The typical published profit and loss account (see MBA’s on p. 5/31), published in accordance with the law, does not tell us very much. Compared to the profit and loss accounts which have been set out in these modules so far, the published version is skeletal and is, therefore, less informative than the ones described earlier. But the Companies Act 1985 requires certain information to be disclosed by way of note, namely, the items shown in Notes 1–3 on pp.
5/35–5/38: these help the reader to reconstruct the trading account.
Some comments on MBA’s consolidated profit and loss account and Notes 1–13 may be useful to help readers understand what lies behind the principal numbers:
1 Financial Reporting Standard No. 3 (FRS 3) ‘Reporting Financial Perform-ance’ requires companies to disclose profits between continuing operations (subdivided into acquisitions and others) and discontinued operations down to the level of operating profit. Note that MBA has not made any acqui-sitions or disposals on 20x2 and so the numbers are slightly easier to understand.
2 Note 1 to the accounts breaks down the turnover, profit and net assets figures into the various segments of MBA’s business. Electronic systems produces slightly less than half MBA’s turnover for 20x2, slightly more than half its profits and requires a very small asset base in comparison with other segments. At the end of Note 1 the geographical split of turnover and profit and net assets is also provided.
3 Exceptional items need to be disclosed separately. An exceptional item is one which is material in amount but which derives from events or transactions that fall within the ordinary activities of the company:
(a) profits or losses on the sale or termination of an operation;
(b) costs of a fundamental re-organisation or re-structuring having a mat-erial effect on the nature and focus of the company’s operations; and;
(c) profits or losses on the disposal of fixed assets.
MBA has £775m of net exceptional gains in 20x2 which are analysed in Note 3 on p. 5/38. Readers will see that the biggest contributor to this figure was the flotation of HWU which netted £745m. By separating these items from the results of ordinary activities, MBA allows the reader to form a view of how the core businesses have performed during the year without the effect of exceptional events masking the numbers.
Note that the operating costs of £6082 million (disclosed in Note 2 on p.
5/37) comprise four major items. It is surprising that there is no obligation on companies to provide an analysis of these very large items. The only indicator of performance in 20x2 is to compare each number with that for 20x1.
From the entry ‘Exceptional items etc’ the remainder of the published profit and loss account describes how the profit is distributed among the interested parties:
1 First charge is interest paid to banks and other providers of borrowings.
Note 4 on p. 5/38 provides a breakdown of this amount; notice that while MBA pays £57 million interest in 20x2 it receives £111 million interest from various deposits and investments. A further £19 million interest received from joint ventures produces a net interest income of
£73 million.
2 Taxation on profits is the next charge; the payment of £433 million is analysed in Note 5 on p. 5/38. Notice that the UK tax amounts to a large proportion of total tax paid; a quick look back at Note 1 will reveal that MBA’s profits are earned mostly in the UK.
3 Minority interests claim £17 million of Profit on ordinary activities after taxation. What are minority interests? Minority shareholders are those remaining in the subsidiaries acquired by MBA. A company is
‘owned’ when over 50 per cent of the voting share capital belongs to one party. When MBA made a bid for certain of its subsidiaries some shareholders did not accept the bid and remained as a minority in the original company. They must be protected in law and be given a proportionate share of the profits of their subsidiary.
4 Dividends are profits paid to shareholders as a return on their investment in the company. From Note 7 we read that for each share held, MBA share-holders were paid 4.20 pence per share in 20x2 and are due a further 8.8 pence per share on the profits of 20x2 which will be paid in cash early in 20x3. Dividend policy is a complex subject and is covered in the MBA Finance course. Boards of directors declare a dividend from profits but in some years, when the company has experienced poor trading conditions which are expected to be overcome, or where a particular event like a cor-porate restructuring has adversely affected profits, the directors are entitled to declare a dividend which exceed available profits. In such a circumstance, the dividend would be charged against reserves, that is the undistributed profits from previous years.
5 Perhaps the most critical of all numbers in the entire accounts is earnings per share or EPS. The stock market likes to see this number growing quarter
by quarter, year by year. Management often feel pressure to deliver yet another record EPS. In 20x2 MBA’s EPS on normal business amounted to 27.1 pence but when the impact of its exceptional events make themselves felt this rises to 38.9 pence per share, a massive increase from the previous year.
Note that a group of companies has to publish its consolidated profit and loss account but it is not required to publish the profit and loss account of the hold-ing company separately. The group must also publish last year’s consolidated figures.
5.12 The Consolidated Balance Sheet (and Parent Company’s Balance Sheet)
In comparison with many other published balance sheets, those of MBA are full of detail on the face of the statement; many companies prefer to keep the statement of major headings only and disclose the details by way of note.
Three items should be particularly noted in MBA’s balance sheets, all of which refer to the nature of consolidated accounts. The first is the item Investments:
Shares in Group Companies (ordinary shares purchased) acquired by the holding company in the subsidiaries owned by MBA, the principal ones of which would be listed in the annual report but are not reproduced here. When the balance sheets of the whole group are consolidated this item disappears and is replaced by the complete assets and liabilities underpinning the investments. The second point to note is that assets not so owned by the holding company are entered in the consolidated balance sheet as Minority interests (the last item in MBA’s consolidated balance sheet).
The third item worthy of note is Goodwill. In the group accounting example given earlier in the module, Ben Nevis acquired 70 per cent of Ben Lomond for
£40, but 70 per cent of Ben Lomond’s net assets amounted to £35. The transaction produced an asset called goodwill on the group balance sheet amounting to £5.
In MBA’s group balance sheet, goodwill amounts to £3281 million, the single largest asset. Accounting for goodwill is a topic that does not lend itself to quick explanation but suffice to say that there are two schools of thought. A group can either write-off each year’s purchased goodwill against reserves (old retained profits) in the balance sheet which would not affect the profit and loss account or it can be capitalised, that is treated like an asset on the balance sheet and each year’s reduction in value charged against that year’s profit. This latter method is the one used by MBA because it is the method mandated by accounting standards. Note 9 on p. 5/39 describes this method clearly and also describes the restatement of the previous year’s figures. Note that in 20x2 MBA’s profits suffered a charge of £189 million in respect of loss in value of goodwill. It can be appreciated that an annual amortisation of goodwill negatively impacts reported profits.
Consider the capital and reserves of MBA. Three items are worthy of expla-nation.
5.12.1 Called-up Share Capital
Under the provisions of the Companies Act companies are authorised to raise a certain sum of money through selling ordinary shares. This amount is normally fixed at a sum far greater than the sum of money required for current operations so that the company has the legal authority to sell more shares to finance expansion should that be deemed appropriate. From Note 19 on p. 5/48 we read that MBA has issued (‘called up’) £133.8 million of its authorised limit of
£175 million. When the amount issued reaches the authorised limit the company will petition the courts to raise its legal limit on authorised share capital.
5.12.2 Share Premium Account
During a company’s lifespan it may issue shares on numerous occasions. On each occasion it prices the shares to be sold in accordance with market conditions;
if it is a company whose shares are quoted on the Stock Exchange it would select a price around the stock market price. This price is likely to be far in excess of the share’s face value (or nominal price). In MBA’s case each share’s face value is 5 pence while the current market value is around £12. Were MBA to issue shares at this time, it would select an issue price of around £12 (or slightly less because it would want to tempt existing shareholders to subscribe for the new shares) and treat the difference between the two amounts (£12 less
£0.05) as share premium. This amount is used for the same purposes as the face value of shares issued, namely to finance the expansion of the business, but the Companies Act requires that the share premium account be shown separately (see separate section in Note 19, p. 5/48).
A very important point: a company’s finances are totally unaffected by the daily movements of its share price on the Stock Exchange. Although managers retain a close interest in the daily share price (an indicator of market confidence), there is no impact on the resources of the company.
5.12.3 Revaluations
The Accounting Policies stated at the outset that MBA has adopted the historical cost convention in drawing up its accounts. However, a close look at Note 19 Equity shareholders’ interest will reveal a revaluation reserve amounting to £847 million. This indicates that the board of MBA has considered it appropriate to revalue (increase!) some assets held at the end of the year. Look at Note 12 Fixed asset investments–joint ventures, associates and other, listed investments have been revalued by exactly £847 million. The directors must be confident that this increase in value is fairly permanent and one that is not liable to reverse.
Note that in published accounts there is no requirement to enter amounts to the last pound or penny; it is adequate to round up each amount to the nearest hundreds, or thousands, or sometimes millions, of pounds provided the truth and fairness of the accounts is not affected by such rounding. Take, for example, MBA’s fixed assets amounting to £5734 million: its accounts would not be clarified, nor would they be more informative if they entered the exact amount of £5 734 276 214.72p which may appear in the books. Conversely, a
small company whose fixed assets amounted to £478.98p might not show a true and fair view by rounding up to £500: the difference is material, that is, the amount would have a significant effect on the overall disclosed financial position of the company, so it would round to £480, depending on the rounding policy selected for the other amounts in the financial statements.