Cape Accounting SBA

Acknowledgements

First of all, I would like to thank God for giving me the life and good health needed to

carry out this dissertation.

Moreover I am very grateful to the staff of the SLCSCCU for assisting in the distribution

of the questionnaires. In particular, I would like to thank the General Manager, Ms. Monrose,

who assisted me from the start to the end of this project. She helped me to understand the

topic better, answered the many queries I had and also administered the distribution of the

questionnaires. I am also grateful to the Head Accountant of the SLCSCCU, Mr. Desouzay who

helped in explaining the breakdown of the financial statements.

Finally, I would like to thank my parents, for providing me with the resources needed to

complete this SBA. My father especially deserves tremendous thanks as his position of

President of the SLCSCCU not only enabled him to advise me on the topic but also to get in

contact with the organization. More importantly, it was he who suggested the research topic to

me, whilst he was also able to access documents that constitute my sources of data.

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Introduction

The St. Lucia Civil Service Co-Operative Credit Union (SLCSCCU) is a member driven financial

institution in St. Lucia. The vision of the SLCSCCU is ‘To be the financial institution of choice for

our members’ which means that they aim to be at the forefront of meeting member needs.

In order to meet this vision, the SLCSCCU aims to:

promote thrift among members

educate members in the Co-Operative principles and financial management

create from the savings of members and other businesses of the society, a source of

credit available to members

borrow money and invest in security

draw, make, accept, endorse, discount, execute and issue financial instruments.

pursue policies that would encourage growth in membership

The very name Credit Union means that this financial co-operative was formed by members

with a common bond to provide themselves with financial services on more favorable terms

than they would normally obtain from the banking sector.

To become a member of the credit union, one must be an employee, member or pensioner of

the Public Service, Statutory Authorities, Agencies of the Government or an immediate family

member and also must be 16 years or older.

Credit Unions are allowed to raise two types of share capital; permanent and withdrawable

share capital. Permanent shares are paid in capital that cannot be withdrawn. On the other

hand, withdrawable shares are paid in capital that can be redeemed under certain conditions.

Withdrawable share capital is peculiar to co-operatives and is not available for other corporate

forms of business such as private and public limited companies. Unlike permanent share capital

in conventional companies, withdrawable share capital:

Is issued on the principal of one member on vote

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Is not as heavily regulated which means that co-operatives enjoy some exemptions from

covering the approval of financial promotions which can reduce the cost of a share

issue. E.g They do not need to draw up a share prospectus

Cannot be transferred between people. The law allows shareholders to withdraw their

share capital, subject to agreed terms and conditions that protect the society’s financial

security.

Withdrawable Shares have been the capital base for the SLCSCCU since inception in 1961.

However, Permanent Shares were introduced in 2004 and from since then 25% of members’

dividend is transferred to Permanent Shares. New members need one permanent and one

withdrawable share at $5.00 each upon opening of account.

However, in 2005, a revised IAS 32 was released stipulating that withdrawable shares should be

treated as a current liability instead of equity. The fundamental reasoning behind this

reclassification was that these shares could be withdrawn at any time by members once certain

conditions were met, hence it should be treated a liability.

This change in standards however, does not come without several implications for the global

Co-Operative society. The SLCSCCU has not yet become compliant with the revised version of

IAS 32. Hence this dissertation is aimed at studying the possible effects of compliance to this

standard on the St. Lucia Civil Service Co-operative Credit Union.

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Aim: What are the possible effects of the reclassification of withdrawable shares

on the St. Lucia Civil Service Co-operative Credit Union Limited?

Objective:

- How can the reclassification of withdrawable shares impact the financial

statements of the SLCSCCU?

- How can the reclassification of withdrawable shares affect the accounting

ratios of the SLCSCCU?

- How can the reclassification of withdrawable shares affect the SLCSCCU’s

ability to attract new membership?

- How can the reclassification of withdrawable shares affect the SLCSCCU’s

lending capability?

Page | 4

Literature Review

The adoption of the amended IAS 32 standard is widely believed by the global co-

operative society to directly threaten the co-operative model since their member shares -

which mainly constitute their capital – can no longer account for equity but classified as

liabilities (ICA, 2008). Consequently, it is hypothesized that co-operative banks’ financial ratios

and financial performance indicators would be dramatically affected. This has sparked

widespread debate amongst the co-operative community who are in disagreement with the

IASB on the change in standards. Hence, the following 9 literature reviews seek to discuss

arguments for and against the change, potential impacts and possible remedies to the issue.

The version of IAS 32 preceding the 2004 amendment states “A financial instrument

issued by the reporting entity should be treated as equity or debt according to whether it meets

the definition of ‘financial liability’ rather than by reference to its legal form.” Under this version

of IAS 32, withdrawable shares were not classified as liabilities because they did not meet the

definition of a liability. (IAS 32, 1998)

However, the revised IAS 32 states “A financial instrument should be classified as either

a financial liability or an equity instrument according to the substance of the contract, not its

legal form, and the definitions of financial liability and equity instrument.” (IAS 32, 2004). Under

this version of IAS 32, withdrawable shares should not be classified as equity because the

contract gives the shareholder the right to request redemption of their shares under certain

conditions.

The main reason for the IASB’s change in standards is the feature of withdrawable

shares that allows them to be redeemed by members. The IASB views such shares as a current

liability because an organization has a contractual obligation to pay their shareholder for these

shares once redemption is requested and certain conditions are met. According to IFRIC 2,

member shares are only considered equity if (a) the entity has an unconditional right to refuse

redemption or (b) local law, regulation or the entity’s governing charter can impose various

types of prohibition on the redemption of member shares (IFRIC, 2012).

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However, the co-operative movement disagrees with the fact that they have to comply

with this amendment. They believe that the International Financial Reporting Standards were

created primarily for investor owned business models and that their co-operative model is

different in many ways. Hence, their argument is that co-operatives should not be forced to

adapt to accounting standards which are designed to meet the needs of external equity

investors that are seeking only a return on their invested capital (Tabet, 2008).

Several effects of the amendment to IAS 32 on co-operatives have been identified.

First of all, it will affect the financial ratios of co-operatives. One such ratio is the debt to

equity ratio which will be extremely high for co-operatives until they become better capitalized.

Furthermore, interest expense will increase significantly since liabilities accrue interest

(SLCSCCU, 2013).

Moreover, it will affect co-operatives ability to attract new membership as the equity

side of the balance sheet would give the impression that the co-operatives are not financially

sound. It will also affect co-operatives’ capacity for lending for two reasons. Firstly, lenders

usually require a certain minimum level of equity, hence, complying with the amended IAS 32

standards may result in co-operatives struggling to meet such minimum requirements.

Adherence to IAS 32 will also affect the lending capability of co-operatives because their ratings

will most likely decrease. Since lenders use ratings of firms to determine whether to loan

money to them, co-operatives will be less assured in seeking credit (Barberini, 2008).

Secondly, adherence to IAS 32 may hamper the creation of new co-operatives which

would find themselves in the situation of having no equity at all if their shares are classified as

liabilities (Barberini, 2007).

Nevertheless, the co-operative community has been actively trying to suggest more

favourable approaches for the treatment of co-operative shares to the IASB. One such remedy

is called the loss absorption approach. According to this approach, participation in losses is

thought to be a decisive criterion for distinguishing between liabilities and equity. A financial

instrument can said to be loss absorbing if it can be used by the entity to cover losses that

Page | 6

might be incurred. This approach states that such instruments should be classified as equity.

The problem is that this approach is not developed enough. The ICA views this as quite

unfortunate because they believe that this approach is perfectly adapted for co-operative

member shares which are loss absorbing in most cases, if not all (Tabet, 2008).

However, whilst the current treatment of co-operative shares remains, it is imperative

that strategies to bolster permanent share capital are employed. One of the basic measures

includes amending membership rules to require a minimum amount to be held in permanent

shares. Another strategy involves issuing deferred shares to members. The proposed

regulations allow for deferred shares to be treated as regulatory capital provided that they

have a minimum maturity of 5 years (Hosin, 2011).

Though the IASB may have a plausible reason for the change in IAS 32, the general

consensus, as seen in the literature discussed, is that this amendment could potentially have

disastrous implication for co-operatives around the world. Nevertheless, the co-operative

society is working diligently to devise a new approach for the treatment of co-operative shares

that would allows most of their shares to be classified as equity. However, whilst the

controversial IAS 32 still stands, co-operatives have begun to employ several strategies to

bolster their permanent capital base and ride the tidal wave threatening to crash on them.

Page | 7

Methods of Data Collection

1. Documentary Research

Documentary research is the use of outside sources, documents to support the

viewpoint or argument of an academic work. The documents used to collect the data

include:

Audited Financial Statements

Comment Letters on Exposure Drafts

Other documents

The main advantage of documentary research is that it is quicker than data

collection methods which require you to collect your own data.

However, its main drawback is that it is very subjective as different researchers

may express different opinions on the topic. Documents may also lack reliability

sometimes and researchers may forge their results.

This method of data collection is the main source for this dissertation due to the

nature of the project. Since the project largely consists of looking at the effects on

financial statements, these documents (financial statements) are be my main source of

data.

2. Questionnaire

This is a document prepared by the investigator containing a set of questions

relating to the problem of enquiry.

The main advantage of a questionnaire is that it is time efficient – a large number

can be distributed in a short time.

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However it main disadvantages are that response rates may be low and the

researcher cannot explain questions to those who have doubt.

The questionnaire was used to investigate whether behaviours of members or

potential members would change as a result of the re-classification of withdrawable

shares.

3. Interview

This is where the investigator directly contacts informants, solicits their co-

operation and collects the data.

Two key advantages of the direct interview is that it ensures a high respond rate

and that the researcher can explain questions which respondents have doubts about.

Two disadvantages however are that it is quite time-consuming and that

respondents may not always be available for the interview.

Mr. Degazon, President of the SLCSCCU, also my father continually assisted me

throughout the project. Most of the assistance came via informal conversation at home.

Hence some of the key points that he made were converted into an interview.

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Procedure for Questionnaire

Sampling

It was decided that a sample of at least 30 respondents would be needed for the survey.

Hence, 40 questionnaires were printed to ensure that at least 30 responses would be

returned.

To ensure that a sample as random as possible was selected, it was decided that

questionnaires would be given to various employees who came into contact with

customers during their daily operations. These employees would then solicit the co-

operation of these customers.

Procedure

The GM of the SLCSCCU, Ms. Monrose was contacted to seek permission to carry out

the survey.

The questionnaires were given to the GM on Friday 7th February 2013.

The GM split the questionnaires between various employees namely; tellers, loan

officers and member services officers.

The questionnaires were distributed to customers over the course of a week. They were

returned on Friday 14th February 2013.

37 out of the 40 questionnaires were returned. This meant that the minimum number of

responses was adequately met.

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Limitations

1. The sample of 37 respondents may not be an adequate representation of the SLCSCCU

member base. The credit union has approximately 16,000 members so a sample of 37

may not have sufficiently represented the views of the entire membership core.

2. Only current members of the SLCSCCU were given questionnaires to answer, thus, the

views of non members were not represented in the findings. Non member views would

have been important on this issue because they are all potential members and one of

the aims of the research was to find out whether the change in IAS 32 would affect

potential membership.

3. In the balance sheets presented for ‘after reclassification’ the Interest Expense Payable

figure was included in the Liabilities section based on the assumption that members

would have not withdrawn their interest yet. However, in actuality, almost all dividends

are withdrawn as soon as they are declared. Therefore, in the case of Interest paid on

deposits, the situation is likely to be the same. Thus total liabilities in this project are

likely to be overstated, which affects the validity of the findings.

4. The financial statements presented for ‘after re-classification’ were only based on the

assumption that re-classification had taken place already, hence leading to some

possible inaccuracy in findings. However, the change in IAS 32 has only taken effect in

the SLCSCCU for the financial year that has just ended. The statements for that year

have not yet been released. An actual set of financial statements prepared under re-

classification would have been more appropriate to make valid conclusions from.

5. Since the change has only been recently implemented by the SLCSCCU, information on

the topic which was specific to the Credit Union was extremely difficult to obtain.

General information on the topic was also very difficult to obtain from public data

sources such as the internet. Much of the data used to compose the literature review

Page | 11

was sourced from inside personnel such as the President and General Manager of the

SLCSCCU.

Page | 12

Impact on Balance Sheets

The Balance Sheet, also known as the Statement of Financial Position provides a

snapshot of the financial position of a business at a particular point in time (usually at the end

of its financial year). It shows the assets, liabilities and equity of the firm.

A comparison of the Balance Sheets before and after re-classification is shown for the

years 2008-11. The changes due to re-classification are highlighted.

2010 Before Re-Classification After Re-Classification

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ASSETS

Cash and Cash Equivalents

Financial Investments

Other Receivables

Loans and Advances to Members

Construction Work in Progress

Property, Plant & Equipment

$

10,920,438

31,433,044

122,879

92,220,464

23,082

4,706,694

139,426,601

$

10,920,438

31,433,044

122,879

92,220,464

23,082

4,706,694

139,426,601

LIABILITIES AND MEMBERS’ EQUITY

Liabilities

Other Payables

Interest Expense Payable

Deposits From Members

Deferred Income

Members’ Withdrawable Shares

Members’ Equity

Share Capital

Statutory Reserve

Education Reserve

Development Fund

Disaster Fund

Funeral & Burial Benefits Scheme

Revaluation Reserve

Retained Earnings

927,658

8,426,246

41,169

9,395,073

107,031,641

14,224,621

500,000

538,156

240,112

682,500

218,578

6,595,920

130,031,528

139,426,601

927,658

3,014,892

8,426,246

41,169

100,496,403

112,906,368

6,535,238

13,621,642

500,000

538,156

240,112

682,500

218,578

4,184,007

26,520,233

139,426,601

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ASSETS



Other Receivables


Construction Work in Progress


$

12,509,729

35,287,747

149,012

97,228,663

13,500

4,756,574

149,945,225

$

12,509,729

35,287,747

149,012

97,228,663

13,500

4,756,574

149,945,225


Liabilities

Other Payables



Deferred Income


Members’ Equity

Share Capital

Statutory Reserve

Education Reserve

Development Fund

Disaster Fund


Revaluation Reserve

Retained Earnings

818,113

9,826,760

32,967

10,677,840

112,816,036

15,789,719

500,000

538,156

240,112

735,500

175,318

8,472,544

139,267,385

149,945,225

818,113

3,187,129

9,826,760

32,967

104,808,872

118,673,841

8,007,164

15,152,293

500,000

538,156

240,112

735,500

175,318

5,922,841

31,271,384

149,945,225

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ASSETS



Other Receivables



$

9,801,448

36,376,874

849,876

107,596,500

4,636,642

159,261,342

$

9,801,448

36,376,874

849,876

107,596,500

4,636,642

159,261,342


Liabilities

Other Payables



Deferred Income


Members’ Equity

Share Capital

Statutory Reserve

Education Reserve

Development Fund

Disaster Fund


Revaluation Reserve

Retained Earnings

1,026,666

10,555,639

25,186

11,607,490

119,793,324

17,254,881

500,000

538,156

240,112

727,325

175,319

8,424,727

147,653,844

159,261,342

1,026,666

3,138,359

10,555,639

25,186

111,477,136

126,222,986

8,316,188

15,989,782

500,000

538,156

240,112

727,325

175,319

6,551,474

33,038,356

159,261,342

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As seen in the Balance Sheets presented, the re-classification of with-drawable shares as

deposits would affect the statement in the following ways:

Shares would be taken out of the Equity section and placed in the Liabilities section,

thus decreasing Members’ Equity and increasing Liabilities.

The appropriation to Statutory Reserves and Retained Earnings would fall because of

the decrease in net profits (explained later). This further reduces Members’ Equity.

NB: In the balance sheets presented for ‘after reclassification’ the Interest Expense Payable

figure was included in the Liabilities section based on the assumption that members had

would not have withdrawn their interest yet. However, in actuality, almost all dividends

are withdrawn as soon as they are declared. Therefore, in the case of Interest paid on

deposits, the situation is likely to be the same. Thus in a more realistic situation, there

would be no liability called Interest Expense Payable in the Liabilities section of the

Balance Sheet.

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Impact on Income Statements

The Income Statement or Statement of Comprehensive Income illustrates the

profitability of a firm over a financial year. Its two basic components are revenues and

expenses, but it also includes gains and losses.

The reclassification of withdrawable shares would only have one main impact on the

Income Statement. The interest to be paid on the newly classified liabilities would increase

total expenses thus reducing net profit.

A comparison of the Income Statements before and after re-classification is shown for the years

2008-11. The changes due to re-classification are highlighted.

Page | 18

2010 Before Re-Classification After Reclassification

Income

Interest Income on Members’ Loans

Less: Interest Expense

Net Interest Income

Other Income

Investment Income

Other Operating Income

Amortization of Grant Fund

$

10,429,563

214,547

10,215,016

1,559,378

164,489

4,131

1,727,998

$

10,429,563

214,547

10,215,016

1,559,378

164,489

4,131

1,727,998

General and Administrative Expenses

Staff Related Expenses

Depreciation

Other Operating Expenses

Impairment Losses on Loans & Advances

Impairment Loss on Investment

Interest on Member Shares

Bank Charges

1,955,166

127,387

1,932,352

774,355

1,705,397

19,274

6,513,931

1,955,166

127,387

1,932,352

774,355

1,705,397

3,014,892

19,274

9,528,823

Net Surplus For The Year 5,429,083 2,414,191

Other Comprehensive Income

Fair Value increase/(decrease) in Investment

Total Comprehensive Income for the Year

(26,886)

5,402,197

(26,886)

2,387,305

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Income



Net Interest Income

Other Income

Investment Income



$

10,623,763

241,383

10,382,380

1,971,377

171,957

8,202

2,151,536

$

10,623,763

241,383

10,382,380

1,971,377

171,957

8,202

2,151,536



Depreciation




Bank Charges

2,133,644

205,813

2,134,810

245,242

16,042

4,735,551

2,133,644

205,813

2,134,790

245,242

3,187,129

16,042

7,922,680




Total Comprehensive Income for the Year

(43,260)

7,755,105 4,611,236

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Income



Net Interest Income

Other Income

Investment Income



$

10,461,196

228,994

10,232,202

1,669,484

253,485

7,779

1,930,748

$

10,461,196

228,994

10,232,202

1,669,484

253,485

7,779

1,930,748



Depreciation




Bank Charges

1,778,799

184,870

2,418,634

458,333

18,001

4,858,637

1,778,799

184,870

2,418,634

458,333

3,138,359

18,001

7,996,996




Total Comprehensive Income for the Year 7,304,313

(14,696)

3,940,188

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Impact on Ratios

The following basic ratios will be affected:

- Debt to Equity Ratio

- Debt to Assets Ratio

- Current Ratio

- Quick Ratio

- Return on Assets

- Return on Capital Employed

- Dividend Pay Out Ratio

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1. Debt to Equity Ratio

Debt-to-Equity ratio is the ratio of total liabilities of a business to its equity. It

measures the degree to which the assets of the business are financed by the debts and

the members' equity of a business.

Debt ¿ Equity Ratio= Total LiabilitiesMembers ' Equity

Lower values of debt-to-equity ratio are favorable indicating less risk. Higher

debt-to-equity ratios are unfavorable because it means that the business relies more on

external lenders thus it is at higher risk, especially at higher interest rates.

Below: Debt to Equity Ratio for the SLCSCCU before and after reclassification of shares

Year Before Re-Classification After Re-Classification

2010 0.07 4.26

2011 0.08 3.79

2012 0.08 3.82

As shown in the table above, the reclassification of shares would exponentially

increase the debt to equity ratio to an unfavorably high amount. This would make the

SLCSCCU less attractive to potential members and lenders.

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2. Debt to Asset Ratio

This is a ratio which indicates the proportion of a company’s assets that are provided

via debt.

Debt Ratio=Total LiabilitiesTotal Assets

The lower the ratio, the more favorable it is. A higher debt to asset ratios is

unfavorable because greater risk will be associated the company’s operations.

Below: Debt to Asset Ratio for the SLCSCCU before and after reclassification of sharesYear Before Re-Classification After Re-Classification

2010 0.07 0.81

2011 0.07 0.79

2012 0.07 0.79

As shown in the table above, the reclassification of shares would make the debt

to asset ratio unfavorably higher, making the SLCSCCU less attractive to potential

members and lenders.

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3. Current Ratio

This is a ratio of the company’s current assets to current liabilities. It gives an

idea of a company’s ability to pay back its short term debts.

Current Ratio= Current AssetsCurrent Liabilities

A low current ratio is unfavourable as it indicates that a company has a low

capability of repaying its short term debts. However, while a low ratio may signal

danger, a high ratio may indicate that firm has resources that are not being used

efficiently. An ideal current ratio lies between 1.5:1 and 2:1.

Below: Current Ratio for the SLCSCCU before and after reclassfication


2010 4.52 0.38

2011 4.49 0.40

2012 4.05 0.37

The table above shows that the reclassification will cause a drastic drop in the

current to unfavourable levels.

4. Liquidity/Quick/Acid Ratio

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The quick ratio measures the ability of a company to meet its short term

obligations with its most liquid assets. Liquid assets include cash, marketable securities,

accounts receivable and current notes receivable.

Liquidity Ratio= Quick AssetsCurrent Liabilities

This ratio is a more conservative version of the current ratio as it provides a

more rigorous assessment of a company’s ability to meet its short term debts. It does

this by eliminating those assets which are least liquid, such as inventory and prepaid

expenses.

Like the current ratio, low quick ratios (usually below 1:1) are unfavourable.

Since the SLCSCCU is not a merchandising firm, it has no stock. Also for the years

observed, the credit union did not possess any prepaid expenses. Hence, the current

and quick ratios for the SLCSCCU are the same for all the years investigated.

Below: Liquidity Ratio for the SLCSCCU before and after reclassfication


2010 4.52 0.38

2011 4.49 0.40

2012 4.05 0.37

Just like the current ratio, the reclassification will cause the liquidity ratio to fall

to unfavourably low levels.

5. Return on Assets (ROA)

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This ratio is a measure of operating performance that indicates how effectively

the assets have been employed during the year. In the denominator we use the average

total assets; which is calculated by averaging the assets figures of the previous year and

current year.

ROA= Net IncomeAverage Total Assets

×100

The higher the ROA ratio the better, as it means that the company is earning

more on less investment.

Below: ROA for the SLCSCCU before and after reclassfication


2010 4.0% 1.8%

2011 5.4% 3.2%

2012 4.7% 2.7%

As shown in the table above, reclassification would lower the ROA figure slightly.

6. Return on Capital Employed (ROCE)

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This ratio is a measure of the returns that a business achieves from its capital

employed. The term capital employed refers to the total sum of common stock, reserves

and long term liabilities. The formula is shown below:

ROCE= Net IncomeCapital Employed

The higher this ratio is the better as it indicates that the firm is using its

resources more efficiently.

Below: ROCE for the SLCSCCU before and after reclassfication


2010 4.2% 9.1%

2011 5.6% 14.7%

2012 4.9% 12.6%

As seen in the table above reclassification of shares would actually increase the

ROCE ratio, making it more attractive to investors and members. This is increase is due

to the capital employed figure (denominator) falling because withdrawable shares

would no longer be considered as capital.

7. Dividend Pay-Out Ratio

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This ratio shows the percentage of earnings that are paid out to shareholders as

dividends.

Dividend PayOut Ratio= DividendsNet Income

×100

Higher dividend pay-out ratios are more attractive to potential investors as they

receive a higher proportion of net surplus as dividends.

Below: Dividend Pay-Out Ratio for the SLCSCCU before and after re-classfication


2010 73.6% 165.4%

2011 43.6% 73.8%

2012 54.0% 32.9%

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The above pie chart shows that the majority of respondents (68%) did not consider the financial

statements of the SLCSCCU as a major factor in their decision to join the organization. Only 32%

considered the financial statements as having played a major role in their decision to join the

SLCSCCU.

Furthermore, out of the 12 respondents who answered ‘Yes’ to Question 1, the most

common aspect of the financial statements and ratios that played a major role in their decision

were related to dividends and profits. 8 respondents gave an answer related to dividends with

some answers including “Dividend Payout Ratio” and “Net Profit Ratio.” The results of this

question are shown below:

Below: Table showing specific aspects of financial statements and ratios that

influenced members to join the SLCSCCU

Answer No. of Respondents

Profits, Dividends 8

Other 3

Page | 30

32%

68%

Persons Who Used the Financial Statements of the SLCSCCU as a Major Factor In Joining

YesNo

The above graph illustrates that the majority of the sample (30) would still join the

SLCSCCU now that their financial statements and ratios are much less attractive due to the

change in IAS 32. Only 6 answered that they will not join the SLCSCCU. 1 respondent did not

answer this question.

Page | 31

83%

17%

Members Who Would Still Join the SLCSCCU Now That Their Statements Reflect Higher Debt and

Lower Equity Levels

YesNo

The above graph shows the major reasons for or major factors responsible for the

sample of members joining the SLCSCCU. The most common reason was dividends with 78% of

respondents selecting this option. The second most selected reasons for joining the SLCSCCU

were the ease of obtaining loans and the tax benefit for purchasing shares with 73%. Another

common factor selected was the lower interest rates on loans compared to banks with 59% of

respondents selecting this factor.

Interestingly, 4 out of the 10 respondents who cited financial statements as a major

factor in their decision to join the SLCSCCU had answered no to the question “Did the financial

statements and ratios of the Credit Union play a major role in you joining the organization?”

Thus these 4 respondents contradicted their answer to Question 1 by selecting financial

statements as a major reason responsible for them joining the SLCSCCU.

Page | 32

Easy to obtain loans

Lower interest rates for loans

Tax benefit for purchase of

shares

Financial Counseling

Patronage Re-fund

Financial Statements

Dividends0

5

10

15

20

25

30

35

27

22

27

13

18

10

29

Major Reasons for Joining the SLCSCCU

A closer look at these respondents’ questionnaires shows that the least number of

options shaded was 5 out of 7. Out of these 4 respondents, 2 of these respondents shaded all of

the options. This suggests that these respondents may have been in a rush so just shaded all or

most of the options. This may not be true however; it may have been that the respondents

changed their minds or that they were not sure or even a misinterpretation of the question.

Page | 33

24%

76%

Members Who Would Be More Inclined to Increase Withdrawals

YesNo

The above graph shows the percentages of respondents who would be more inclined to

increase their withdrawals now that their withdrawable shares have been re-classified as

deposits or liabilities instead of equity. The majority of respondents (28) said that they will not

be inclined to withdraw more. Only 9 respondents said that they will be inclined to withdraw

more.

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Evaluation

The Impact of the Re-Classification on the Balance Sheet

The effects of the re-classification on the Financial Statements are clearly negative. First

of all, in the balance sheet, it would significantly increase liabilities and reduce members’ equity

giving off the impression that the SLCSCCU is not financially sound.

In the three Balance Sheets presented, after re-classification, Liabilities would increase

by an average of 1066%! In Lehmann’s terms, Liabilities would increase more than ten-fold!

This is primarily due to the large amount of withdrawable shares that would have been

transferred to the Liabilities section. This massive increase can be explained by the fact that

these with-drawable shares are the main capital base for the SLCSCCU.

Moreover, Members’ Equity would decrease by an average of 78.5%. Again this is

primarily due to the with-drawable shares being taken out of the Members’ Equity Section. Also

playing a very small role in this fall in Members’ Equity figure is the fall in amounts for Statutory

Reserves and Retained Earnings. As explained earlier, these figures would drop slightly due to

the fall in net income, which would lead to a smaller amount being appropriated to them.

The Impact of Re-Classification on the Income Statement

Just like the Balance Sheet, the impact on the Income Statement would be negative.

Interest expense rather than dividends would have to be paid on the newly classified deposits

since they would be no longer considered equity. This would have the effect of increasing the

expense figure in the Income Statement and thus reducing Net Income. In the three Income

Statements presented, the re-classification would have reduced net income by an average of

48%

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The Impact of Re-Classification on the Financial Ratios

As shown earlier the majority of ratios would be affected adversely by the re-

classification which would make the SLCSCCU less attractive to stakeholders. These ratios

include:

Debt to Equity Ratio

Debt to Assets Ratio

Current Ratio

Quick Ratio

Return on Assets

However, a couple of ratios would actually be impacted on favourably. These two ratios are

the:

Return on Capital Employed

Dividend Pay Out Ratio

The Impact of Re-Classification on Attracting Membership

Overall, the re-classification of withdrawable shares as deposits would have a negative

effect on the financial statements and ratios of the SLCSCCU. But would this severely affect the

cooperative’s ability to attract new members? The results of the questionnaire suggest

otherwise.

The majority of respondents claimed that the financial statements and ratios of the

SLCSCCU did not play a major role in their decision to join the co-operative. Furthermore, 83%

of respondents said that if they were not yet a member, they would still join the SLCSCCU even

though their financial statements are much less attractive.

When asked what were there major reasons for or major factors for joining the

SLCSCCU, ‘Financial Statements’ was the least selected option with only 27% of respondents

Page | 36

selecting it. Instead, the reasons most commonly selected were “Dividends”, “Ease of Obtaining

Loans” and “Tax Benefit for Purchasing Shares”.

This goes to show that the members of the SLCSCCU did not join because of the financial

position of the firm as reflected in its statements but instead, because of the services that it

provides and the benefits that they can receive as members. Hence, it can be concluded that

though the re-classification would make the financial statements and ratios less attractive, this

would barely deter potential members from joining the co-operative.

Impact on Lending Capability

According to Mr. Degazon, the re-classification would adversely affect the SLCSCCU’s

ability to receive long term loans as the cooperative’s financial statements would not be as

attractive as before.

However, this effect will not have any impact on the SLCSCCU in the present day or near

future, since the cooperative does not usually borrow large sums of money. This is seen in the

three Balance Sheets presented; there are no long term loans in the Liabilities section of the

Balance Sheet.

Other Possible Effects

The first of these effects concerns the tax deduction granted to those who purchase

shares of the SLCSCCU. Now that they will be classified as deposits, would they still be

considered a tax deductible expense? If they no longer qualify for tax-deductions, it would

reduce the incentive for members to purchase with-drawable shares in the SLCSCCU.

The Inland Revenue Departments’ ruling on this matter is pending, but according to Mr.

Degazon, it is likely that the department will retain the tax deductible status of these with-

drawable shares which bodes well for the SLCSCCU.

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The second possible effect concerns the mandatory interest expense. According to Mrs

Monrose, in the event of a loss, if the shares were still classified as equity, the cooperative

would have the option to withhold dividends from members in order to reduce the impact of

the loss. However, now that these shares are classified as deposits, it would still be obligated to

pay interest whether or not a loss occurs.

It should be noted however, that the SLCSCCU does not frequently make losses. As

shown in the three Income Statements presented, the cooperative made a healthy profit for all

three years.

Finally, the SLCSCCU has to re-think of a strategy to boost its permanent share capital.

This is because, a few years ago, it was decided at an AGM that 25% of dividends declared

would be transferred to members’ permanent capital. This was implemented to boost the

capital base of the cooperative. However, with the re-classification of the withdrawable shares

as deposits, they will yield interest, not dividends. The SLCSCCU now has to find a more

innovative way to boost the permanent share capital of the organization.

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Recommendations

1. The WOCCU should gather more support for and assist in the development of the loss

absorption approach. This criteria for determining equity is better suited to cooperatives

whose majority of with-drawable shares are loss absorbing.

2. The SLCSCCU should amend membership rules to require a minimum amount to be held

in permanent shares. This would help build up the number of permanent shares and

thus bolster the equity section of the Balance Sheet.

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Conclusion

The re-classification of withdrawable shares to deposits will have a drastic effect on the

financial statements and ratios of the SLCSCCU thus making the cooperative seems much less

financially sound.

This drastic effect however, is not likely to be echoed in the cooperatives ability to

attract members since people join the SLCSCCU based on the services it provides and not its

financial standing as reflected by its statements.

Though the re-classification will reduce the SLCSCCU’S attractiveness to lenders, this will

not have any major effect on the cooperatives operations since it is not in the habit of

borrowing large sums of money. And even if the situation does arise in the future where the

SLCSCCU has to borrow long-term, it will most likely have a much stronger permanent share

base by then.

In order to cushion the possible effects of the change in IAS 32, it is recommended that

the WOCCU assists in helping develop the loss absorption approach and also that the SLCSCCU

require members to hold a minimum amount in permanent shares.

In conclusion, though the effects of re-classification will severely affect the financial

statements and ratios of the SLCSCCU, in actuality, it would not impact much on the

organization.

Page | 40

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Economy & Finance

Cape Accounting SBA