A • Analyse d’activité B • Analyse de structure
The International Financial Reporting Standards (IFRS) replaced the International Accounting Standards in 2001. The IFRS are used to present consolidated (group) and sometimes all domestic accounts in the European Union, Australia, Russia, etc.
Nowadays 113 countries accept or apply IFRS, and their number may expand in the future. In France, both systems (the French one and the international one) still coexist.
The “philosophy” of the IFRS may be summarized in one word: realism. Accounts are presented so as to facilitate a realistic view of the financial situation of an entity.
Though this objective is laudable, the implementation of IFRS has made comparisons difficult between years for a same company, and also between companies.
SECTION I • Fundamental Differences Induced by the IAS-IFRS (Les différences fondamentales induites par les IAS-IFRS)
There is no reason to compare directly financial accounts using French and International standards, as they provide quite different types of information. To start with, they do not share exactly the same principles.
A • IFRS principles and assumptions
The IFRS allow financial capital maintenance to be presented in nominal monetary units, that is to say using historical cost accounting cost when inflation or deflation is low enough. The other possible model is to present capital maintenance in units of constant purchasing power.
The key assumptions in the IFRS are:
1. Accrual basis accounting: the effects of transactions and other events are recognized when they occur (not when cash flows occur).
2. Going concern: a company will continue to operate in the foreseeable future.
There are no accounting principles as in the French system, just requirements regard-ing qualitative characteristics of financial accounts:
1. Understandability (immediate understanding for all users).
2. Reliability, that is financial information provided in accounts must be:
a. true and fair,
b. free of material errors, c. neutral (free from bias), d. complete,
e. substance over form (accounts must express economic reality), f. prudence.
3. Comparability (accounts can be compared from one period to another, as well as from a group to another).
4. Relevance (information drawn from accounts may influence decisions).
The concepts in the IFRS are also quite different. Direct translations from French to English do not allow these differences to be understood.
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B • Key IFRS concepts
“An item is recognized in the financial statements when it is probable future economic benefit will flow to or from an entity or when the resource can be reliably measured”.
The economic benefit can be drawn from (or be due to):
– combining assets, – exchanging assets, – paying debt,
– distributing dividends, etc.
Accordingly, there are specific definitions to be given to the components of a balance sheet (or financial position):
1. An asset is a resource controlled by an enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.
The existence of a future economic benefit allows assets and expenses to be distinguished: anything which is purchased with no prospect of yielding any benefit in the foreseeable future is considered an expense.
Le « territoire » des actifs s’élargit
Supposons qu’une entreprise loue un bien. Dans les normes françaises, ce dernier n’apparaîtra nulle part dans les états financiers. Seul le loyer sera comptabilisé en autres achats et charges externes. Dans le cas d’une opération de crédit-bail, il faudra d’ailleurs procéder à un retraitement pour « réincorporer » l’actif dans les comptes de l’entreprise. Dans le cadre des IFRS, un bien loué sur la plus grande partie de sa vie économique, racheté par le locataire au terme du contrat de bail, ou encore soumis à une option d’achat telle que l’on peut être quasi certain qu’elle sera exercée (pour ne citer que certaines conditions possibles) sera incorporé aux actifs de l’entreprise. C’est en effet le locataire qui bénéficie des avantages économiques et assume principale-ment les risques sur le bien en question.
En vertu du même principe, les créances escomptées restent au bilan de la société jusqu’à leur échéance, car le risque d’impayé est assumé par l’entreprise et non l’établissement escompteur. Dans le cas d’une opération d’affacturage (avec garantie contre les impayés), la créance peut sortir de l’actif.
2. A liability is a present obligation of an enterprise arising from past events, the settlement of which is expected to result in an outflow of the enterprise’s resources (payments in cash or in-kind, transfers of assets, swap obligations, conversions into equity).
Les « passifs » au sens des IFRS n’incluent pas les capitaux propres
Ces derniers sont définis comme la différence entre actifs et passifs : les ressources (attention, ici il s’agit des actifs) nettes des obligations.
3. Equity is the residual interest in the assets of the enterprise, after deducting all the liabilities. The value of equity depends on the accounting model (his-torical cost accounting or purchasing power).
The simplified structure of the financial position (or balance sheet) is presented as below:
ASSETS
EQUITY
LIABILITIES
The notion of future benefit also has consequences on the income statement or profit and loss account. This document helps appreciate an enterprise’s financial perfor-mance. The components of the income statement are defined as follows:
1. Revenues are increases in economic benefit during an accounting period in the form of inflows or enhancements of assets, or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
Une nuance à souligner
Les IFRS utilisent deux termes distincts pour recouvrir des réalités qu’ils ne distinguent finalement pas : les produits des activités ordinaires (revenues) seraient différents des profits (income) comme les plus-values sur cessions d’actifs. Cependant, il n’y a aucune obligation comptable à les traiter séparément, ce qui pose parfois un prob-lème d’appréciation de l’impact des produits exceptionnels sur le résultat. De la même manière, on utilise deux mots distincts pour « charges » (expenses) et « pertes » (losses) qui sont traitées en un même bloc.
La comptabilisation d’un produit sur vente s’opère en IFRS non pas à la livraison, mais au moment où l’acheteur accepte le transfert des « bénéfices et des risques », c’est-à-dire le transfert de propriété. Cela explique des écarts de comptabilisation entre les ventes aux comptes sociaux et celles qui peuvent apparaître aux normes IFRS. Par
ail-leurs, les remises et rabais sont directement déduits de la valeur des ventes.
2. Expenses are decreases in economic benefits during an accounting period, in the form of outflows, or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
C • The fair value principle
Fair value is a principle that runs through IFRS bookkeeping. Economic benefits and resources must be presented as closely as possible to their market value (the “current transaction between willing parties, other than in a liquidation”).
CA company purchases machinery to be operated (and not to be resold, otherwise, it would be considered as an expense). It is stated as “property, plant and equipment”, at acquisition cost (including purchase costs, plus all expenses that ensure the asset is in working condition, for instance transport, interest due to possible borrowings, minus all revenues due to the operation, such as subsidies, discounts, etc.). Components of complex assets can be stated separately (IAS
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16 “Property, plant and equipment”). In this specific case, machines will be considered as single units. Let us suppose this initial value is €10,000.
1. If the historical cost accounting model is used, a depreciation method is chosen for the whole useful life of the machinery (5 years). In this case, the straight-line method is used with no resi-dual value. Thus the depreciation charge per year will be:
Annual depreciation charge = 10,000 5 = €2,000 per year
This charge will be recorded every year, and the value of machinery will decrease by €2,000 per year.
Nevertheless, the reporting of annual accounts requires a reevaluation of all assets, and care must be taken to ensure that this theoretical value (named the carrying amount) does not exceed the recoverable value of the machinery. This is known as the impairment procedure (IAS 36). The recoverable value is the higher value of the fair value (the realistic resale price) and of discounted cash flows (expectable cash inflows – expectable cash outflows, see Chapter 7).
After 3 years, the carrying amount is €4,000. The future cash flow opportunities should not reach more than a net present value (value-in-use) of €2,000. This machinery could be rea-sonably sold at a price of €3,000. The recoverable value is the higher figure: i.e. €3,000. An impairment loss of €1,000 (4,000-3,000) must be recorded in the accounts. It will be written as an expense in the income statement, and the value of this machinery in the balance sheet will only be €3,000.
At the end of each reporting period, an entity must assess whether a long-lived asset may be impaired. The process is named the “impairment test”. Impairments of non-current assets can be fully reversed, but the book-value cannot exceed the historical cost calculated for the same period (if the historical cost accounting model is the one to be implemented). When it is difficult to estimate the value-in-use of a single non-current asset, the future net cash flows can be determined for a set of assets named a
“cash generating unit”. A cash generating unit is the smallest set of assets generating an independent stream of cash flows. During impairment tests, cash generating units are treated like single assets.
C2. If the purchasing power model is implemented, then the fair value method is chosen. This method allows assets to be recorded at their current market value, even if it is higher than the initial purchase price.
Let us suppose that a shortage in this kind of machinery suddenly occurs, because of a lack of raw materials. The situation may last up to several years. The prevailing market price after three years reaches €5,000 for the type of machine currently in use. Machinery will be recorded for
€5,000, and the revaluation surplus (€1,000) will be transferred to retained earnings.
Here are some examples of the principles that have to be applied to assets:
Assets (designation) Key rules
Tangible assets IAS 16, IAS 36
Property, plant and equipment Valued using the historical cost accounting model (with impairment procedure) Or at fair value
Intangible assets IAS 38
R&D expenses Research expenses are recorded as expenses
(income statement) whereas development expenses can be recorded as assets and amortized thereafter.
Others
Patents, trademarks, and all other intangible assets (except goodwill)
Amortized and can be revalued using the fair value principle (if a market for such assets exists)
Financial assets IAS 32, IAS 39, IFRS 7 (IFRS 9 to replace IAS 39 in 2013)
Financial assets at fair value through profit or loss
Used for trading: bank accounts, cash accounts, equity or debt securities held with the intention to make short term profit, derivatives (when not used for hedging).
At fair value. Any stated change in value is reported in the income statement.
Loans and receivables
Accounts receivables (when an entity provides money, goods or services directly to a debtor with no intention of trading the receivable)
Amortized cost accounting model: carrying value + interest (if any) – amortization (time value of money, see Ch.7). IFRS 9 introduces disclosures about risk credit.
Held-to-maturity assets
Assets with fixed maturity, or intention of the entity to hold them
Depreciated cost accounting model (in Europe)
Financial assets available for sale All assets which are not included in the previous categories
At fair value. Any stated change in value will have a direct impact on equity (revalued surplus or loss).
Hedging instruments (derivatives) Fair value hedge
Hedging of exposed assets or liabilities (forwards, calls or puts)
Fair value gain/loss recorded in the income statement. Compensates the change in fair value of the hedged asset/liability. No impact on income.
Cash flow hedge
Hedging of cash flows (swaps, forwards)
Effective portion of change in fair value:
equity (cash flow hedging reserve).
Ineffective: other gains or losses (income statement)
The fair value principle also applies to some categories of liabilities.
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Liabilities (designation) Key rules (IAS 39, IAS 47) Financial liabilities held for trading
Short selling (sale of securities that are not available in assets).
At fair value through profit or loss
Other financial liabilities
Accounts payable, long-term borrowings, short-term borrowings
Amortized cost accounting model: carrying value + interest (if any) – amortization (time value of money).
For borrowings, effective interest rates take into account additional costs of debt and discounts.
As far as revenues are concerned, deferred payments imply discounting accounts payable.
SECTION II • Operational Analysis of Consolidated Accounts (L’analyse d’activité des comptes de groupe)
Operational analysis aims at assessing enterprise’s ability to earn income and sustain growth from a short term perspective. The main document to be examined in such a process is the income statement.
A • The income statement in consolidated accounts
There is no prescribed format for income statements. Expenses can be classified by nature or by function. The income statement is commonly presented as a list of reve-nues and expenses including diverse contribution assessments, as shown below.
Continuing Operations Year
Revenue – Cost of sales
= Gross profit
+ Other operating income – Distribution cost – Administrative expenses – Other operating expenses – Share of results of associates – Restructuring costs
= Profit (or loss) from operations + Investment income
– Finance costs
= Profit (or loss) before tax Tax
Profit for the period from continuing operations (A) Discontinued Operations
Profit or loss for the period from discontinued operations (B)
Profit for the period
Share of results of associates (C) TOTAL COMPREHENSIVE INCOME Attributable to the group Attributable to minority interest
Some significant differences with the French presentation of income statements have to be underlined:
1. Revenue and cost of sales include current and exceptional figures. In France, the CNC (Centre National de la Comptabilité) considers that non-cur-rent operations have to be detailed separately from the income statement.
Generally speaking, companies mention this information when it shows an important impact on gross profits.
2. Finance costs can be presented either as above (apart from investment income) or as “net finance costs”. In the latter case, it is not possible to indentify clearly the gross cost of debt.
3. Issued share options are recorded at fair value as an expense (just like wages), with counterpart in equity.
4. Earnings per share are presented according to two standards (basic EPS based on the average number of shares, diluted EPS, including potential shares like convertible bonds or share options).
Now more than ever, a thorough reading of appendixes is necessary to provide rele-vant analysis of an income statement.
B • Appraising strategy and effects: scope of consolidation perimeter and revenue In consolidated accounts, a change in revenue can be explained by current factors (price and volume effects) and specific ones (exchange rates, changes in scopes). Price and volume effects are analyzed as in any company, but their impact has to be clearly iden-tified. To do so, information must be grasped in reports, appendixes and comments.
Changes in consolidated companies may express some aspects of strategy (diversifi-cation, external growth, outsourcing, etc.). From the same perspective, the financial impact of discontinued activities is worth taking into account. Moreover, sales are pre-sented by segment. “An operating segment is a component of an entity that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity); whose operating results are reviewed regularly by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance and for which discrete financial information is available” (IFRS 8-2). In contrast to IAS 14, which imposed normative segments (geographic or acti-vities), IFRS 8 (which replaced IAS 14 in January, 2009) suggests that segments must reproduce the way internal reporting is structured.
As a result, the way segments are structured must be compared with strategic syntheses.
A consistence has to be found between these information sources.
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CIn its annual report in 2009, Adidas introduced three activity segments: Wholesale (Adidas and Reebok business activities with retailers), Retail (own-retail activities of the Adidas and Reebok brands), and Other Business (specific and specialized brands).1 There was a substantial change compared to 2008: sales used to be presented per brand (Adidas, Reebok, others). This is consistent with a change in strategy announced as follows: “Establishment of joint operating models for the Adidas and Reebok brands in most markets around the globe.” For instance, the financial year summary mentions important information about changes in revenue in the Retail segment:
“Currency-neutral sales per segment increased by 7%.
In 2009, Retail revenues increased by 7% on a currency-neutral basis. Concept store, factory out-let and other retail format sales were all up on the prior year. Currency translation effects posi-tively impacted segment revenues in euro terms. Sales grew 10% to €1.906 billion, from €1.738 billion in the previous year. Currency-neutral comparable store sales, however, decreased 6%
compared to the previous year, with declines in all store formats.
Own-retail store base increase
As at December 31, 2009, the Adidas Group Retail segment was operating 2,212 stores. This represented a net increase of 328 or 17% versus the previous year-end level of 1,884. Over the course of the year, the Group opened 416 new stores; 88 stores were closed; and two stores were remodeled.
The number of concept stores increased by 184 to 1,203 at the end of 2009 (2008: 1,019). The number of factory outlets grew by 74 to 755 at the end of the year (2008: 681). Concession cor-ners increased by 71 to 244 (2008: 173). Other formats, which include e-commerce, declined by 1 to 10 (2008: 11). Of the total number of stores, 1,626 were Adidas and 586 Reebok branded (2008: 1,311 Adidas, 573 Reebok).”
“Currency neutral” means that the effect of variances in exchange rates has been eliminated from calculations.
C • Operational analysis
As shown above, accessing profitability analysis is much more complicated in consoli-dated accounts. Information has to be found elsewhere (appendixes and comments).
As in the French system, the starting point is the analysis of margins.
1. Source : http://adidas-group.corporate-publications.com
CAdidas’ consolidated income statement will be considered to continue the example in the present section.
€ in millions 2009 2008 Change
Net sales 10 381 10 799 (3.9%)
Cost of sales 5 669 5 543 2.3%
Gross profit 4 712 5 256 (10.4 %)
(% of net sales) 45,4% 48,7% (3.3pp)
Royalty and commission income 86 89 (3.9%)
Other operating income 100 103 (2.8%)
Other operating expenses 4 390 4 378 0.3%
Operating profit 508 1 070 (52.6 %)
(% of net sales) 4,9% 9,9% (5.0pp)
Financial income 19 37 (48.6%)
Financial expenses 169 203 (17.0%)
Income before taxes 358 904 (60.4%)
(% of net sales) 3,4% 8,4% (4.9pp)
Income taxes 113 260 (56.7%)
(% of income before taxes) 31,6% 28,8% 2.7pp
Net income 245 644 (61.9%)
(% of net sales) 2,4% 6,0% (3.6pp)
Net income attributable to shareholders 245 642 (61.8%)
(% of net sales) 2,4% 5,9% (3.6pp)
Net income attributable to minority interests - 2 (95.1%)
Basic earnings per share (in €) 1.25 3.25 (61.5%)
Diluted earnings per share (in €) 1.22 3.07 (60.2%)
Source : http://adidas-group.corporate-publications.com
We focus here on key contributions and ratios used for both internal and comparative analyses.
1. Gross profit:
Revenue – Cost of sales
= Gross profit The gross profit ratio
Gross profit
Revenue
indicates how much of each dollar in sales is avai-lable to meet expenses and profits after paying for the goods that were sold. Its cal-culation method depends on management accounting options. Nevertheless, “cost of sales” is often equal to consumed material (and other resources) plus cost of goods1
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sold plus labor (full production cost). It is sometimes necessary to exclude the impact of non-current activities (like selling plants, subsidiaries, etc.).
CAdidas’ decreasing gross profit ratio is due to an increase in “higher input costs” (raw materi-als), additional currency clearance and labor expenses.
2. EBITDA (Earning Before Interest, Tax, Depreciation and Amortization)
Gross profit + Other operating income – Distribution cost – Administrative expenses – Other operating expenses
= EBITDA
Depreciations and amortizations have to be subtracted from all expenses. It is also rec-ommended that all elements which do not induce out-of-pocket costs (share options
Depreciations and amortizations have to be subtracted from all expenses. It is also rec-ommended that all elements which do not induce out-of-pocket costs (share options