Financial Reporting on Sainsbury - Coursework Example

?Sainsbury's Financial reporting Table of Contents Table of Contents 2 Overview 3 Analysis of accounting policies 3 Conclusion 8 Bibliography 11 Overview Sainsbury Plc is a UK based FTSE 100 listed company. The primary activities of the company include grocery, retail and financial services. The three main operating segments are retailing in the form of convenience stores and supermarket; financial services such as the bank joint ventures of Sainsbury and investment in properties. It runs nearly 872 stores of which 537 are supermarkets and 335 are convenience stores. The company has a joint ownership with Lloyds Banking Group and also has joint ventures in properties with The British Land Company Plc and Land Securities Group Plc (Reuters, 2011). In financial year 2010 the main joint ventures of the Group were The Harvest Limited Partnership, BL Sainsbury Superstores Limited and Sainsbury Bank Plc. In all these ventures the company has a share of 50 percent. The Directors of the company are accountable for the preparation of Annual Report, Remuneration Report and relevant financial statements as per the applicable regulations. The financial statements of the Company and the Group are prepared in accordance with the International Financial Reporting Standards (IFRS) (J Sainsbury Plc, 2010). Analysis of accounting policies a) At the end of each financial year and also in the event of any impairment indication, there is a review of the carrying value of the tangible and intangible assets by the Group to identify any impairment losses. If such indication is revealed then the recoverable value of the asset is calculated to determine the amount of impairment loss. If the cash flows from the assets are not independent of the other assets the Group determines the recoverable amount of the cash-generating-unit (CGU). When there exists objective evidence regarding impairment loss on receivables and loans, then the carrying amount of the financial assets is reduced to the present value of the anticipated future cash flows which is obtained by discounting the financial asset using the original effective rate of interest. For 2010 the total impairment shown in the books of the company is ?23 million. This has been with respect to assets like land & buildings and fixtures &equipments. The depreciation on the assets is provided on the basis of straight line method based on the bases of 50 years or term of the lease in the case of leasehold properties and freehold building and period of 3 to 15 years for fixtures & equipments and vehicles. Good-will is shown as an asset in the balance sheet of the Group in the respective period. It is tested annually for impairment and in the event of an indication of impairment the value of good-will is carried forward at cost minus accumulated losses on impairment. The losses on impairment are shown in the income statement in the year in which it occurs. The impairment loss in respect of the “equity instruments are not reversed”. If in a following period there is a rise in the fair value of the debt instrument classified as “available for sale” and this rise can be attributed to the happening of an event, after such loss has been shown in the income statement, then it is reversed through the company’s income statement. As per IAS 36 relating to ‘Impairment of Assets’ for impairment testing each store is treated by the Group as a CGU (cash generating unit). Tesco Plc also applies the same accounting policy for the impairment losses. Like Sainsbury the tangible assets of Tesco such as plant & equipment and property are reviewed as per IAS 36 if indications are found that the carrying amount of the asset may not be realised (Tesco, 2010). b) Sainsbury reported “Derivative financial instruments” of ?20 million in its balance sheet. The business activities of the Group make it vulnerable to financial risks that may arise in the case of exchange rate fluctuations and adverse movement in the interest rates. These risks are managed by the company using derivative instruments such as interest rate swap and forward contracts. The principle financial risks are- exchange rate risks and interest rate risk. The exchange rate risk may arise as adverse exchange rate fluctuations may impact its future purchase of inventory denominated in overseas currency. Besides there may also be changes in the fair value of financial liabilities or financial assets due to interest rate movements which exposes the company to significant financial risk. The company has not maintained any provision for impairment of financial instruments. The financial instruments are recognised in the balance sheet using the fair value basis. For the financial year ending 2010 the Group reported the forward contract at a fair value of ?9 million for the purpose of hedging its foreign currency exposure in trade purchases. On this date the Group reported its forward contract at a fair value of ?2 million. The company uses interest rate swaps, commodity contracts and foreign exchange contracts to hedge against interest rate risk, fuel exposure and currency risk. For 2010 the Group had an investment in interest rate swap of ?401 million. This enabled the company to hedge adverse movements in interest rates on fixed secured loans. As per swap terms the Group pays floating at an agreed upon spread above 3 months LIBOR and receives fixed. Therefore, by way of interest rate swaps the inflow of the company remains fixed and outflow remains variable. It seems that the Treasury of the company anticipates interest rate to fall as evident from the interest rate strategy adopted by it. A forward contract enables the company to hedge against adverse movements in the foreign exchange rates. The future purchase of inventory of the Group is denominated in foreign currency. The company hedges its future cash flow position by the use of derivative instruments. If it remains unhedged then the financial position of the company may get severely impacted. This is because unpredictable and unexpected appreciations of the foreign currency say US dollars would mean that the company will have to shell out higher value of pound sterling for settling its inventory payments. As a result of this the cash outflow of the company will rise thereby impacting its profitability. Other than currency risk the activities of the business are also exposed to commodity risk which may arise due to its consumption of fuel, electricity and gas. To limit the risk arising from the price of these commodities the Group requires its forecasted purchase to be appropriately hedged. An adverse movement in the price of these commodities means a rise in the business costs thereby impacting the financial standing of Sainsbury. The derivative instruments of the Group are reported at fair value as on the date of contract and also at subsequent periods of reporting. To make way for hedge accounting, at the very inception the Group lays down hedging risk strategy, relationship between the items which is hedged and the corresponding instruments used to hedge. For any changes in the fair value of these instruments, which cannot qualify for hedge accounting, are shown as finance cost or income in the income statement. After the instrument used for hedging is exercised or expires or is terminated there is a discontinuation of hedge accounting. In the absence of any active markets the fair value of the financial instruments is derived using valuation techniques which includes inputs relating to asset or liability that do not have any observable data from the market. The risk management policy or the hedging strategy adopted by the company are designed in a way as to minimise possible negative impacts on the financial performance of the Group by identifying the exposures and establishing suitable risk controls and limits. The derivative instruments are used by the company only for the purpose of business needs and not for the purpose of any speculative gains. The hedging policy of the company is in line with Tesco Plc which too uses instruments like forward contracts for hedging against foreign currency fluctuations. Like Sainsbury it does not use financial instruments for trading activities rather its use is limited to hedging against exposures (Tesco, 2010). This shows that the hedging policy of the company is in line with the industry practice. c) For the post-employment benefits like pensions the company uses IAS 19. The pension schemes of the company have been subject to “triennial valuation”. As per the actuarial assumptions the future pension is expected to increase 2.2% to 3.4%. There are no post-employment obligations in the off-balance sheet. The expected return on the assets is obtained as the weighted average expected return from the various asset classes. This is based on historical trend and the future outlook of the financial markets. The expected return has been estimated to be 6.4%. The return seems realistic as they are based on historical performances of each asset class along with their expected future outcome. A difference between the actual and forecasted parameters can result in excessive surplus or deficit. This impacts the liability side of the balance sheet of the company. Conclusion The financial disclosure practices of Sainsbury are in line with the accounting rules and regulations. In the annual reports of the company the accounting policies relating to asset impairment, financial instruments, hedge accounting, pensions etc have been duly followed. Owing to the nature of its business operations the company is exposed to various financial risks. The instruments used for hedging the risks have been valued as per the fair value or in the absence of an observable market data they have been valued using valuation techniques. The hedge accounting is used for depicting the value of the financial instruments. For the instruments that expire or are exercised the hedge accounting is discontinued. As per IASB conceptual framework the main objective of financial reporting is to give a fair and accurate view of the operations of the company. This facilitates effective decision-making by the company’s existing and potential investors. It gives them an idea whether the management is handling the business functions properly and is making apt use of the available resources (IASB, 2010). In line with the conceptual framework the Directors of Sainsbury are responsible for the preparation of the financial statements. The presentation of the financial reports is in line with the industry parameters as reflected from similar accounting policies adopted by its peer company Tesco Plc. In respect of the financial instruments the company has used the fair value technique and in the absence of an active market it has given credence to the valuation technique. The actuarial forecasts have also been based on important financial assumptions. All this shows that the financial reporting of the company is in line with the established accounting rules and regulations. Reference J Sainsbury Plc. (2010). Annual Report and Financial Statements 2010. [Pdf}. IASB. (2010). The Reporting Entity. Conceptual Framework for Financial Reporting. Available at: http://www.iasb.org/NR/rdonlyres/363A9F3B-D41C-41E7-9715-79715E815BB1/0/EDConceptualFrameworkMar10.pdf [Accessed on April 21, 2011]. Reuters. (2011). Full Description. J Sainsbury PLC. Available at: http://uk.reuters.com/business/quotes/companyProfile?symbol=SBRY.L [Accessed on April 21, 2011]. Tesco. (2010). Annual Report and Financial Statements. Available at: http://ar2010.tescoplc.com/~/media/Files/T/Tesco-Annual-Report-2009/Attachments/pdf/tesco-annualreport.pdf [Accessed on April 21, 2011]. Bibliography Deloitte Global Services Limited. (2011). Summary of International Financial Reporting Standards. Available at: http://www.iasplus.com/standard/framewk.htm J Sainsbury plc. (2011). About Us. Available at: http://www.j-sainsbury.co.uk/index.asp?pageid=189 Yahoo Finance. (2011). Business Summary. J Sainsbury PLC. Available at: http://finance.yahoo.com/q/pr?s=SBRY.L+Profile Read More