REPORT
To           : A private shareholder
From      : Management accountant
Date       : 31/12/2014
Subject   : Performance and position of Mion

As requested, I have analyzed the performance and position of Mion. My analysis is based on extracts from the financial statements for the year ended 31 December 2014 with comparative figures for the year ended 31 December 2013. A number of key measures have been calculated and these are set out in the attached Appendix.

SALES
The company has opened six new stores during the year. However, sales have only increased very slightly in 2014 and annual sales per store have fallen. This may be because the new stores have only opened part way through the year and have therefore not contributed a full year’s revenue. Alternatively, there may have been an increase in the level of sales tax.

Annual sales per store are still above the industry average. On the face of it, this is a good sign. However, it is possible that Mion has large stores relative to the rest of the sector.

PROFITABILITY
Gross profit margin has increased very slightly during the year and this is a little above the industry average. However, although net profit margin has increased significantly during the year, this is still below the industry average. The increase in net profit margin has occurred because operating expenses have fallen by over a quarter in 2014. The operating profit margin has risen from 3.8% in 2013 to 4.5% in 2014.

Given the information available, the mostly likely cause of this fall is the increase in asset lives and the resulting reduction in the depreciation expense. As might be expected, the company has a considerable investment in property, plant & equipment and depreciation would normally be significant expense. An increase in asset is relatively unusual and it is possible the directors have used this method to deliberately improve the operating and the net profit margins. (They may have been particularly concerned that the net profit margin has obviously been well below the industry average.)

On the other hand, the directors may have carried out their review of assets lives in good faith or there could be another legitimate reason why operating expenses have fallen. For example, the 2013 figure may have been inflated by a significant “one off” expense.

It is impossible to prove that the profit figure has been manipulated on the basis of the very limited information available. Information about the reasons for the fall in operating expenses and review of asset lives and about the property, plant & equipment held by the company would be extremely useful.

OTHER MATTERS
Non-current asset turnover has improved slightly, but still below the industry average. This suggests that the company uses its asset less efficiently than others in the same sector. However, increasing the asset lives will have reduced the ratio for 2014; it is possible that the company’s asset turnover would have approached the sector average had the review not been carried out. Given that six new stores have opened in 2014, it is surprising that property, plant & equipment has only increased by GHS5 million in the year. It is possible that most of the investment in new property was made during 2013.

The current ratio for both years is extremely low. Supermarkets often do have relatively low current and quick ratios, but no average figure for the industry is available, so it is difficult to tell whether this is normal for the type of operation. Short-term liquidity appears not to be a problem because the company has a positive cash balance which has increased in the year. However, the appearance of the statement of financial position suggests that this has been achieved by delaying payment to suppliers. Trade and other payables have increased by nearly 9%, while revenue and cost of sales have only increased by approximately 3%.
The debt/ equity ratio has fallen in the year and gearing does not appear to be a problem.

CONCLUSION
Mion’s profit margins appear to be reasonable for a company in its industry sector. Although its net profit margin is below the industry average, this is improving. There are no apparent short-term liquidity problems.

It is possible at least some of this improvement has been achieved by deliberately reducing the operating expenses for the year. If, as seems likely, the directors wish to sell their interest in the company in the near future, improved results will help to secure a better price.
However, it is impossible to be certain that this has happened without much more detailed information about the reason for the fall in operating expenses. There may be legitimate explanation for the improvement in the company’s profit margins.

APPENDIX:

Relevance:
Information has the quality of relevance when it can influence, on a timely basis, users’ economic decisions. It helps to evaluate past, present and future events by confirming or perhaps correcting past evaluations of economic events. There are many ways of interpreting and applying the concept of relevance, for example, only material information is considered relevant as, by definition, information is material only if its omission or misstatement could influence users. Another common debate regarding relevance is whether current value information is more relevant than that based on historical cost. An interesting emphasis placed on relevance within the Framework is that relevant information assists in the predictive ability of financial statements.
That is not to say the financial statements should be predictive in the sense of forecasts, but that (past) information should be presented in a manner that assists users to assess an entity’s ability to take advantage of opportunities and react to adverse situations. A good example of this is the separate presentation of discontinued operations in the income statement. From this users will be better able to assess the parts of the entity that will produce future profits (continuing operations) and users can judge the merits of the discontinuation ie has the entity sold a profitable part of the business (which would lead users to question why), or has the entity acted to curtail the adverse effect of a loss making operation.

Faithful representation:
The Framework states that for information to be useful it must be reliable. The quality of reliability is described as being free from material error (accurate) and a faithful representation of that which it purports to portray (i.e. the financial statements are a faithful representation of the entity’s underlying transactions). There can be occasions where the legal form of a transaction can be engineered to disguise the economic reality of the transaction. A cornerstone of faithful representation is that transactions must be accounted for according to their substance (i.e. commercial intent or economic reality) rather than their legal or contrived form. To represent faithfully, information must be neutral (free from bias). Biased information attempts to influence users (perhaps to come to a predetermined decision) by the manner in which it is presented. It is recognized that financial statements cannot be absolutely accurate due to inevitable uncertainties surrounding their preparation. A typical example would be estimating the useful economic lives of non-current assets. This is addressed by the use of prudence which is the exercise of a degree of caution in matters of uncertainty. However prudence cannot be used to deliberately understate profit or create excessive provisions (this would break the neutrality principle). Reliable information must also be complete, omitted information (that should be reported) will obviously mislead users.

Comparability:
Comparability is fundamental to assessing an entity’s performance. Users will compare an entity’s results over time and also with other similar entities. This is the principal reason why financial statements contain corresponding amounts for previous period(s). Comparability is enhanced by the use (and disclosure) of consistent accounting policies such that users can confirm that comparative information (for calculating trends) is comparable and the disclosure of accounting policies at least informs users if different entities use different policies. That said, comparability should not stand in the way of improved accounting practices (usually through new Standards); it is recognized that there are occasions where it is necessary to adopt new accounting policies if they would enhance relevance and reliability.

Compliance-based approach:
A compliance-based approach is primarily designed to ensure that the company acts within the letter of the law and that violations are prevented, detected and punished. Some organizations faced with the legal consequences of unethical behaviour take legal precautions such as those below;
** Compliance procedures
** Audits of contracts
** Whistleblower Opportunities
** Disciplinary procedures
Corporate compliance is limited in that it refers only to the law but legal compliance is not an adequate means for addressing the full range of ethical issues that arise every day. This is especially the case where voluntary codes of conduct and self-regulation are perhaps more prevalent.

Integrity-based approach:
An integrity-based approach combines a concern for the law with emphasis on managerial responsibility for ethical behaviour. Integrity strategies strive to define companies guiding values, aspirations and patterns of thought and conduct. When integrated into day-to-day operations of an organization, such strategies can help prevent damaging ethical lapses, while taping into powerful human impulses for moral thought and action. An integrity based approach to ethics treats ethics as an issue of organization culture.
Ethics management has several tasks;
** To define and give life to an organization’s defining values
** To create an environment that supports ethically sound behaviour
** To instil a sense of shared accountability amongst employees

The table below indicates some of the differences between the two approaches;

In conclusion, mere compliance with the law is no guide to exemplary behaviour, an integrity-based approach incorporates ethics into corporate culture and systems.

The following is a set of key actions required to help organizations maximize the value from ethical performance within an ethical culture.

• Make it a strategic priority
• Set the tone from the top
• Develop a code of ethics
• Develop and support routes to report suspected violations
• Engage and communicate
• Focus on training
• Measure effectiveness and revisit regularly
  

The International Integrated Reporting Council (IIRC) has released a framework for integrated reporting. The Framework establishes principles and concepts which govern the overall content of an integrated report. An integrated report sets out how the organization’s strategy, governance, performance and prospects can lead to the creation of value. The IIRC has set out a principles-based framework rather than specifying a detailed disclosure and measurement standard. This enables each company to set out its own report rather than adopting a checklist approach. The integrated report aims to provide an insight into the company’s resources and relationships, which are known as the capitals and how the company interacts with the external environment and the capitals to create value. These capitals can be financial, manufactured, intellectual, human, and social relationship, and natural capital but companies need not adopt these classifications. Integrated reporting is built around the following key components:
(i) Organizational overview and the external environment under which it operates

(ii) Governance structure and how this supports its ability to create value

(iii) Business model

(iv) Risks and opportunities and how they are dealing with them and how they affect the company’s ability to create value

(v) Strategy and resource allocation

(vi) Performance and achievement of strategic objectives for the period and outcomes

(vii) Outlook and challenges facing the company and their implications

(viii) The basis of presentation needs to be determined including what matters are to be included in the integrated report and how the elements are quantified or evaluated.

The Framework does not require discrete sections to be compiled in the report but there should be a high level review to ensure that all relevant aspects are included. An integrated report should provide insight into the nature and quality of the organization’s relationships with its key stakeholders, including how and to what extent the organization understands, takes into account and responds to their needs and interests. Further, the report should be consistent over time to enable comparison with other entities. The IIRC considered the nature of value and value creation. These terms can include the total of all the capitals, the benefit captured by the company, the market value or cash flows of the organization and the successful achievement of the company’s objectives. However, the conclusion reached was that the Framework should not define value from any one particular perspective because value depends upon the individual company’s own perspective. It can be shown through movement of capital and can be defined as value created for the company or for others. An integrated report should not attempt to quantify value as assessments of value are left to those using the report. The report does not contain a statement from those ‘charged with governance’ acknowledging their responsibility for the integrated report. This may undermine the reliability and credibility of the integrated report. There has been discussion about whether the Framework constitutes suitable criteria for report preparation and for assurance. There is a degree of uncertainty as to measurement standards to be used for the information reported and how a preparer can ascertain the completeness of the report. The IIRC has stated that the prescription of specific measurement methods is beyond the scope of a principles-based framework. The Framework contains information on the principles-based approach and indicates that there is a need to include quantitative indicators whenever practicable and possible. Additionally, consistency of measurement methods across different reports is of paramount importance. There is outline guidance on the selection of suitable quantitative indicators.

There are additional concerns over the ability to assess future disclosures, and there may be a need for confidence intervals to be disclosed. The preparation of an integrated report requires judgment but there is a requirement for the report to describe its basis of preparation and presentation, including the significant frameworks and methods used to quantify or evaluate material matters. Also included is the disclosure of a summary of how the company determined the materiality limits and a description of the reporting boundaries. A company should consider how to describe the disclosures without causing a significant loss of competitive advantage. The entity will consider what advantage a competitor could actually gain from information in the integrated report, and will balance this against the need for disclosure.

On the acquisition of a subsidiary, the purchase consideration must be allocated to the fair value of its net assets with the residue being classed as goodwill (or negative goodwill if the assets have a greater fair value than the purchase consideration. IFRS 3 revised Business Combinations recognizes that it is not always possible to accurately determine the value of some assets at the date of acquisition and therefore allows a measurement period up to the end of the first full reporting period following the period of acquisition. As the revision to the value of Accra Ltd.’s assets was due to more detailed information becoming available, the fall in its asset values should be treated as an adjustment to provisional valuations made at the time of acquisition. In effect the net assets and goodwill should be restated to GH₵15,000,000 and GH₵9,000,000 respectively; the fall of GH₵1,000,000 is not an impairment loss and should not be charged to the income statement. The above assumes that the recoverable value of the company as a whole is greater than GH₵24,000,000.

The fall in value of Tema Ltd.’s assets is the result of events that occurred after the acquisition (i.e. physical damage to the plant) and this does constitute an impairment loss. The plant and machinery and machinery should be written down to its recoverable amount and the loss charged to the income statement. On the assumption that the recoverable value of the company as a whole has not fallen, goodwill will not be affected.

On the basis of the original estimates, AT Group Ltd.’s earth – moving plant was not impaired, the value in use of GH₵500,000 being greater than its carrying value. However due to the dramatic increase in interest rates causing AT Group Ltd.’s cost of capital to increase, the value in use of the plant will have to be recalculated. As the discount rate has risen this will cause the value in use to fall. There is insufficient information to be able to quantify this fall. If the new discounted value is above the carrying value of GH₵400,000 there is still no impairment. If it is between GH₵245,000 and GH₵400,000, this will be the recoverable amount of the plant and it should be written down to this value. As the plant can be sold for GH₵250,000 less the selling costs of GH₵5,000; then GH₵245,000 is the least amount that the plant should be written down to even if its revised value in use is below this figure.

The treatment of the research and development costs in the year to 30th June 2015 was correct due to the element of uncertainty at that date. The development costs of GH₵75,000 written off in that same period should not be capitalized at a later date even if the uncertainties leading to its original write off are favourably resolved. The treatment of the development costs in the year to 30th June 2015 is incorrect. The directors’ decision to continue the development is logical as at the time of the decision the future costs are estimated at only GH₵10,000 and the future revenues are expected to be GH₵150,000. It is also true that the project is now expected to lead to an overall deficit of GH₵135,000 (120+75+80+10-150 in GH₵’000). However at 30th June 2015, the unexpensed development costs of GH₵80,000 are expected to be recovered. Provided the criteria in IAS 38 Intangible

Assets are met these costs of GH₵80,000 should be recognized as an asset in the statement of financial position and matched to the future earnings of the new product. Thus, the director’s logic of writing off the GH₵80,000 development costs at 30th June 2015 because of an expected overall loss is flawed. The directors do not have the choice to write off the development expenditure.

An impairment loss arises where the carrying value of an asset, or group of assets, is higher than their recoverable amounts. In effect the standard requires that assets should not appear in a statement of financial position at a value which is higher than they are worth. The recoverable amount of an asset is defined as the higher of its net realizable value (i.e. the amount at which it can be sold for net of direct selling expenses) or its value in use (i.e. its estimated future net cash flows discounted to a present value). IAS 36 Impairment of Assets recognizes that many assets do not produce independent cash flows and therefore the value in use may have to be calculated for a group of assets – a cash generating unit.

The standard recognizes that it would be too onerous for companies to have to test for impaired assets every year and therefore only requires impairment reviews when there is some indication that impairment has occurred. The exception to this general principle is where an intangible asset has an indefinite useful or is not yet available for use, in which case an impairment review is required at least annually. This also applies to goodwill acquired in a business combination. Impairments generally arise where there has been an event or change in circumstances. It may be that something has happened to the assets themselves (e.g. physical damage) or there has been a change in the economic environment relating to the assets.

Indicators of Impairment which may be available from internal or external sources;

• Poor operating results – this could be a current operating loss or a low profit. One year’s losses in itself does not necessarily mean there has been an impairment, but if this is coupled with previous losses or expected future losses then there is an indication of impairment.
• A significant decline in an asset’s market value (in excess of normal depreciation through use or the passage of time) or evidence of obsolescence (through market changes or technology) or physical damage.
• Evidence of a reduction in the useful economic life or the estimated residual value of assets.
• Adverse changes in the market or economy such as the entrance of a major competitor, new statutory or regulatory rules or any indicator of value that has been used to value an asset.
• A commitment to a significant reorganization or restructuring of the business.
• Loss of key employees or major customers.
• Increases in long-term interest rates which could materially impact on value in use calculations thus affecting the recoverable amounts of assets.
• Where the carrying amount of an entity’s net assets is more than its market capitalization.
  

The amount to be capitalized to the cost price of the warehouse in 2014 can be calculated as follows:

Accounting for Investments – Avocado Group Ltd.

Investment in Akwadu Productions:
After the second acquisition on October 1, 2015, Avocado Ltd holds a total of 57% of the issued share capital of Akwadu Productions and so has control over Akwadu Productions from that date. The holding will be treated as an available for sale financial asset up to September 30, 2015. And as a subsidiary from October 1, 2015 under the provisions of IFRS 3 Business Combinations. From October 1, 2015, Avocado Ltd should be consolidated, pro-rating for three months control in the consolidated statement of comprehensive income for the year ended 31st December 2015.
In a step acquisition where control is acquired, IFRS 3 requires that the original investment is treated as being realized at its fair value. This fair value is added to the consideration paid for the controlling interest in the subsidiary and the proportionate non-controlling interest to calculate the goodwill arising on consolidation.

Investment in Akpakpa Ventures Ltd.:
Avocado Ltd has acquired 90% of the issued ordinary share capital of Akpakpa Ventures Ltd. Therefore it is assumed to have control of Akpakpa Ltd and should consolidate it as a subsidiary under the provisions of IFRS 10 Consolidated Financial Statements. As the subsidiary was acquired mid-year, the income, expenses and other comprehensive income should be pro-rated in the consolidated statement of profit or loss and other comprehensive income for ten months that avocado Ltd had control.

Investment in Waatre Impex Ltd.:
Although Akpakpa Ventures Ltd holds 65% of the issued ordinary share capital of Waatree Impex Ltd, the investment is held exclusively with a view to sale within the next four months. Therefore the holding will be included in the group’s financial statements under the provisions of IFRS 5 Non-current assets held for sale and discontinued operations.
Avocado Ltd holds 90% of Akpakpa’s 65% interest in Waatree Impex Ltd. As Avocado’s intends to sell the investment in the next four months and is actively marketing it, the assumption must be that it meets the IFRS 5 criteria to be treated as held for sale. The assets and liabilities of Waatre Impex Ltd will be treated as held for sale. The assets and liabilities of Waatre Impex Ltd will be treated as a disposal to the group and measured at the lower of carrying amount and fair value less costs to sell. Waatre Impex Ltd will not be consolidated line by line, but rather as two single amounts, assets held for sale and liabilities held for sale. In the consolidated statement of comprehensive income, the minimum required is to show as a single line entitled to discontinued operations the profit of Waatre Impex Ltd and any gain or loss on re-measuring the investments to fair value less costs to sell.
Investment in Akutu Brothers Ltd.:
Avocado Ltd holds 40% of the issued ordinary share capital of Akutu Brothers Ltd. Therefore it is assumed to be able to exercise significant influence over Akutu Brothers Ltd which should be treated as an associate under the provisions of IAS 28 Investments in Associates and Joint Ventures. Akutu Brothers Ltd will be included in the group’s financial statements using equity accounting. In the consolidated statement of financial position, the investment should be measured at cost on initial recognition and then in each subsequent period the group share of Akutu Brothers Ltd.’s post-acquisition retained reserves should be added less any goodwill impairment. In the consolidated statement of comprehensive income, the group share (40%) of Akutu Brothers Ltd.’s profit and other comprehensive income should be included.

There are several reasons why an accountant should study ethics. The moral beliefs that an individual holds may not be sufficient because often these are simple beliefs about complex issues. The study of ethics can sort out these complex issues by teaching the principles that are operating in these cases. Often there may be ethical principles which conflict and it may be difficult to decide on a course of action. The study of ethics can help by developing ethical reasoning in accountants by providing insight into how to deal with conflicting principles and why a certain course of action is desirable.

Another important reason to study ethics is to understand the nature of one’s own opinion and ethical values. Ethical principles should be compatible with other values in life. For example, one’s reaction to the following circumstances: the choice between keeping your job and violating professional and ethical responsibilities, the resolution of conflicts of interest if they involve family.

A good reason for studying ethics is also to identify the basic ethical principles that should be applied. Professional accountants are required to adhere to a set of fundamental principles in the course of their professional duty, such as confidentiality, objectivity, professional behaviour, integrity and professional competence and due care. The main aim of professional ethics is to serve as a moral guideline for professional accountants. By referring back to the set of ethical guidelines, the accountant is able to decide on the most appropriate course of action, which will be in line with the professional body’s stance on ethics.

Although the takeover does not benefit the company, its executives or society as a whole, the action is deceptive, unethical and hence unfair. It violates the relationship of trust, which the company has with society and the professional code of ethics. There are nothing but good reasons against the false disclosure of profits.

The directors should be persuaded that professional ethics are an inherent part of the accounting profession. Professional ethics are a set of moral standards applicable to all professionals. Each professional body has its own ethical code which requires its members to adhere to a set of fundamental principles in the course of their professional duty, such as confidentiality, objectivity, professional behaviour, integrity and professional competence and due care.

Often there may be ethical principles which conflict with the profit motive and it may be difficult to decide on a course of action. An accountant has an ethical obligation to encourage the directors to operate within certain boundaries when determining the profit figure. Users are becoming reactive to unethical behaviour by directors. This is leading to greater investment in ethical companies with the result that unethical practices can have a greater impact on the value of an entity than the reporting of a smaller profit figure. Ethical issues are becoming more and more complex and it critical to have an underlying structure of ethical reasoning, and not purely be driven by the profit motive.