19-05-2014

Total words:4350

Financial reporting-an international approach

Prepared

By

Sheik Munaem Ahmed

ID: 307141

Prepared

For

Feroz Kassam Kanji

307141

One of the large fashion retailers is Next Plc.with wide range of customer appeal in the UK

and abroad, currently Next’s online shopping facility is available to around 50 countries of

the world including the USA. From 1986 Next Plc has been always increasing its market

share by using diverse business strategies such as diversifying its products in the competitive

market and making a gross profit of about 1125.8 million in the fiscal year 2012/2013 with

revenue in excess of £3562.8 million that makes it one of the leading retailers in UK.

Currently they have more than 700 stores around the world while employing over 30000

people Nextplc.co.uk, (2014).

Question no 1

According to the IASB conceptual framework (2010) the general purpose and the objective

of financial reporting is to present financial information regarding the reporting entity that is

helpful to lenders, creditors, existing and potential investors to make decision about selling or

holding equity, buying, or debt instruments and about granting capital to the entity Mehta,

Alkafaji, Ghosh and Ankarath, (2013).

This information is very much important to the users because it allows the users to assess

how efficiently and effectively management has exonerated their responsibilities to use the

entity's active resources not only to assess an entity's scenario for future net cash inflows

(Iasplus.com, 2014).

The financial reports are prepared from the entity’s perspective, instead of the entity’s capital

providers. An entity attains its assets from capital providers in exchange for claims to its

liabilities and equity. Capital providers include Lenders, Equity investors, and other creditors.

Basic qualitative characteristics of financial reporting differentiate the useful financial

information from non useful or misleading information. A good report must have two

fundamental qualitative characteristics.According to IASB information is said tobe relevant if

it influences theeconomic decisions ofusers by helping them evaluate past,present or future

events.Next Plc showed their Discontinued and continued operation separately which is

relevant and user can understand it easily.

Enhancing qualitative characteristics are used to distinguish more-useful information from

less-useful information and to improve the decision usefulness of financial reporting

information that is relevant and faithfully represented Mehta, Alkafaji, Ghosh and Ankarath,

(2013).

Comparability of a report enables the users to recognize likeness and the distinction between

two sets of economic phenomena. Information will be more useful if it can be compared

similar information about the same entity for some other period and with similar information

about the other entities. Next Plc used straight line depreciation method. Therefore, this

report can be compared with different time frame of the company also with the other

company like Marks & Spencer that follow the same reporting procedure.

Quality information which is verifiable will provide confident to its users. The verifiability of

a report concentrates on whether the measurement or recognition method is correctly applied.

Verification could be done either indirectly or directly

307141

Reporting information should be available to decision makers on time so that it can influence

the decision process. Lack of timeliness may get a negative response from the decision

maker. According to FASB making availability of the reports on timely manner enhance the

faithful representation and relevance of the information. Next Plc always published their

report on time.

Different level of user of financial report will have different level of understanding. But it

does not means to bring simplicity on the report but it means that “the report must be geared

to the abilities and knowledge of the users concerned, (Alexander, Britton and Jorissen,

2011).

When the information is characterized, presented and classified clearly and concisely, the

understandability will be enhanced. However, users of financial information are assumed to

have reasonable knowledge to be able to read the financial report and reviewing and

analyzing the information with reasonable diligence. For example, a Glossary part of the

Next Plc report helps the user to understand the report those who have not got professional

knowledge. Moreover, tables, charts and graph also help the reader to read the report quickly

with less time and less word that ultimately increased the understandability of the report.

307141

Question Number 2

The chief investment officer at Royal London Asset Management,Robert Talbut, has

criticized the short of information in annual reports that has effected from short of simplicity

in the region of which set of users annual reports are intended at.

Long-term capital providers are the primary users of accounts and that need accounts that

serve them, Talbut also mention that “trying toserve everybody has ledto obfuscation and

lackof information and insight” (Accountancyage.com, 2014).

According to Talbut, accounts had become too focused on compliance as the front ends of

accounts were viewed as "marketing documents". He added we need to make surethe back-

end actually represent a practical portrait of what is going on in the company".

For example, the majority individual retail investors wouldnot read all theaccounts but they

want toknow about the company’s weak management issues, going concern issues,poor

controls, profitability, or leading heads which generally bringdown businesses - Barings,

WorldCom,Enron, etc.

Introducing a new type of audit committee report will increase the quality of annual reports

as suggested by Talbut. Also in terms of accounting standard it is necessary to ensure

interested party can understand the idea of fair and true is “an override for accounts and it

needs to be used". Talbut suggest the IASB to reintroduce the idea of prudence. Though, the

idea of prudence had dropped bythe IASB in 2010 fromits conceptual framework for the sake

of neutrality concept.

But Talbut criticised it and urged for its reinstatement. He said "I don't believe prudence can

be equated with neutrality" and "Prudent accounts are essential for the confidence of

investors."

IASB should pay attention to Robert Talbut's view that is mention above and had been made

from many quarters.

Ian Mackintosh advised to re-establish prudence as an elementary accounting concept in the

same Audit Quality Forum; he also mentions that it would beto surrender to commonsense

rather surrender the IASB's independence to the EU.

Some might arguethat it isclear from consultations presentlyunderway thatthe profession

doesnot understand what it meansto serve the publicinterest. When convergence ofUK GAAP

with IFRS began,there was said tobe "an expectation gap"on the part ofusers with no rightto

rely onthe financial statements.That expectation gap has been widened,not narrowed, by

recognising aplethora of user groups within theIASB's present framework document.

From the writer’s point of view, if IASB consider serving the public interest by identifying a

wide range of users necessary will be seriously mistaken. Therefore, IASB can adopt

accounting policies that aims to provide economic stability to fulfil its public interest

mandate. Moreover, profession have the duty at the micro level whereas, government has it at

the macro level.

However, published figure may get importance to other group of users but have nolegal rights

to rely onthem. If, there isany expectation gap onthe part of other users could beaddressed by

advising other users to seek independent advice or lowering those expectations.

307141

Prudence should therefore be restored as amatter of public interest.Next annual accounts

reports consist of 101 pages covering all the areas of financial transaction by complying the

rules and regulation of accounting standard and company policy to meet the demand of

financial statement users. So it could be safe to say that Next’s annual account has got the

right balance.

307141

Question Number 3

Financial statements are prepared to make understandable to the person who reads and who

have "a reasonable knowledge of business and economic activities and accounting and who

are willing to study the information diligently" Gibson,(2013). And their capability of

understanding and analyzing the financial statements will help them to be successful in the

business world.

Users of a financial statement could be internal or external. Potential and existing external

investors are most important users of a financial statement as they play a significant role in

financing the company for short term or longer term. Some of the potential existing external

investor’s users are the equity investor group, loan creditor group, supplier and trade creditor

group.

Equity investor group is formed of existing and potential shareholders. This group of users

look for combination of two things or for one thing: income, a money return by way of

capital gain or dividend, or by selling their share at a higher price than the purchased price

Alexander, Britton and Jorissen,(2011). Though these two are closely related but the only

difference is the time scale. Still the simple theory is made hugely difficult in practice by the

effects on share prices of other equity investor’s belief. They will need this information to

assess the company potential for success and profitability and based on this analysis they will

take the decision to invest or to sell their share.

The loan creditor group includes of short-term, medium and long- term lenders of money.

Importantly this group of users will look for the answer of when they will get their

investment back? Short term loan providers will calculate the amount of cash that the

business have currently or will have soon to take the investment decision Gibson,(2013).

They will also consider the net realizable value of all the assets. Similarly, supplier and trade

creditors group needs the same information like short-term loan creditors. However supplier

and trade creditors group will also require forming a longer-term notion of the business.

Moreover, supplier and trade creditors group wants to know the ability of the company to pay

its obligations when they become due. In terms of long term loan creditors they need to see

the longer- term view of the firm and its future cash position by analysing the financial

statement. Moreover, they need to analyze the strength and position of the business some way

into the future before to take any investment decision. So, if the company have got the ability

to pay its liability upon maturity will most likely influence the investor towards a positive

response.

To sum up, both existing and potential investors needs this information for estimating the

potential success and future profits of the firm. Hence, the financial statement of a firm will

be a good guide to estimate the future profit if and only the statement is presented fairly and

honestly by complying all the rules and regulation of IASB’s .

307141

Question Number 4

It is very much important for an investor to know how much money a company is making

before taking the investment decision. But the public limited company provide several

“earnings” figure to its investors. So, the investor should look at company’s earnings reports.

Where the investor will see three different measures of profits net income, basic EPS and

diluted EPS.

Net income isthe total profit after taxes thatthe company made the year.In terms of

shareholders point of view it is best to look at EPS of the company. According to Elliott and

Elliott, (2008) EPS is the part of the company profits to be paid to each outstanding share of

common stock. According to IAS 33 the main objectives of calculating the EPS is to provide

a platform for to improve performance comparisons between different reporting periods for

the same entity and different entities in the same reporting period. [IAS 33.1]

Generally, the basic per-shareis the net income dividedby the number of general shares

outstanding.It will represent the whole earnings attributableto every share that investor will

own to Elliott and Elliott, (2008). Although this figure stilldoesn't express the whole story to

the investor. As because the number ofshares outstanding might change notably if any ofthe

employees or investors of the company who have rightsto shares that don'tcurrently exist

exercise those rights.For instance, most companies issue preferred shares or debt that can be

transformed into normal stock under certain situation and top executives are regularly paidin

part with stock options.However,diluted earnings per share take all that into account.It

represents the situation by considering;if all the existing rightsto general shares were

exercised then wthat will be the total earnings attributable to every share.

For the period from 2012 to 2013 the basic EPS and diluted EPS of NEXT plc has increased

respectively 282p to 320.1p and 275.1p to 311.7p and thanks to their strategy of share buy-

back, increase in net profit after tax and the decrease of the total number of share in issue.

Even if the EPS ratio increased proportionally more thanthe dividends per share,the company

hasbeen wised notto level outthis two ratios.As a matter of fact,whereas the net profit after

tax didnot increase as muchas the dividend per share,we can even assume thatthe increase in

dividends pershare was too high Therefore,that could be one ofthe reasons why the

confidence ofthe market in the Next’sshare remains proportionally thesame despite the

307141

increasingin earnings per share ratio.The market could have seenthat company tries toboost

its dividends pershare.

307141

Question Number 5

Property, plant and equipment (PP&E) is a term that can be found on the balance sheet of a

company annual report. PP&E is the long term or noncurrent asset section of the balance

sheet. Land, office equipment, buildings, vehicles, machinery, furniture and fixtures used in a

business are included in this classification. Moreover, accumulated depreciation for these

assets is also included in property, plant and equipment (except for land, which is not

depreciated).

Normally, the PP&E assets are recorded at their cost followed by a deduction for the

accumulated depreciation that applies to all of these assets (AccountingCoach.com, 2014).

IAS 16 states that company must have to show their PP&E on the statement of financial

position at its carrying values Iasplus.com,( 2014). Next has shown their balance of PP&E at

cost and depreciated it on straight line basis on the balance sheet. That gives a chance to

compare it with other companies within the same industry. They have provided sufficient

information about the property, plant and equipment. There is detailed information about the

types of assets such as their free hold assets, leased assets and plant and fittings. There is

proper adjustment in the workings about the addition and disposal of assets so that the user of

the financial statements can get a clear idea about the changes in the balance of property,

plant and equipment of the firm.

According to the IFRS lease is “a contract in which the right to use a specified asset or assets

is conveyed, for a period of time, in exchange for consideration The exposure draft also

proposes guidance on distinguishing between a lease and a contract that represents a purchase

or sale and on distinguishing a lease from a service contract “.

According to IAS 17 two types of lease are the finance and operating leases. Operating lease

is a lease other than financial lease. On the other hand lease that transfers substantially all the

risks and rewards incident to ownership of an asset to the lessees known as finance lease.

NEXT plc do have an amount of £1811.8m operating lease as an off balance finance but they

do not have a significant amount of finance lease in the statement of financial position.

However, operating lease engages the higher level of expenses reported and appears on the

company's income statement. Expenses, including the operating lease expense, reduce the

company's net income. Also company have no ability to sell or modify the asset without the

lessor's permission due to the lack of ownership. Another disadvantage of operating lease is

lack of continuity makes it difficult for the company to plan. On top of that, it is very easy to

change the finance lease to operating lease by accounting engineering to falsifying the

financial statement. Although , IASB and FASB are working together to introduce a common

standard for lease accounting.

Financial instrument

According to (Clendon, 2014) “financial instrument is a contract that gives rise to a financial

asset of one entity and a financial liability or equity instrument of another entity”. It is

307141

fundamentally important that the instrument are classified correctly either an equity

instrument or a financial liability otherwise it will directly impact on the calculation of

gearing ratio. Gearing ratio is very much important for the user of the financial statement to

assess the financial risk of the company.

Financial instrument can be categorized into cash instrument which is financial instrument

whose value is determine directly by the market and derivative instrument which derive its

value from the value and characteristics of one or more underlying entities such as an index,

asset, or interest rate. Next plc has followed derivative financial instrument to manage

interest rate and foreign exchange rate. If Changes in the foreign currency derivatives or

interest rate derivatives do not meet the criteria for hedge accounting in IAS 39 are

recognized in the income statement Nextplc.co.uk, (2014).

307141

Question number 6

Generally companies release three primary financial statements ona regular basis and,a cash

flow statement is one of them. Acash flow statement showswhere money is going out and

fromwhere the money is coming in. This statement can provide valuable information to a

potential investor however it has some drawbacks as well.

A statement of cashflow statement consists ofoperating activities,investing activities and

financial activities. Cash flow statement provide the detailed look at the changes in the

amount of cash that a company holds over time that helps to get the wide view of the success

of the company. Moreover cashflow statement also shows whether the company has enough

money to expand. But it will not look at assets holdings of the company. However it does not

consider about future growth of the company.

In Next Plc cash conversion period is 43 days which includes Next Plc converse their

working capital into cash within 45 days. On the other hand Next Plc is generating more cash

then operating profit in 2013 &2012 respectively 116% and 111%. As a result it is seen that

Next Plc is very efficient to convert profit into cash due to well experienced management.

The cash flow statement of Next shows an increase in the overall cash flow of the firm

amounting up to £82.1 million from the year 2012 to 2013. The changes in the cash flow of

the firm have been an aggregate result of the following reasons:

The increase in the net cash generation from the operating activities by £133.1 million

because of various reasons has been a key fact for the rise in the cash flow of the firm.

The reasons are the reduction in the depreciation and impairment of assets and loss on

disposal of assets, rise in the share option charge and less expenditure in inventory

and the ore favorable exchange movement.

The increase in investment of £15.5 million by Next is a result of the large fall in the

disposal of subsidiary from year 2012 to 2013. Though the investment in new plants

were lesser but the fall of proceed from the disposal was so high that it could not

bring a positive figure of the investment activities.

The increase spending of the firm in financing activities in 2013 by an amount of £45

million has been a result of the purchase of share and a larger dividend paid by Next.

In addition, the decrease in the profit from share disposals an interest receipts is liable

for the negative balance of the investment activities.

From the investors points of view cash flow statement is very much important as it shows

how much actual cash a company has generated. Many companies has shown profit on the

income statement but struggled later because of insufficient cash flows. So the potential

investor should look for the company’s ability to generate cash before taking investment

decision.

307141

Question Number 7

Profitability Ratiostells company's abilityto generate profitrelated to its expensesduring a

specificperiod. Most ratioswith higher valuecompared to previousyear or competitor

indicatesthat company hasgood performance Mard, (2002).

Calculations of gross profit margin of NEXT plc are as follows

Formula ═ Gross profit

Revenue

2013 2012

═ 1116.7

3547.8

═ 31.5%

═ 1045.3

3441.1

═ 30.4%

Gross profitmargin MeasuresCompany’s profitabilitycompared to itsturnover. This ratiomust

be more thanone torun a business. If ratiois less thanone business cannot surviveregardless of

size ofturnover of thebusiness. And thisratio also indicate howmuch profitablethe business is

Mard, (2002).

In the year 2013 Next Plc. there is a increased of 4% of gross profit, whichshows slight

improvement thanlast year, whereas,its competitor Marks&Spencer gross profitmargin is

greater than Next Plc. It showssimilar trend asNext Plc. MarkandSpencer are spendingonly

62% on itscost of salewhile NextPlc. has 70%. This resultillustrates that priceof raw

materialof Next Plc. is higherthan Mark&Spencer or thecompany is sellingits products

justonly 29% percent higherthan its cost.Next Plc. offersmany promotional offersfor its

costumersthan Mark & Spencer. For instance, itoffered half -price saleduring Christmas

period, Buyone-get one freeand other occasionaloffers, which cutcompany’s gross

profitmargin.

ROCE:

Return on capitalemployed tells the percentageof profit beforeinterest and taxcompared to its

investedcapital including long-termdebt and shareholdersfund Mard, (2002).

Formula ═ Profit before interest and tax

Total asset – current liabilities

2013 2012

═ 621.6+29.00

1893.6-816

═ 60.4%

═ 570.3+28.9

1854.2-742.4

═ 53.9%

Next Plc. Has verysatisfactory ROCEpercentage compared toits competitor Mark&Spencer.

Next Plc.gained 12% growth thanlast year. This indicates Next Plc.has used itscapital to

maximize itsprofit. In brief, resultsfrom profitability ratiossuggest that, NextPlc.is more

profitablecompany despite Mark&Spencer have greaterrevenue. Mark&Spencer is

earninghigher gross profitmargin but it isspending more onits overhead costand interest

expenses,whereas NextPlc. has lowergross profit margin. Nonetheless,higher operating

307141

profitmargin as wellas net profit margin. It can bebecause of itspromotional offers. NextPlc.is

offering products inlower price andtaking benefits ofeconomies of scale.

Gearing ratio

This ratio determines the balance between long-term debt and shareholders’ equity.

Formula ═ Debt

Equity

2013 2012

═ 792.00

285.6

═ 277.3%

═ 889.1

222.7

═ 399.2%

In the abovetable, Next Plc. has 277.3% gearingratio, which is decreasedthan last year. But

stillgearing ratio is highthat shows thatNext Plc.is more riskierbusiness. Moreover NextPlc. is

highly gearedthan Mark & Spencer. Next Plc.should focus on growththrough buying.

Dividend coverratio:

Dividend Coverage Ratiostates the numberof times anorganization is capableof paying

dividends toshareholders from the profitsearned during an accountingperiod.

Formula ═ Profit for the year

Dividend paid

2013 2012

═ 473.1

147.7

═ 3.20 times

═ 430

135.1

═ 3.18 times

0ne times paid

Dividend Coverage Ratioindicates the capacity of anorganization to pay dividendsout of

profit attributableto the share holders Mard, (2002).A dividend cover of 3implies that

acompany has sufficient earningsto pay dividends amountingto 3times ofthe present dividend

payout during theperiod. Investors use dividend coverratio to gauge the levelof risk

associated withthe receipt ofdividends on their investment.A low dividend covermay suggest

investors thatthe company may notbe able to sustainthe current levelof dividends in case ofa

downward trend incompany's profitability in the future whichcould impact the valuation

ofshares.

Inventory turnover in days:

307141

Managing inventory isvery important in acompany that sellsproducts to makea profit.

Calculating inventory days isan indicator of howwell the business is doing interms of

inventory.It involves determining the costof goods sold and average inventoryin a given

period.In most cases,an inventory turnover ratiois calculated to measurethe performance

ofoverall inventory and to findout how the company ismeeting product demands Hussey and

Ong, (2005).

.

Formula ═ inventory Ẋ 365

Cost of goods sold

2013 2012

═ 331.8 Ẋ 365

2437

═ 50 times

═ 371.9 Ẋ 365

2395.8

═ 57 times

Generally,the lower the ratio thebetter use of inventory.High numbers shows ahuge amount

of capital invested in inventory.NextPlc. is taking less time to sell its stock compare to last

year. It shows that Next Plc. has not over purchased or a sale has increased since thestock

was purchased.

307141

Question Number 8

A chairman statement is a letter from the board to shareholders reporting on the company’s

situation normally comes with the annual report Lee,(2006). Chairman is most senior

executive person of the company conveyer of the stakeholder interest to the board. It is a

voluntary report and it should be presented at the beginning of the report.

According to the chairman of NEXT year 2013was another goodyear for them.Underlying

EPS grew by 16.6%to297.7p and they propose toincrease the full year dividend to105p.

Moreover, while UK economy was struggling to growth NEXT dividend and EPS have

grown by 15%. operating margins and group underlying profit before tax rose during the

year. In addition to cash flow was very strong at the same time and they returned £390m toits

shareholders through dividend andshare buybacks.And the last two years performance was

great as well where share price raised by over 100%.

The chairman also expect a challenging year ahead and planning to investing in improving

their products, Brand and returning cash to its shareholder through controlling cost. Next year

might be an economic down turn worldwide and he did not provide any specific plan for that.

He explained the current year performance and hoping to do the well in the coming year as

well, where hope is hope. Also he did not mention anything about environmental issue.

However, their past performance was very good and it might indicate that the management

are well experienced and probably the upcoming year will also be good year for them.

Next plc corporate responsibility (CR) is concentrating on key business-related

environmental, ethical and social impacts in a way that aims to convey value to its

stakeholders. The report shows that how the focus of their CR programme supports to

continue to grow their business by acting responsibly. CR is a strategy but not only an ethical

issue. They act fairly and responsibly across their whole business. They believe they are

making good progress by being a great employer, reducing our impact on the environment

and trading responsibly.

They are committed to working with their suppliers to help them understand and develop

their businesses to be compliant to their Code of Practice requirements. They do work

directly with their various suppliers and establishing long-term m relationships with them to

help them achieve the requirements of their Code.

With the issue of environmental challenges they reduce carbon emissions by 3%, improve the

efficiency of their vehicles, consumption of energy was reduced by 4% compared to last year;

and 30% reduction achieved to date against a target of 35% by 2015. Also fuel intensity was

reduced by 8% compared to last year.

They maintained their operational waste at 85% diverted from landfill. In regards to the

health and safety within the business an 11% reduction in all employee accidents in the retail

stores, 14% reduction in Distribution and 17% reduction in warehousing. However, they did

not show any concern about the people who are working with supplier. Most of the suppliers

of the NEXT plc products are India, China and Bangladesh. In most cases suppliers from

307141

Bangladesh does not provide safe working environment and better wages to its employees.

As for example, On 24 April 2013, Rana Plaza in Bangladesh had collapsed due to the poor

working environment that cause a total death of 1,129 people while Approximately 2,515

were injured. It is Next plc sole responsibility to look after these issues from the social

perspective.

Normally CR is good and improves corporate accountability to its stake holder says Mullerat

(2010). Although, some argues that there are no common bench mark to which performance

can be compared. There are problems with the verification and expectation of using this

report by a wide range of stakeholders is proving incorrect Lee,(2006). And lastly, most often

readership of this report is largely restricted to the socially responsible community Mullerat

(2010).

307141

References

AccountingCoach.com, (2014). What is reported as property, plant and equipment? |

AccountingCoach. [online] Available at:

http://www.accountingcoach.com/blog/property-plant-equipment [Accessed 16 May.

2014].

Alexander, D., Britton, A. and Jorissen, A. (2011). International financial reporting and

analysis. 1st ed. Andover: South-Western/Cengage Learning.

Clendon, T. (2014). What is a financial instrument? | ACCA Qualification | Students | ACCA

Global. [online] Accaglobal.com. Available at:

http://www.accaglobal.com/uk/en/student/acca-qual-student-journey/qual-resource/acca-

qualification/f7/technical-articles/what-financial-instrument.html [Accessed 16 May.

2014].

Iasplus.com, (2014). IAS 16 — Property, Plant and Equipment. [online] Available at:

http://www.iasplus.com/en-gb/standards/ias/ias16 [Accessed 16 May. 2014].

Nextplc.co.uk, (2014). Financial summary - Next Plc. [online] Available at:

http://www.nextplc.co.uk/financial-information/financial-summary.aspx [Accessed 16

May. 2014].