adverse consequences such as disciplinary action.” Fear of loss of control Fearing loss of control of the CEO acts as an important motive for earnings management. Zouari et al (2012) state “we find a significant positive relationship between CEO characteristics and earnings management, suggesting that as reputed CEO is well compensated, he is more afraid to lose his compensation level, therefore his incentive to manipulate firm’s earnings increases.” Wage negotiations Agreement with the trade unions for the purpose of revision in wages takes place usually once in 3 to 5 years. The improvement in performance of the company during the previous year of negotiations scheduled may increase the bargaining power of the trade unions, and to avoid such situation the companies may engage in earnings management. Public/Rights/Bond Issues The earnings management in a planned manner take place prior to public, rights or bond issues by a company. Also, at the time of acquisitions or stake sales the companies engage in earnings management in such a way to engineer the process in their favour. Price controls and monopoly or monopolistic situations When there are price controls in a monopoly or monopolistic situations, to avoid the attention of the regulatory authorities of the governments the companies may downplay their performance. Private information & Tax planning The weaker companies may conceal certain private information which would have a severe impact on the estimates of profitability or sustainability of the earnings. Withholding such information can be construed as earnings management. Earnings management is also done by way of tax planning or tax avoidance. The taxation policy of the governments sometimes acts as an inducement for the companies to engage in earnings management. For example, “The AMT created an incentive to shift income to 1986 from 1987 to avoid the 20% tax rate on alternative minimum taxable income (AMTI) and an effective marginal rate of 10% on AMT book exposure.” (Boynton et al, 1992) CEO’s vested interests The CEO for the purpose of extending his terms as in the case of political appointments in the public sector undertakings may like to show good results to increase his chances of continuance in the office. Regulation of the earnings management practices Kasznik (1997) states “managers, fearing costly legal actions by shareholders and loss of reputation for accuracy, use positive discretionary accruals to manage reported earnings upward when realized earnings fall below their earnings predictions... In particular, a more positive stock price change at the time of the forecast disclosure and during the subsequent period, and greater analyst following, are associated with a greater amount of income-increasing discretionary accruals.” In the IAS and IFRS the standard setters seek to develop standards for accounting and reporting based on the internationally accepted principles to ensure quality of the reports for the benefit of all the stakeholders of the businesses and industries.  “Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, emphasizes usefulness to present and potential investors, creditors, and others in making rational investment, credit, and similar decisions...Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, emphasizes that usefulness of financial reporting information for those decisions rests on the cornerstones of relevance and reliability” (FASB, 2008, paragraph 9). While the discretionary powers are judicially used by the companies while making assumptions or provisions to reflect the true and fair view of the companies’ operations the motives for aggressive earnings management make them to adopt the methods which undermine the principles as the motives are not in the interest of the stakeholders. Sun and Rath (2008) “highlight the two competing perspectives in viewing EM; the opportunistic behaviour of managers using accounting discretion to increase their compensation or protecting their job security, and signalling mechanism that managers used to communicate their expectations of firm performance to investors and therefore maximize shareholders’ wealth.” There are genuine difference of opinions as to the desirability and efficacy of various regulatory guidelines. “The SEC issued Staff Accounting Bulletin (SAB No. 101) to address its concern that firms were masking true performance by managing earnings using accelerated revenue recognition. Critics of this Accounting Bulletin stated that it would eliminate industry-accepted revenue recognition practices and reduce the quality of reported earnings” (Altamuro et al, 2005). FASB reflects the critics’ position treating it as value relevant information about the future performance. According to Memis and Cetenak (2012) “whether international big audit firms provide high quality services or not, audit environment, which affected directly by legal environment and effectiveness of legal system, is more important than audit quality.” The regulatory changes introduced in the US such as The Securities and Exchange Commission stipulating publicly traded companies to make periodical disclosures relating to the business through Regulation Fair Disclosure and Sarbanes and Oxley Act significantly impacted on the accrual based earnings management. Consequently the level of risks has considerably increased compared to the benefits derived in the process. The serious consequences attached to the risks undertaken prevented the managers to engage in earnings management indiscriminately by way of estimations or discretions. “SOX was designed to enhance the reliability of financial reporting and to improve audit quality. At Ernst & Young, we believe it has done both; although, more work surely remains. SOX forged a new era for the US audit profession by ending over 100 years of self-regulation and establishing independent oversight of public company audits by the Public Company Accounting Oversight Board (PCAOB)” (Ernst & Young, 2012) Conclusion The companies engage in earnings management through real earnings management or accrual earnings management or both. There are several methods and techniques used by the companies for earnings management. Though earnings management is accepted to a certain level in view of stability of the earnings, desirability of prudence and need for conservatism in reported earnings, aggressive earnings management with ulterior motives other than the interest of the stakeholders is a cause for concern. If stringent regulatory measures are introduced to curb earnings management it will affect the flexibility in accounting and reporting which is also important in the business context and majority of the companies with good management practices will also suffer. The level of accrual earnings management in the recent years has been brought under control through various regulatory measures of the governments and international accounting bodies. References Abarbanell, J. and Lehavy, R., 2003. Can Cost Recommendations Predict Earnings Management and Analysts’ Earnings Forecast Errors? Journal of Accounting Research, Vol. 41(1) 1-31. Altamuro, J., Beatty, A.L. and Weber, J., 2005. The Effects of Accelerated Revenue Recognition on Earnings Management and Earnings Informativeness: Evidence from SEC Staff Accounting Bulletin No. 101. Accounting Review. Vol 80(2) 373-401. Anderson, M., Banker, R. and S. Janakiraman. 2003. Are selling, general, and administrative costs “sticky”? Journal of Accounting Research. 41(1): 47-63. Bartov, E., Givoly, D. and Hayn, C., 2001. The rewards to meeting or beating earnings Expectations. Journal of Accounting and Economics 33 (2002) 173–204. Bointon, C.E., Dobbins, P.S. and Plesko, G.A., 1998. Earnings Management and the Corporate Alternative Minimum Tax. Journal of Accounting Research. Vol. 30, Supplement 1992. 131-154. Ernst & Young, 2012. The Sarbanes-Oxley Act at 10: Enhancing the reliability of financial reporting and audit quality. [online] Available at: [Accessed 23 December 20120]. FASB, 2008. Statement of Financial Accounting Concepts No. 6, Elements of Financial Statements. [online] Available at: [Accessed 23 December 20120]. Healy, P.M. and Wahlen, J.M., 1999. A Review of the Earnings Management Literature and its implications for Standard Setting. Accounting Horizons (December): 365-383. Infinancials, 2012. SABMiller PlC financial analysis, [online] Available at: [Accessed 23 December 20120]. Jackson, S.B. and Pitman, M.K., 2009. Auditors and Earnings Management. The CPAJournal. [online] Available at: [Accessed 23 December 20120]. Kasznik, R., 1997. On the Association Between Voluntary Disclosure and Earnings Management. Research Paper No. 1401R, Graduate School of Stanford University. [online] Available at: [Accessed 23 December 20120]. Kim, J. and Yi, C.H., 2006. Ownership Structure, Business Group Affiliation, Listing Status, and Earnings Management: Evidence from Korea. Contemporary Accounting Research. Summer 2006, Vol. 23 Issue 2, p427-464. Memis, M.U. and Cetenak, E.H., 2012. Earnings Management, Audit Quality and Legal Environment: An International Comparison. International Journal of Economics and Financial Issues. Vol. 2 (4) 460-469. , M.W., Elliott, J.A. and Tarpley, R.L., 2003. How Are Earnings Managed? Examples from Auditors. Accounting Horizons. Supplement 2003. 17-35. SABMiller plc, 2012. Interim Report 2012. [online] Available at: [Accessed 23 December 20120]. SABMiller plc, 2012. Annual Report 2012. Sun, L. and Rath, S., 2008. Fundamental Determinants, Opportunistic Behavior and Signalling Mechanism: An Integration of Earnings Management Perspectives new accounting standards that limit the amount of financial reporting discretion. International Review of Business Research Papers. Vol.4 No.4 Aug-Sept. 2008, Pp. 406-420. Teoh, S.H., Welch, I. and Wong, T.J., 1997. Earnings management and the underperformance of seasoned equity offerings. Journal of Financial Economics 50 (1998) 63-99. Ventureline, 2012. Earnings Management Definition. [online] Available at: [Accessed 23 December 20120]. Zouari, Z., Lakhal. and Nekhili, M., 2012. Do CEO’s Characteristics Affect Earnings Management? Evidence from France. SSRN. [online] Available at: [Accessed 23 December 20120]. Appendices Annexure - I Sabmiller PlC Peer group:Ratios based on Fri, 21 Dec 2012 Sabmiller PlC Peer group Enterprise Value EV/EBITDA Relevance (in thousands USD) 2013 next 12 mth Score Sabmiller PlC 92 337 514 14.01 14.33 Molson Coors Brewing... 8 782 620 6.68 6.69 100% Heineken 49 129 598 8.64 8.66 95% Ambev Bebidas Americ... 126 669 483 15.28 15.31 86% Asahi Group Holdings... 15 870 355 7.55 7.55 79% Heineken Holding 33 658 116 5.92 5.94 76% Kirin Holdings Compa... 27 055 033 7.30 7.31 72% Sabmiller PlC Benchmark EV/EBITDA next 12 mth Company Sabmiller PlC 14.33 Peer group Sabmiller PlC excluded 9.77 Sabmiller PlC included 10.66 Sector Brewers 9.88 S&P 500 7.91 STOXX Europe 600 6.73 Country ZAF 8.03 Source: Infinancials Read More