Santos 2013 Financial Analysis - Case Study Example

LIABILITIES: SANTOS CASE STUDY Name: Course Professor’s name University name City, State Date of submission Contents LIABILITIES: SANTOS CASE STUDY 1 Name: 1 Course 1 Professor’s name 1 University name 1 City, State 1 Date of submission 1 Contents 2 Executive Summary 3 Introduction 4 Discussions 4 Conclusion 11 References 12 Executive Summary Essentially, it’s a fundamental requirement for financial statements to be prepared based on accounting concepts and principles that are accrual based. The foundation of which, is based on faithful representation of the accounting equation, A=L+ C, where a- Assets, L-liabilities, and C-capital. The following report focuses on only one side of the equation; the liabilities, their classification, recognition and measurement. It is a response to the assertion that liabilities definition is quite comprehensive. In addition, it also explains the drawbacks associated with liabilities during the presentation in the financial Several findings emerge from the report analysis. Firstly, ‘liabilities’ is a balance sheet item that appears in all company financial statements. The recognition and measurement of such items is, guided by the IASB conceptual framework for consistency across the globe, hence enhancing comparability of the statements. In addition, the framework plays a great role in establishing confidence in the statements presented to the management. Secondly, there are constant dilemmas in accounting for liabilities, with many accountants. In effect, it has outlined a conceptual ramification through which instances of these dilemmas can be solved. They include accounting objectives, their qualitative characteristics, the elements, constraints in the accounting information, assumptions, principles and constraints as discussed below. In summary, accounting information is regarded relevant and reliable if it meets the criteria of qualitative characteristic associated with the presentation of financial statements. Some of them are; timeliness, consistency, and understandability and faithful representation. The report is divided into three major segments, the introduction, the discussions and the conclusion. The company used in the analysis is Santos limited’s financial statements for the year ended 2013. Liabilities Introduction Definition A liability is defined using three basic aspects; one –present obligations, two – must have arisen from past transactions and three – its settlement in the future is expected to result in an outflow of economic benefits with certainty, from the respective entity. Its recognition and measurement is to a large extent, guided by the objectivity, accrual and prudence concepts. Generally, one should recognize a liability when there is a probability that the subject company will experience economic outflow of resources besides the fact that it can be easily measured with utmost reliability. They are also considered legally enforceable contracts as a result of a past transaction. The following are some of the most common ways through which obligations expected to result in an outflow of economic resources in the future: Cash payments- This is the most common method of payment, where liabilities due are settled with cash Asset transfers and service provisions Obligations swaps- this occurs where one exchanges an obligation with another in an offsetting transaction Conversion to equity-In this option, the creditor offers the debtor an option to convert the liability into equity in the firm Discussions Measurement and recognition According to the objectivity accounting concept, a liability should only be recognized in the financial statements if the management is sure that the transaction engaged will result in an outflow of economic resources at a future date. In addition, the value of the specific liability should be measurable and ascertained with ease. Nevertheless, there are liabilities that do not meet the aforementioned recognition criteria, hence regarded as contingent liabilities. The conceptual framework requires a disclosure of such liabilities in the notes to the financial, instead of including it in the financial position liability segment. Liabilities that should appear in the financial statements are classified into two major categories; current and noncurrent liabilities. Generally, current liabilities are those which a company expects to pay within a years’ fiscal accounting period through the use of current assets or the creation of other current liabilities resulting in an economic outflow. Furthermore, it is worth noting that both the current and non current liabilities are measured at their liquidation and present value, respectively, noncurrent liabilities are measured at the present value or the liquidation value as well. In the case of current liabilities, the time value of money is disregarded since they are settled in a period not lasting more than a year. Additionally, they are commonly used to fund a company’s working capital requirements. Moreover, current liabilities are often tied to an organization’s liquidity status through the use of the current and quick ratios. The accepted threshold limit of this ratio falls between 1 and 2. The best examples of this category of liabilities are the accounts payable, and the notes payable. The accounts payable, being the verbal contractual amounts that arise from the purchase of inventory besides the service provision services in the normal business operations of a company. These are the amounts on which most firms get their discounts from upon meeting certain payment dates. Conversely, notes payable make up the formal contractual agreements that are interest-bearing. Others include accruing current liabilities and loan notes. On the other hand, non current liabilities span in a period that lasts more than a year. Both of these items are recorded on the balance sheet in the order of payment. The disclosure of all financial statement items, as previously mentioned is guided by certain standards, principles and assumptions. The IASB organization body is one that provides an international scale for measurement and recognition qualitative characteristics. Following the IASBconceptual framework, below are assumptions made with respect to recognition and measurement, which applies to all items across the financial statements, hence liabilities; 1. An economic entity- Each firm should be treated separately from its owners 2. Going concern - Reporting is made on the assumption that the business will continue operating in the future 3. Periodicity - Proper accounting period should be established for more efficient and accuracy, especially for reporting commitments and liabilities. 4. Monetary unit - a similar currency should be maintained for consistency They are guided by the following principles: 1. Historical cost - states that all assets and Liabilities should be stated at their initial cost 2. Realization- revenues should be realized when there is a certain probability of completeness of the transaction process and collectibility of the money due 3. Matching – This requires expenses to be matched against income for a specific accounting financial period 4. Full disclosure- This is also called the conservatism principle Liabilities and problems encountered in their measurement in the present IASB context AASB has recently recognized that liabilities should be explicitly recognized as obligations, as opposed to previous definitions that infer to a future economic outflow of a firm’s resources. Firstly, there is the problem of uncertainty in the definitions and recognition of liabilities. Evidently, it’s a much more complex when one questions what threshold has been established to establish the term ‘expected’ with assurance. The current framework of AASB states that liabilities recognition and measurement should completely disregard the word expected; liabilities should clearly show the certainty of economic outflow in the future, commonly known as the transfer of economic resources. Classification of other forms of liabilities disclosed in the notes to the financial statements Liabilities are classified into the following categories 1. Contingent liabilities- These are liabilities that are dependent on a future event occurrence, thus making its outcome unknown. They are characterized by the following characteristics: One – probable future commitment, two – they are also not sufficiently defined in the present, three – the amount considered a contingent liability is always quite material, according to the materiality accounting concept, four –for faithful representation qualitative characteristic of financial reporting, it must relate to past events and five – they are not recognized since they do not meet the criteria for recognition. However, there is a category of contingent liabilities that are recorded on the face of financial statements such as warranties, coupons and premiums when they are probable. 2. Constructive obligations- These categories stems from a company’s actions of indication to others the acceptance of certain responsibilities, creating expectations to honor them. A good example is the proposed dividends ratified by stakeholders before it matures into a legal obligation. Apparently, for instance, a company contaminates ground water and reports in its financial of action being taken to restore the environment without a legal suit or government amounts to a constructive liability. Others include: provisions, legal liability, financial liabilities and executory contracts. Problems with measurement of liabilities Irrelevance school of thought on possible future actions. According to this, it is not always certain that in future the company will continue to remain a going concern. In fact, some companies enter liquidation before the maturity of liabilities is reached. Secondly, in instances where the company has liabilities taking a longer period of maturity may result in an early settlement that results in penalties for the respective firm. The discount rate. This mostly affects loans taken up at interest rates that are not fixed. Consequently, the forces of demand and supply results in a fluctuation of the market interest rates which alter effective interest rates. Furthermore, at inception of liabilities, they are measured in historical costs on the assumption that the liability will be held to maturity; hence any changes in the liabilities are accounted for as amortization at a premium or a discount, according to the current IASB context. Ethical issues. This is an aspect that tends to be overlooked in defining provision liabilities. Although guided by the prudence and materiality concepts, their determination is purely subjective hence subject to manipulation. Consistent reporting of liabilities is usually tied to clear definition and precise judgement of liability amounts. Judgement calls instances. This occurs when an auditor or an accountant is ready to make an error for the sake of full disclosure pertaining conservatism concept. Categorization evaluation and treatment of liabilities in Santos 2013 financial report. The company selected for this analysis is Santos Ltd, financial reports for the year ended 2013. The company has a compliance statement stating that it complies with all standards issued by the IASB such as the AASB and the IFRS (Santos 2013 Annual Financial Report, 2013, p. 75). Following a critical analysis, the firm has both items of current and non-current liabilities in its financial position statement. It has also presented the balance sheet in an accrual based concept faithfully following the accounting equation model. The following constitutes the current liabilities line item: (Santos 2013 Annual Financial Report, 2013, p. 72). Trade & other payables- These relate to goods and services that are received in the normal operations of Santos operations. They are also non-interest bearing according to the management, besides the fact that they are settled in the normal terms and conditions. Deferred income and current tax liabilities Interest-bearing borrowings- This section is composed of finance lease liability due for payment in a year’s time. Commercial papers, unsecured bank loans and long-term loans section payable within a year. They are recognized at their initial fair value, after which any amortization is recognized in the income statement using an effective interest rate (Santos 2013 Annual Financial Report, 2013, p. 86). Similarly, fixed rate notes are also recognized at their fair value (Santos 2013 Annual Financial Report, 2013). Provisions- this includes employee benefits, restoration expense, remediation expense, carbon and other provisions. The provision for restoration, remediation and carbon are examples of constructive liabilities of the company. The company management reviews restoration costs periodically or an accurate estimate of the provision. They are stated at carrying value in the notes (Santos 2013 Annual Financial Report, 2013, p. 89). For better decision making by the shareholders, the management has included a movement schedule or the provisions ignores which are characterized by line items such as disposal, change in discount rates and exchange differences. Pertaining remediation costs, the management only recognizes their existence when there is a present obligation to revert in unexpected loss, similar to the carbon cost provision. Other financial liabilities Similarly, the following are constituents of non-current liabilities: Deferred income Interest-bearing borrowings- This includes finance lease liability due in a year, the secured and the unsecured bank loans, medium term, long term and subordinated notes. Provisions- This includes employee benefits, defined benefit obligation, restoration, remedial and other expenses provisions. Other financial liabilities (Santos 2013 Annual Financial Report, 2013, p. 39) The company also has commitments disclosed as notes to the financial statements. They consist of finance lease commitments and remuneration commitments- these are salaries due to the management personnel who the company commits to spend in the following subsequent period once the contracts of the personnel’s are renewed (Santos 2013 Annual Financial Report, 2013, p. 74). There is also evidence of constructive liability where Santos management undertakes to take responsibility of a guarantor on loans taken up by its subsidiary, Santos Finance Ltd, which is a wholly owned subsidiary (Santos 2013 Annual Financial Report, 2013, p. 79). Contingent liabilities The firm has a contingent liability that has impacted its exploration timing and production operations negatively. In addition, it is not probable that the outcome may further deteriorate the current situation of the organization. Exploration timings and operations. Nevertheless, the management has states that the aggregate of the outcomes whose value cannot be predicted is not material to the overall company’s asset base (Santos 2013 Annual Financial Report, 2013, p. 78). Lastly, the company also has financial liabilities divided into, all other financial liabilities and held for trading. Conclusion In summary, it is evident that accounting requires clear identification of liabilities, including the amounts at which they are recorded in the balance sheet. In addition, accountants have more often than not, only focused on the settlement cost of a liability, when in fact, in some instances, give results that are disquieting. However, with the introduction of the IFRS and the AASB for companies within Australia, the financial statement presentation has continued to be more consistent and faithfully represented. In cases where liability amounts require judgements, professionals are engaged in the process and the estimated disclosed as a footnote to the financial statements. IASB conceptual framework outlines the principles and assumptions that managements should observe in order to ensure correct representation of the accounting equation, in this case, the liabilities. References McGraw-Hill Higher Education, 2007. Recognition and Measurement Concepts. [Online] Available at: http://highered.mheducation.com/sites/0072994029/student_view0/ebook/chapter1/chbody1/recognition_and_measurement_concepts.html [Accessed 21 January 2014]. Santos 2013 Annual Financial Report, 2013. Santos 2013 Annual Financial Report, Australia: s.n. Read More