Corporate Accounting - Research Paper Example

ID] [module and module number] Executive Summary The purpose of this paper is to examine the accounting practices and issues of a company such as Santos Limited. By looking at the companys annual report and financial statements for the year 2008, issues regarding the companys accounting practices are looked at. This paper aims to look at various items that concern the companys accounting policies for its operations. These items include the companys equity, debt financing, tax accounting practices, and property, plant and equipment, the practices of Santos Limited as regards recording and accounting for its operations are delved upon. The individual items are identified as regards the policies associated with accounting them, as well as the changes that have taken place within the company over the year and their significance with the companys performance. Lastly, conclusion about the companys state of operations is made based on the findings about the operational performance of Santos Limited. Based on the figures presented in the annual report, the companys overall performance is gauged. I. Body A. Companys operations and its industry conditions Santos Limited is an Australian oil and gas exploration company. The companys major activities include looking for oil and gas fields, then developing these fields to produce gas, oil and other energy resources. The company has produced 54.4 million barrels of oil equivalent, lower than the previous two years. This figure is comprised of sales of gas and ethane, condensate, crude oil, liquefied petroleum gas, and liquefied natural gas. The company has posed a substantial growth in 2008 with 11% increase in sales revenue from 2007. Consequently, the company has experienced increase in its net profits as well as operating cash flow. The companys return on equity for 2008 is 48.6%. During the year, the company is faced with challenges due to the fluctuating oil prices, reaching up to $150 per barrel. The volatility of the stock market as well as the effect of the financial credit crunch have impacted the industry as a whole. However, Santos is able to counter these events by its fixed price contracts. The level of the companys resources has enabled it to prepare during times of volatile prices. B. Companys equity The equity of Santos Limited is comprised of its share capital, its retained earnings, and reserves. From 2007 to 2008, the companys equity has grown from 3093.1 million to 4478.3 million (Santos Ltd 2008, 107). The companys share capital amounts to 2531.3 million in 2008, up from its figure of 2331.6 in 2007 (Santos Ltd 2008, 107). This significant increase in share capital can be attributed to the following activities: 2.5 million in shares options exercised by the employees, issue of additional shares which amounts to 253.1 million, and a decrease in share capital as the company has bought back 56.4 million worth of stock (Santos Ltd 2008, 107). Activities such as the shares buy-back as well as the issue of additional shares are in line with the plan of Santos Limited to optimize its capital structure, in order to maintain a gearing ratio which is less than 45%, and a credit rating from Standard and Poor of BBB+ (Santos Ltd 2008, 110). The consolidated figure and the figure of Santos Ltd differ due to the equity that is attributable to minority interests. By looking at the companys retained earnings, it is apparent that the retained earnings has significantly increased from 1034.4 in 2007 to 2135.8 in 2008 (Santos Ltd 2008, 107). This increase in mainly attributable to the companys recognition of net income, which amounts to 1632.9 million, a good thing that the equity is increased by the income from companys operations. In line with the companys plan to buy back some shares in order to return the capital to shareholders, as according to the companys chairman (Santos Ltd 2008, 8), the retained earnings is decreased by that activity by 245.0 million in 2008. The company has also declared dividends which amount to 286.3 million—also a deduction from the retained earnings amount. The companys reserves include translation reserve and fair value reserve, which are also part of the companys equity. As the company operates in some areas outside Australia, the fluctuation due to the difference in currencies and foreign exchange rates is reflected in the translation reserve (Santos Ltd 2008, 108). In 2008, the company has recognised an increase in the reserve by 93.5 which is attributable to the companys income from operations which results in a negative 186.8 million figure in its balance sheet (Santos Ltd 2008, 108). The fair value reserve, on the other hand reflects the net cumulative changes in the value of the companys available-for-sale investments. In 2008, the fair value reserve is decreased by 9.4, which results in a figure of negative 2.0 million. C. Companys debt The debt section of Santos Limited is categorized into current liabilities and long-term liabilities. The companys current liabilities section is comprised of trade and other payables, deferred income, interest-bearing loans and borrowings, current tax liabilities, provisions, and other current liabilities. The companys long-term liabilities include long-term deferred income, interest-bearing loans and borrowings, deferred tax liabilities, provisions, and other non-current liabilities. The companys total liabilities have increased its figure from 4227.1 in 2007 to 5323.6 in 2008 (Santos Ltd 2008, 73). The deferred tax liabilities figure has increased from 743.0 million in 2007 to 744.1 million in 2008 (Santos Ltd 2008, 103). The tax liability in 2008 has an actual figure of 839.1 million in 2008, but with the set-off of tax, the net figure is 744.1 million (Santos Ltd 2008, 103). The companys trade and other payables has decreased from 609.7 million in 2007 to 604.8 million in 2008 (Santos Ltd 2008, 104). As apparent in these figures, the company has either increased or decreased amounts by very small increments in an effort to remain at the current stable levels. The companys interest-bearing loans and borrowings are separated into two categories, current and non-current. Santos Limited has decreased its current interest-bearing loans and borrowings from 103.1 million in 2007 to 98.6 million in 2008 (Santos Ltd 2008, 103). Although the company has decreased its level of borrowings, according to its annual report, the large portion of this borrowing is comprised mainly of bank-loans and long-term note in contrast to commercial papers and medium term notes comprising the large portion of borrowing in 2007. According to the annual report, this change in the borrowing mix is done by entering an interest-rate swap in order to utilize the lower interest rates, which result in 5.74% weighted average in 2008, as compared to 6.62% in 2007 (Santos Ltd 2008, 103). Provisions are also part of the companys debt mix. These provisions, classified as either current or non-current include items such as liability for annual leave, liability for long service leave, restoration, non-executive directors retirement benefits, and liability for defined benefit obligations. The current portion of it has increased from 112.4 million in 2007, to 116.7 million in 2008 (Santos Ltd 2008, 106). The non-current portion of it has resulted in a huge increase from 543.6 million in 2007 to 808.0 million in 2008 (Santos Ltd 2008, 106). The large portion of this increase in 2008 is attributable to the provisions for removal and restoration of facilities. The companys other liabilities section is categorised into current and non-current liabilities. This section includes cross-currency swap contracts, interest rate swap contracts, and fair value of embedded derivatives. The current portion is decreased in 2008 to 8.1 million from 15.4 million in 2007, while the non-current portion is decreased from its 14.5 million in 2007 to 9.0 million in 2008 (Santos Ltd 2008, 107). The company utilizes debt in more than 50% of financing its total assets: 54.31% of its total financing is debt in 2008. This proportion is down from last years 57.75%. D. Tax accounting The companys income tax expense has increased by a significant amount from 195.7 million in 2007 to 768.4 million in 2008. The major portion of this increase is attributable to the companys tax expense for the current year amounting to 726.7 million at 30% (Santos Limited 2008, 90), as a result of the higher operating profit before tax for the year. According to the annual report, this tax expense figure incorporates the sales of 40% of the companys GNLG project to Malaysia Petronas (Santos Ltd 2008, 12). The company has increased its deferred tax as well, to 50.2 million in 2008 from a negative 17.3 million in 2007 (Santos Ltd 2008, 90). These results in a total income tax for the company of 768.4 million. The royalty-related tax expenses however are down from 163.6 million in 2006 to 114.7 million in 2008. By adding the companys income tax expense and the royalty-related expense, the total tax expense for Santos Limited in 2008 amounts to 883.1, more than double the companys total tax expense in 2007 (Santos Ltd 2008, 90). By looking at the breakdown of the tax schedule in the companys annual report, a major thing to note is the companys practice of not recognising the foreign losses, which could have given a company a lower income tax expense. Foreign losses amount to 26.4 million in 2008, lower than its figure in 2007 of 38.5 million. The taxation of Santos Limited falls into two different categories: the royalty-related taxation and income tax. According to the companys annual report, royalty-related taxation such as “petroleum resource rent tax, resource rent royalty, and additional profit tax are also recognised as income tax according to the AASB 112 income taxes (Santos Ltd 2008, 83). According to the companys annual report, Santos Limited recognises income tax on income statement as a comprised by both current and deferred tax using the tax rates at the date that the balance sheet is prepared (Santos Ltd 2008, 83).” The income tax rate in 2007 is 30%. The company determines deferred tax by the balance sheet approach, or as according to the annual report, by “providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the appropriate tax bases (Santos Ltd 2008, 83).” The companys deferred tax assets in 2008 is higher than in 2007, from 86.8 the previous year to 111.0 in the current year. Some of the major portions of this figure include other land, plant and equipment, interest-bearing loans and borrowings and employee benefits, defined benefit obligations and provisions. As for the deferred tax liabilities, it is comprised mostly by deferred tax on oil and gas assets, royalty related taxes, exploration and evaluation assets, other items, inventories, and derivative financial instruments. The deferred tax liabilities on oil and gas assets are the highest. E. Property, plant and equipment, and intangibles The property, plant and equipment of Santos Limited of the company is comprised of the oil and gas assets, and other land, building, and equipment. The oil and gas assets figure has increased from 5584.4 million in 2007 to 6254.8 million in 2008, a significant contribution to the increase in total assets (Santos Ltd 2008, 73). Other land, building and equipment have increased by 47.9 million in 2008 (Santos Ltd 2008, 93). The intangibles include the companys exploration and evaluation assets, which increased from 332.4 million in 2007 to 427.5 million in 2008 (Santos Ltd 2008, 96). According to the companys annual report, oil and gas assets are “oil and gas field which are being developed for future production or in the production phase (Santos Ltd 2008, 78).” The company accounts oil and gas assets differently when they are in the development phase and when they are in the production phase. When the assets are in the development phase, they are “accounted separately as tangible assets and include past exploration and evaluation costs, development drilling and other subsurface expenditure, surface plant and equipment and any associated land and buildings (Santos Ltd 2008, 78).” Producing assets are accounted for “as tangible assets and include past exploration and evaluation costs, pre-production development costs, and the ongoing costs of continuing to develop reserves for production and to expand or replace plant and equipment, and any associated land and buildings (Santos Ltd 2008, 79).” As for other land, plant and equipment, these costs are recorded at historical value. According to the annual report, the costs related to plant and equipment include “cost of rotatable spares and insurance spares that are purchased for back up, […] the costs of major cyclical maintenance […] if they are eligible for capitalisation (Santos Ltd 2008, 79).” The depreciation method that Santos Limited uses is the straight-line method for every onshore individual asset (Santos Ltd 2008, 83). Buildings are depreciated over the periods of 20-50 years. As for plant and equipment: computer equipment are estimated to have a useful life of 3-5 years; motor vehicles are estimated to have useful life of 4-7 years; for furniture and fittings, those are depreciated over 10-20 years; for pipelines, 10-30 years; and for plant and facilities, 10-50 years (Santos Ltd 2008, 79). As for offshore assets, plants and equipment are depreciated using the unit of production method on a cash-generating unit basis. The companys exploration and evaluation assets have increased from 332.4 million in 2007 to 427.5 million in 2008 (Santos Limited 2008, 73). This figure is accounted by the company using the successful efforts of accounting where the expenses are recorded when incurred, but the “costs of successful wells and the costs of acquiring interests in new exploration assets, which are capitalised as intangible exploration and devaluation (Santos Ltd 2008, 82).” According to the companys annual report, the “cost of wells are initially capitalised pending the results of the well (Santos Ltd 2008, 82).” When these discoveries enter the development phase, they are classified as oil and gas assets. The depletion method used to amortise these intangibles and natural resources is the unit of production method. According to the companys annual report, this is “based on heating value which will amortise the cost of carried forward exploration, evaluation and subsurface development expenditure over the life of the estimated “Proven plus Probable” reserves in a cash generating unit, together with future subsurface costs necessary to develop the hydrocarbon reserves in the respective cash-generating units (Santos Ltd 2008, 79).” F. Summary of companys financial operations Santos Limited has fared well in 2008, by reaching a net profit after tax of 1650 million and an operating cash flow of 1473 million during the year. Although the level of sales revenue has been higher than the past years, it has been the highest since 2004. The large increase in the companys after tax profit is mainly attributable to the companys sale of the 40% interest of its GNLG project to Malaysias Petronas. Therefore, the huge sale has resulted in lower operating expenses for the company, which has given the shareholders an ROE of 48.6% during the year (Santos Limited 2008, 6). The companys operations seem to be stable and sustainable as it continues to invest in profitable projects. However, this huge increase in the companys performance is attributable to a major event, which is the sale of an interest in GNLG due to its prior anticipation of the future viability of the natural gas project in the market. Therefore, although the company has performed well during the period, the record-level of sales can not be expected in the future. Nevertheless, this has helped the company perform well even in the midst of the global financial crisis. In line with this huge increase in after-tax net profit, the earnings per share has increased to 273. The company has declared higher dividends as well, up at 42 cents per share. The companys gearing ratio has also decreased during the year, from previous years 37.3% to 10.2%. All the figures are favourable for the company, except that the companys production has been lower than the previous two years. According to the company, this is attributable to the accident that happened during the first half of the year, which results in death of a contractor. Thus, the companys production had to be stopped for investigation as well as changing provisions for safety. II. Conclusion Santos Limited has performed well during the year, even through the global financial crisis. The companys sale of its 40% interest to Malaysias Petronas has helped the company to perform well during the year. All in all, the companys figures are favourable during the year. The company has reduced the proportion of its debt financing by around 3%, enabling it to stick to its previous capital structure, thus have plenty of surpluses in retained earnings to be distributed to its shareholders. This has allowed the company to grow by using funds from its operations, instead of resorting to other sources of capital. With a very high return on equity, the company has really done a good job during the year, as apparent in its gearing ratio, dividends declared, ROE, operating profit, operating cash flow and net profits. However, although, the huge sale has rescued the company from the effect of the financial crisis, the strong performance due to a big event does not signify that the same thing will hold true in the future. Although the year has been good for the company, the level of ROE for example is hard to believe to be sustainable. Nevertheless, the companys overall operations could be considered in good health as it continues to invest in profitable exploration and production projects. The companys move to sell its 40% stake in its GNLG project is a strategic move in order to free up some cash and secure internal financing for growth through its retained earnings. Reference Santos Limited 2008. Annual Report. Read More