Corporate Financial Reporting - Example

Report on + for Morgan Advanced Material PLC Contents Contents 2 Extracts of Balance Sheet7 List of References 11 Report on Benchmarks for Morgan Advanced Material PLC. Introduction This report provides the information to be benchmarked by the audit team. For auditing Morgan Advances Materials (MGAM), financial information of Renishaw PLC (RSW) is benchmarked. RSW is selected as it operates in the similar industry and is listed in FTSE 350 shares. Out of five companies listed in the similar sector of MGAM, RSW has the most similar products, services and industry of customers in relevance to MGAM, which make it most suitable for comparison amongst FTSE 350 companies (Exchange, 2015). About Morgan Advanced Materials MGAM has been operating successfully in electronic and electrical equipment industry over years. It has a diversified clientele including Pharmaceutical, Surgical, and energy and security and defence sector. About Renishaw RSW sells in more than 34 countries across the globe. It sells mainly in sectors of electrical item related to metrology, additive manufacturing, neurology and spectroscopy. The Group has installed state-of-art plant to manufacture these items. Apart from this, it also provides services for calibration and testing of machine performance (Renishaw, 2015). Financial Information of Renishaw Following are the variation in the income statement and balance sheet of Renishaw that will be of assistance to study the industry trends: Extracts of Income Statement Revenue 2% Cost of sales 8% Gross Profit -3% Distribution costs 9% Operating profit -11% Net finance charges 17% Profits from associates -24% Profit after tax 17% Income taxes -29% Net Profit 28% Extracts of Balance Sheet Property, plant and equipment 20% Investments in associates 70% Trade receivables 20% Cash and cash equivalents 64% Total current assets 20% Current liabilities Trade payables 2% Provisions 21% Other payables 15% Non-current liabilities Other payables 44% There has been no significant growth in revenue despite the increase in costs of sales. This indicates that the company is under pressure to meet the customers’ demands, while maintaining its previous prices. Distribution costs of the company have also increased. This reflects a positive side of the business as well, since Renishaw PLC might have borne the distribution costs to expand its customer base. Finance charges have escalated materially by 17%. Property, plant and equipment have also increased by 20%, which indicates that long term financing is financing much of the capital expenditures. The company’s liquidity indicators show positive results. Trade payables have just increased by 2% whereas trade receivables have increased by about 20%. It might have created a risk of cash and receivables being stuck in the market but this is not the case as the company’s cash and cash equivalents have increased by 64%. It proves that the company is not in liquidity crisis and has extended credit to customers as per its policy. Provisions and other payables have also decreased which proves RSW’s healthy liquidity position. There has been a significant decline in investments in associates, however profit and loss statement shows profits from associates witnessing a decline of 24%. Disposal of shares in associates might have been because of such profit decline. It must be studied whether the nature of associates’ business is similar to the nature of MGAM so that its implications can also be assessed on MGAM’s financial statements. Financial Information of MGAM from 2012 to 2014 Extracts of Income Statement Following are the trends of Income statement of MGAM: Chart 1: Income statement The income statement of MGAM shows a consistent decline in revenue. This decline in revenue is consistent with the performance of RSW. However, the MGAM has been able to contain its costs of operating business. Contrary to RSW, MGAM has a reverse trend in Operating costs. It creates a risk of understatement of expenses in order to increase profitability. Contrary to this, it is possible that MGAM is achieving economies to scale. Both these possibilities necessitate that operating costs shall be audited while practicing professional scepticism. From 2012-2014, net profit decreased from £76.1 million to £12.3 million and cash and cash equivalents have also decreased from £80 million to £63 million. Declining profitability and cash liquidity could have caused the risk of going concern, but MGAM’s current assets (£394 million) are far more than current liabilities (£250.8 million), which reduce this risk to a reasonable level. Both profits and cash balances have suffered declining trend, which is exactly opposite to that of RSW. Therefore, reasons behind this opposite movement shall be examined accordingly with a questioning mind. Restructuring costs have declined this year, but it shall not be taken as benchmark for comparison as it is a one-off item and does not constitute normal part of operations. Extracts of Balance Sheet Current Assets Chart 2: Current assets Current assets have shown a bit of improvement after decline in 2013. Downward trend in inventory indicates that the company is avoiding blocking any cash balance in its stock. It is defensive strategy as evident from static values of Trade and other receivables, which indicates that company is not extending more credit in the market. Both these factors alarm about company’s defensive policies against foreseeable liquidity crisis. Non-current assets Chart 3: Non-Current assets RSW’s property, plant and equipment showed 20% increase, whereas, MGAM’s non-current assets have decreased in the long run. Deferred tax assets have increased but that does not signal any growth for the organization since companies do not run by saving or claiming taxes primarily. Liabilities In year 2013, there was a sudden decline in non-current liabilities of the company, whereas current liabilities increased. In 2014, current liabilities remained almost static and non-current liabilities increased. Trade and other payable also maintain a straight trend. This trend is not in line with RSW that has decreased its both the liabilities - current and non-current. The basic risk that is evident from the trend is that there is an increase in risk-bearing liabilities. Keeping in view, the declining cash flow position of MGAM, there is a risk of non-payment of the liabilities. As these liabilities are contractual obligations, therefore provisioning must be audited thoroughly since non-payment may lead the company to litigations. It must be noted that provisions of RSW have increased which indicates the existence of foreseeable obligations. Provisioning to be audited in detail, as MGAM might be inclined to under-estimating its expenses to increase its profitability. New Revenue Recognition Requirements Background International Accounting Standards Setting Board (IASB) has introduced a new International Financial Reporting Standard (IFRS) for revenue recognition known as IFRS 15 – Revenue from Contract with Customers. The company has not yet implemented it earlier than its effective date: January 1, 2017. The details of the revised requirements and their impact on the financial statements of MGAM are discussed below. Matters Critical to the Application of IFRS 15 at MGAM It is stated in the annual report of MGAM, there is no significant impact on the revenue even if IFRS 15 is applied, which is in line with most of the accounting experts. But still, MGAM will have to make regular assessments concerning any changes in the revenue recognized. The most critical part will be to determine the status of the party whether it is a collaborator or customer. Contracts like Production sharing shall not fall in the domain of IFRS 15 and hence will not affect the revenue reflected (EY, 2014). At times, MGAM might be involved in providing a finished product to the customer, during the production of which, the customer also plays an active role. In such a case, it is difficult to treat the sale as sale of goods or services. IFRS 15 resolved such issues. Impact on Financial Statements Pre-sale or after-sale services such as warranties and samples also impact the amount of revenues. Samples or free items constitute of sales, thereby increasing the sales of companies (IFRS, 2014). Responsibilities of Reporting Accountants • Accountant at MGAM must ensure that the standard is applied accordingly during the transition phase, which requires the application of IFRS to the contracts that are running during the year from their inception. • Proper disclosures shall be made so that any resultant inconsistency is made clear to the readers of the financial statements. • The accountants should aim at reducing the subjectivity during the assessment of the considerations of IFRS 15 so that revenue is less likely to be manipulated. Conclusion Although material variations and trends have been highlighted in the report, the report does not provide an exhaustive list of matters to be indicated. Moreover, following trend summary indicates that MGAM is showing results against industry competitors, which makes it riskier client. An audit requires judgment and questioning mind that enhances its quality. This report provides a preliminary analytical review, and detailed testing will reveal further matters to be examined. Following are the benchmarks to be used along with their trend in RSW and the consistency or inconsistency of these trends in MGAM. Benchmark Trend in RSW Consistency/Inconsistent trend of MGAM Revenue Increase Inconsistent Cost of Sales Increase Inconsistent Net Finance charges Increase Inconsistent Net Profit Increase Inconsistent Property, plant and equipment Increase Inconsistent Current assets Increase Consistent Provisions Decrease Inconsistent Current liabilities Decrease Consistent List of References Exchange, L. S., 2015. FTSE 350 - Share prices. [Online] Available at: [Accessed 7 April 2015]. EY, 2014. IFRS 15 – the new revenue recognition standard. [Online] Available at: [Accessed 6 April 2015]. IFRS, 2014. Revenue recognition: finally, a Standard approach for all. [Online] Available at: [Accessed 6 April 2015]. IFRS 15 - Revenue from contracts with Customers. 2015. [Online] Available at: [Accessed 6 April 2015]. Renishaw, 2015. Renishaw news. [Online] Available at: [Accessed 26 April 2015]. Read More