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FINANCIAL REPORTING STANDARD
Terms in this set (21)
Discuss factors which may indicate a going concern problem for Acellerate, and factors which indicate otherwise.
Indicators of an ability to continue as a going concern:
• Positive operating profit.
• High cash flow from operating activities.
• Positive cash balance.
• Site closures.
Indicators of an inability to continue as a going concern:
• A significant decrease in sales revenue.
• Excessive reliance on short term borrowings (Need to repay E$174m borrowings in 2021)
• Reducing cash balances.
• Going from profit making to loss making over the past 12 months.
• Adverse key financial ratios.
• Site closures
Definition of corporate governance
Corporate governance is the means by which a company is operated and controlled.
Companies should be run well in the interests of a range of stakeholders (not just shareholders), including the wider community.
The UK and many other countries adopt a 'principles-based' corporate governance regime, which leaves it to individual companies to decide how best they can adhere to corporate governance principles.
Other countries, such as the USA adopts a 'rules based' approach which is more prescriptive in how to comply with corporate governance requirements.
Both approaches seek to achieve the same objectives.
The key corporate governance principles
2. Effective board of directors
5. Relations with shareholders
It is acknowledged that some of the issues noted above will necessarily incur additional cost if implemented by Acellerate.
However, the additional costs incurred may lead to improvements in the way that the company operates and in the quality of decision-making.
Any changes introduced to improve corporate governance are likely to be viewed favourably by decision-makers when submitting tenders for contracts especially with government bodies.
Other suggestions, such as the formalisation of holding regular board meetings and recording decisions at those meetings could be implemented very easily with minimal cost.
Similarly, allocating responsibility to a director to maintain a risk register (along with information relating to management of risks identified) probably only formalises what currently happens on a day-today basis.
A company should have effective leadership from a board of directors which has collective responsibility for decision-making.
Ideally, there should be a split of responsibilities between
- chair of the board who is responsible for the smooth running and conduct of board meetings, and
- the managing director who is the chief operating officer on a day-to-day basis.
Additionally, there should be both executive and non-executive directors - provide a robust and objective challenge to the operational directors in board meetings to ensure that their strategies and policies are appropriate and effective.
Acellerate may benefit from the appointment of a director to chair board meetings and the appointment of one or more non-executive directors.
These appointments would not need to be full-time, but they may add value to the decision-making process within board meetings, as well as demonstrate awareness of corporate governance issues
Effectiveness of the board of directors
The board should comprise of individuals who have an appropriate range of skills, expertise and experience to ensure that it can discharge its responsibilities effectively. This includes appropriate induction training for new board members, and they should have sufficient time and resources to discharge their responsibilities.
Acellerate has an experienced Board. However, it may wish to have an induction session for any new directors appointed, along with ensuring that meetings are held regularly (e.g. quarterly) and that minutes of such meetings are taken and circulated to all board members
The board should be accountable for its decisions which should be based upon a balanced and objective assessment of the position and prospects of the company. This includes the requirement to maintain sound risk management and internal control systems.
It may be appropriate for a current director to take on responsibility for risk managements and perhaps maintain a risk register, along with notes of how those risks have been managed or mitigated. The effectiveness of internal control systems should be subject to regular review.
This could be achieved, for example, by requesting an external firm of accountants to conduct a review of our internal control systems and report its findings to the board
Care would need to be exercised to ensure that any appointed firm is sufficiently independent of the external audit reporting function.
Remuneration of directors should be adequate to recruit and retain individuals of the required calibre, but without being excessive.
Non-executive directors, (if appointed) could share some of the responsibility for determining a transparent remuneration policy for board members, and to evaluate their performance, particularly if part of the remuneration package is performance related.
Relations with shareholders
The board has responsibility to ensure that there is an effective dialogue with shareholders. At present Joseph Waller is the sole shareholder but shareholder relations may become more important if the shareholder base is expanded at a future date in order to raise additional finance.
Acellerate should ensure that the annual reports and accounts provide information to shareholders and other stakeholders that is relevant and reliable and which enables them to assess their investment in the company.
Valuation of Property, Plant, and Equipment
The Framework requires that the elements recognised in the financial statements are quantified in monetary terms. This requires the selection of a measurement basis. There are a number of different ways of measuring assets such as property.
An entity should select the base that would provide the most relevant and faithful representation of the property in line with the fundamental qualitative characteristics. For example, if the property is volatile in price and highly sensitive to market factors, then a current value approach would be more relevant. If the property was to be held in the long term and is stable in value it could be considered that historical cost provides the more relevant (and less costly) information.
Property is generally assumed to be held in the long term and mostly stable in value, even in times of recession and as such Acellerate appear to have held Property, Plant and Equipment at its historic cost value.
The global economic recession has impacted the business, and no doubt property prices, though
out most of 2020. This may mean that the value of Acellerate's property has reduced, however this does not necessarily mean that a revaluation, or an impairment, would be necessary.
The difference between a property impairment and a property revaluation
An asset impairment and asset revaluation are two very similar adjustments, with subtle differences. Both require the evaluation of the asset for their fair value, and then take appropriate action in updating their ledgers.
The major difference between the two is that a revaluation can be made upwards to increase the value of the asset to market value, or downwards to decrease the value.
An impairment, on the other hand, only refers to a fall in the market value.
Another difference between the two is the event which triggers the adjustment.
An asset revaluation can happen at any point, usually when the directors feel that the carrying value of the asset is significantly lower than their fair value, and want to reflect that fair value on the Statement of Financial Position.
Typically a revaluation would increase the carrying value initially, although in subsequent years the value may reduce, resulting in a downward revaluation.
An asset impairment is unique, in that at the end of each reporting date, an entity should assess whether there is any indication that an asset may be impaired. If such indications exist, the recoverable amount should be estimated, i.e. an impairment review should be carried out. If no such indications exist, it is not necessary to carry out an impairment review.
Typical indicators that an asset has been impaired would include a decline in market value, technological, legal or economic changes, physical damage or plans to dispose of the asset.
If an entity revalue a property in accordance with IAS 16 Property, plant and equipment (IAS 16), the impact of the associated accounting entries is to state the asset account at the revalued amount, eliminate the accumulated depreciation to date relating to the property, and increase or decrease the revaluation surplus within equity in the statement of financial position.
How the revaluation of a property is accounted for in the financial statements
The accounting entry for an increase in valuation would be:
Debit: Property asset account with the increase in value from original value
Debit: Accumulated depreciation (depreciation up to the revaluation date)
Credit: Revaluation surplus (revalued amount - previous carrying amount)
The revaluation surplus arising is an unrealised gain and it will be disclosed as an item of 'other comprehensive income' in the statement of profit or loss and other comprehensive income.
The accounting entry for a decrease in valuation would be:
Credit: Property asset account with the decrease in value from original cost
Debit: Accumulated depreciation on property to remove existing accumulate depreciation.
Debit: Statement of profit or loss (expense) with the decrease in value from carrying value.
Note that the debit to the statement of profit or loss would be debited against the revaluation surplus account if the asset had previously be revalued upwards.
The new carrying amount of the property will be depreciated over its remaining estimated useful
This will give an annual depreciation charge which will be charged as an expense in the statement of profit or loss in arriving at profit before tax for the year.
How the impairment of a property is accounted for in the financial statements
In line with IAS 36 Impairment of Assets (IAS 36) an impairment loss occurs when the recoverable amount of an asset is below its carrying amount.
The recoverable amount would be calculated by taking the higher of the:
- net selling price (Fair value - costs to sell) versus
- the value in use (presesnt value of estimated future cash flow arising from use and disposal assets).
Any impairment loss should be recorded as an expense in the statement of profit or loss, unless the asset has previously been revalued upwards. If the asset had previously been revalued, the impairment can be offset against the revaluation surplus.
The accounting entry for these steps is identical to those of a downwards revaluation. The impairment and the downward revaluation are essentially the same, with different names.
Whether the property must be revalued/impaired annually, or can this be done periodically.
If Acellerate choose to revalue it is not necessary for the property to be revalued every year, and for that revaluation to be incorporated into the financial statements.
However, it is important that the information in the financial statements is reliable and relevant for users of financial information. Therefore, the revaluation must be performed with sufficient frequency that the information relating to the property is relevant and reliable to users. It may be suggested that, the more volatile the property valuation, the more frequently it should be subject
to incorporating that valuation in the financial statements.
If the property subsequently falls in value, then this should be accounted for in the financial statements. The fall in value should first be set against the revaluation surplus relating to that property, with any excess fall in value written off as an expense in the statement of profit or loss.
As there would then be a change in the carrying amount of the property, the annual depreciation charge must be recalculated based upon the remaining estimated life of the property at that point in time.
If Acellerate choose to conduct an impairment review, and the recession is deemed to have impaired the carrying value of the property, then this would be accounted for as a one off.
Subsequently, Acellerate would still have to conduct their normal annual impairment reviews, but would not be bound to impair the value with any regularity, only where there were future indications of further impairment
Whether it is necessary to show all items of property, plant and equipment at their recoverable value in order to have a consistent accounting policy
In common with other IFRS Standards, IAS 16 requires that its accounting requirements should be applied consistently. IAS 16 requires that all items of the same class should be subject to the same valuation model, normally the cost model or the valuation model. However, if different classes of property, plant and equipment can be distinguished, it is possible to apply a different valuation model to each class of property plant and equipment.
Therefore, it is possible for the valuation model to be applied when accounting for the property, whilst the cost model is applied to other items of plant and equipment such as machinery and office equipment.
IAS 36 differs slightly to IAS 16 in this regard, in that only the asset which has actually been impaired should be reduced in value, other items of the same class would be subject to the same impairment review, but would not have to be impaired unless the indicators for impairment were present to those assets specifically.
Information relating to the valuation model, along with method(s) and rate(s) of depreciation should be disclosed within the notes to the financial statements. If the asset is deemed to have been impaired then the reasons for this should be detailed
Lease - Accounting treatment
The contract you have outlined is likely to fall within the definition of a lease for the purposes of IFRS 16 since it permits us to use an asset in exchange for
payment going forward. As such, we would recognise a lease liability in our statement of financial position at the present value of the payments that have not yet been made, in this case, E$5.5m. In this case, there are no residual value guarantees or purchase options, so we do not need to consider these matters further.
If the first payment of rent is to be made at the inception of the lease, this would be deducted from the E$5.5 on initial recognition.
We would also recognise a right-of-use asset in our statement of financial position. In our case, this would include the E$5.5m present value of the lease payments, plus any initial direct costs and the costs of restoring the site to its initial state at the end of the lease.
In this case, the lease term is 20 years with no options to cancel or renew. The lease term on which the present value calculation should be based is, therefore,
the nominal 20 years.
The lease liability will be increased at the implicit interest rate in the lease. The interest charge will be expensed to the statement of profit & loss. The lease liability will be decreased by the payments made under the lease and recorded at the new value (after both the interest increase and payment decrease adjustments) in the statement of financial position. The lease liability will be reflected in both current liabilities to the extent that it is payable within one year and non-current liabilities in relation to subsequent years.
The right-of-use asset declines in value over the life of the lease, reflecting the fact that we will have the use of it for a shorter period. We would record it in
the statement of financial position at its amortised value. Depreciation will be calculated over the shorter of the useful life or the term of the lease. In this instance, I would expect that to be the 20 years of the lease. We would therefore reduce the value of the asset straight line over 20 years, or E$275k p.a. In the event that there is any impairment loss during the life of the lease, this would also be deducted from the right of use asset.
Property Plant and Equipment - Accounting treatment
In accordance with IAS 16 Property, Plant and Equipment an asset should be recognised as an asset when:
- it is probable that future economic benefits will flow to the entity and
- the cost of the asset can be measured reliably
Applying IAS 16 Property Plant and Equipment, the site would be recorded at cost in the statement of financial position, including any costs incurred to bring it into a workable condition. Given that the site is considered to have an indefinite useful life, this implies that the site currently has no buildings on it. The treatment of any structures we erect would need to be considered separately, but in general, buildings would be capitalised and depreciated over their useful life.
The costs of establishing the shuttle service and the running costs thereof would not be recognised as a part of the cost of the larger 10,000 sqm. the site, since they do not relate directly to the asset.
IAS 16 requires that we apply either the cost model or the revaluation model. The choice between these methods is our option, but we will be required to apply that choice consistently to assets of the same class. If we have already made an election between these models on other land assets, then we would follow that election.
The cost model would generally require no ongoing entries in relation to the land since it has an indefinite useful life and there is, therefore, no depreciation.
The revaluation model would require us to revalue the property periodically and record the asset at its fair value.
In both models, if there are impairment losses in the future, we would be required to write down the asset accordingly. The asset would be held at cost less impairment losses under the cost model, or fair value less impairment losses under the revaluation model.
Explains any additional costs over the shorter term that we may need to consider
Additional costs to be considered
In order to establish the new business, we will need to hire and train the staff required to run the new facility. This could include retaining recruitment consultants to find suitable candidates, allocating management time to interview candidates, the costs associated with drawing up employment contracts and researching applicable employment law in Seldomland. Training is likely to be an ongoing cost, but this will be significantly front-loaded, as the whole of the new team will need to be shown how the business is to be run.
We will also need to establish IT and communications systems for the new business. The new facility itself will require these systems, but they will also need to be integrated with existing business systems so that we have seamless reporting across the group. I am sure that Megan and Gavin will be very keen to ensure that this is the case.
We may also have security costs as part of the expansion. This could include the cost of CCTV, security guards or physical access controls. We must understand any potential security threats that the new centre could pose. Although it is unlikely that we will be the target of a robbery, we do not have any experience of operating a business in Seldomland and thus, we should strive to manage any risks that could occur during the expansion.
how these may be financed
The most immediate and obvious method of financing our short-term costs is through using our cash balance. We had a sharp drop in our cash balance between 2019 and 2020 (-25%) and thus it may not be fully appropriate to use our cash balance for all of the short-term costs that will be incurred as part of this expansion. However, one advantage associated with this type of financing is that carries no interest cost and requires no action in regard to managing receivables or payables.
Another method of financing these costs would be to collect any receivables balances that we have due on our commercial credit facility. I am aware that Acellerate offers commercial customers a credit facility and it may be possible to call in some of that debt if it is overdue. It may even be possible to offer an early settlement discount to our commercial customers, as long as that early settlement discount is lower than the interest rate on overdrafts.
Finally, we could increase our cash reserves immediately by engaging the services of a factoring company. There are two different types of factoring - With recourse, under which, the factor does not take the risk of bad debts and without recourse, under which, the factor does take the risk of bad debts. Engaging in a factor could release some cash immediately as factors provide a percentage of the value of a credit sale immediately and then provide the remainder (minus a charge) at a later date. This may be a way to get some immediate cash to service some of the costs associated with the proposal. Whilst factoring is a great way to raise short-term financing, it is also quite expensive and may be unnecessary if our existing cash balance already covers the shorter-term costs associated with the expansion.
Non-financial Considerations for Replacement Decision
One non-financial consideration that we should make in regards to this decision is whether our maintenance and sales staff would require additional training if we were to choose the electric fleet. We already offer some electric vehicles, but perhaps these new electrical vehicles may be more complex and could require our maintenance staff, in particular, to go on training courses to learn how these cars are configured. In addition, our sales staff may require training and a debrief on the benefits of these cars such that they will be able to answer any customer queries in relation to these cars and use the "green" credentials of these vehicles to help increase sales.
The environmental impact of our decision also needs to be considered. The direction of travel in patterns of consumer behaviour is generally towards "greener" alternatives. This is likely to be especially true among our younger customers, who may generally be more environmentally conscious. Electric vehicles, therefore, offer us the chance to position Acellerate as a brand committed to reducing adverse impacts on the environment. This is likely to stand us in good stead for the future as today's young customers mature into frequent business users. Electric vehicles generally come from newer, more 'tech savvy' manufacturers. We may find that such manufacturers are leading the charge towards connected technology. Therefore, increasing the electric proportion of our fleet will help ensure our connected-car technologies are leading the rental market.
Financial Considerations for Replacement Decision
The initial cost of electric vehicles is significantly higher than that of conventional ones. Using the figures provided, this is expected to amount to an increase of E$29.60-20.85 = E$8.75m to purchase the electric vehicles. This is around 4% of our fleet's value, and we will therefore need to consider:
- how this additional expenditure would be financed and whether it is likely to constrain our future borrowing ability. We already have a substantial amount of borrowings, and we will need to consider the impact that either option will have on our capital structure. Increasing our borrowings significantly will increase our debt servicing payments, and this may put pressure on our profits.
The running costs of our vehicles form a significant part of the overall fleet cost. For a small car, the initial difference in the purchase price is E$4,000. However, the running costs per year for a small conventional vehicle are budgeted to be E$4,720. We anticipate that the running costs of electric vehicles will be 40% less than their conventional counterparts. As an example, we could expect to save E$4,720 x 0.4 x 4 = E$7,552 over the 4 year life of our small vehicles, more than offsetting the increased initial outlay. Similar savings would apply to the other vehicle sizes in our fleet, making the electric vehicles seem very attractive over their useful lives.
100% First Year Allowances, Impact on Replacement Decision
Tax depreciation allowances are available on items of plant and machinery (including cars used for business purposes) at a rate of 25% per year on a reducing balance basis. A full year's allowance is available in the year of purchase.
At the moment, we are able to claim a capital allowance of 25% on a reducing balance basis. The government's proposal would mean that we would be able to use the full cost of the fleet as a tax-deductible expense. If we are to purchase the electrical fleet per your attached schedule, it would cost us E$29.6 million. If the government provide 100% allowances, this will give us a tax deduction of E$29.6 million in 2021 or whichever year we decide to make this purchase. This is far more than the current capital allowance, which would grant us a tax-deductible expense of E$7.4 million in Year 1. Given that our business model is to generally keep cars for less than one year, the new tax allowances could be an incentive for Acellerate to pursue the electrical car option.
This being said, it is important to note that the new incentives may be somewhat irrelevant to Acellerate if the company fails to make a profit in 2021. Our financial performance in 2020 was such that we made a loss. As a result of making a loss, we would not have made any tax payments, and thus if we make a loss again in 2021, these tax deductions will not be as relevant.
In addition, I would assume that the government is allowing the tax deductions for electric vehicles to be claimed entirely in the first year of purchase. This means that it might make more sense for Acellerate to replace electric vehicles annually rather than keeping them for a four year period. The government may institute rules around this, however, so we should carefully examine any instruction on this new capital allowance.
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