A New Ratio from Manchester Business School

Hi friends,

Attended a taster seminar by Mr Bob Ryan of Manchester Business School.

Interestingly he is rumoured to be the examiner for ACCA's new financial management paper. After listening to him for 2 hours, I wish "All the Best" to those taking that paper :)...

Back to the topic proper.

What is the issue?
When companies are required to show aggressive numbers, creative accounting (hei! actually some are not so creative after all) becomes the order of the day. Companies like Enron, ACCS and Informatics are at various stages of proving their respective revenue recognition being true.

Is there a magic panacea to detect this problem before it explodes and takes the savings of thousands of good hardworking people and places thousands of people out of work?

The ultimate test of a true revenue is whether that revenue is convertible to "CASH".

The question an investor, a good CEO, a good CFO should asked is whether the Operating Cash Flow (OCF) commensurates with the rapidly growing Operating Profit (OP). If OP had grown by 300% while OCF grew by a meagre 2%, one should ask where had the OP gone to?

The Panacea
The panacea as proposed by Mr Bob Ryan required us to calculate the COP, Cash to Operating Profit ratio.

COP = EBITDA / OCF

The steady state would be COP = 1 where a $1 of EBITDA would translate to $1 of OCF.

Mr Bob Ryan said the ratio would have detected a severe dislocation in ENRON given its COP of 19!!!!!!

Tired and sleepy.. pardon me for any typo and factual disjointment..
Good night and take care.

Bonus issue of new shares

For my students.

Many are unable to tell the difference between bonus issue and rights issue of shares. I wish to present my interpretation on bonus issue to shed some light on this front.

Is this a possible exam questions? Of course, my friends.

Bonus Issue
Essentially we are issuing new shares by capitalising the reserves ie.

DR Reserve account
CR Share capital account

Any cash flow from the issue?
No money exchanged.
The company will send notices to shareholders to inform on the number of shares allocated based on the approved ratio.

Example - You were holding 1,000 shares prior to bonus issue. The company has been approved to issue bonus shares on the basis of 1:4. You would be issued 250 bonus shares for a total holding of 1,250 shares.

Are you any richer given the higher number of shares you now have?
Theoretically no. Has the company make any monies from the exercise? The answer is no. It is merely a paper exercise. Every existing shareholder maintains status quo in terms of their percentage ownership of the company.

Then why would a company do a bonus issue?
The company has essentially issued more shares to increase liquidity of the counter by reducing the absolute dollar value of each share. For example, DBS Bank may issue enough bonus shares to reduce its current share price from an "expensive and prohibitive level" of $20 to a more affordable level of $8. Then more people can "afford" to buy the shares and participate in success of DBS Bank.

Trust this helps. :)

Opening Stock and Closing Stock

For my Students.

Issues
You may have noticed that the Closing Stock figure is usually placed outside the Trial Balance. You would then use the figure in computing Cost of Sales in the Profit and Loss (P&L) Account. The figure is then presented as part of Current Assets in the Balance Sheet.

Have you ever wonder where did the Closing Stock figure come from and how it enters the accounting system? Two questions on stock were asked for Jun 2006 ACCA Paper 1.1 Preparing Financial Statement.

My views
Profit and Loss account is part of the double entry system.

Balance Sheet and Trial Balance are essentially just listing of account balances.

Closing stock balance is a factor of price and quantity.

• The quantity is tracked by the no. of deliveries in and out over the financial year and confirmed after a physical stock count after end of financial year.
• Price is determined after doing the FRS2's lower-of-cost-and-NRV exercise.

To transfer the Opening Stock to P&L account,
DR P&L account
CR Stock account

To bring Closing Stock into the accounting system,
DR Stock account
CR P&L account

Not many lecturers can or bother to explain this nowadays.
Hope it helps. Cheers :)

Amendments to Companies Act (Part 2)

What are the other amendments made?

1. Reforms in the capital maintenance regime.
2. Liberalise the amalgamation process for companies.

Huh!!! Blur???
What do you mean? I share the same reaction as you. Allow me to present my understanding of these lesser known rules as compared to those discussed in Part 1, my earlier posting.


What is that?
The regime ensures that the shareholders cannot happily deplete capital from the entity without due consideration to the creditors' interest and the working capital needs of its daily operations.

Under the old regime, the following are prohibited:-

• financial assistance to 3rd parties to buy its shares;
• reduce share capital (unless you got permission from High Court) and;
• share buybacks.

Under the new regime, the following are now in force.

• Company can now give financial assistance to buy its shares. How much? Up to 10% of share capital or if all shareholders are offered the same assistance.
• Now a company can do a capital reduction through a special resolution subject to 2 conditions. The company must perform a solvency test and do the necessary publicity ie. an advert in a national newspaper.
• Why do the publicity? If you, a creditor of the company, saw the Notice in the newspaper and are unhappy with the proposal, you may seek legal redress.
• The directors must sign a "Solvency Statement" ie. to confirm that the company can meet its obligations and that assets > liabilities. So if the coffee aunty's salary is not paid when due, the directors who signed that Solvency Statement may to pay her salary personally!

These changes further escalate the directors' responsibilities in managing the affairs of companies. They are earning their fees. :)

Amendments to Companies Act (Part 1)

What are the amendments made?

1. Shares no longer have a par value.
2. Companies can hold treasury shares.

Effective date - 30 Jan 2006

What are the implications?

1. In the absence of par value, a company may have greater flexibility in pricing new shares to be issued in raising new capital. This was a particular concern when distressed companies faced tremendous difficulties in attempting to encourage take up of new shares priced at par value.
2. The term "Authorised Capital" is now part of history too.
3. Treasury shares are shares of the company purchased during share buybacks for various reasons eg. to enhance shareholders' value. The company now has the flexibility to hold these purchased shares in a treasury account for possible subsequent issuance eg. as part of employee compensation scheme.
4. For balance sheets as at on or after 30 Jan 2006, you should not see any share premium account and capital redemption reserve. These accounts will now be part of Share Capital account under the Act.

FRS103 for 2 companies who got married

What is the Rule?
According to FRS 103 for Business Combinations, all intangible assets acquired in a business transaction must be separately identified and valued by the buyer. Applicable from Jan 2005.

This new requirement has affected the way companies think and work in the following areas:-

• states how business acquisitions should be accounted for
• the valuation of intangible assets
• defining the various types of intangibles acquired into registered trade marks, patented technology, trade secrect and/or the plain old goodwill
  

What is the big deal between the old and new rulings?
Under the old regime, the buyer can basically disregard its existence by letting it "rot away" ie. being amortised away somewhere in the balance sheet.

Under the current FRS103, the buyer's management has to make an effort in protecting and enhancing these intangible assets' value after acquiring them. Annual review for impairment is necessary.

Shareholders of the buying company or the investing community would be reminded to query its management over any significant impact on profit due to changes to valuation of intangibles. This happened to DBS Bank last year.

For the selling company, it would accelerate a sale if its management is able to crystalise the intangible assets to the buying company by compiling a comprehensive customer database, registering trade marks, patenting innovative technologies and protecting trade secrets.

Directors are sweating over Interim Results

What is the Rule ?
Directors are required to confirm that "to the best of their knowledge, nothing has come to the attention of the Board of Directors which may render the interim results false or misleading". Effective 1 Sep 2006.

This is a negative confirmation rule ie. to state that generally there is nothing wrong, as compared to "generally everything is ok".

So why are the directors sweating over it?
- unable to rely on the comprehensive audit work done by auditors in year-end audit
- they have to worry whether the internal processes and procedures are vigorious
- especially if the company has operations over many countries with thousands of employee
- wondering to buy professional assurance service and incur more compliance costs

What is the proposed solution?
ACCA has proposed that directors should be allowed to explicit:-
- add a "read-and-act-at-your-own-risk statement" and,
- the numbers are mere estimates.

Conclusion
There is a need to find a balance to give some interim information to shareholders on the performance of the company and yet put certain amount to pressure to ensure credibility of information presented by directors.

Reference - "Use estimates to take heat off directors: Accounting bosy", Lee Su Shyan, ST 25 Sep 2006