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Accounting Theory And Governance: Financial Knowledge

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Question:

Discuss about the Accounting Theory and Governance for Financial Knowledge.

 

Answer:

Introduction

Financial knowledge has been a must in order to take the review of the company financial performance. As the investors it is not possible to review the whole business performance and to take decisions to invest in the various choices of investment options. In this regards Australia Securities and Investment Commission (ASIC) has provided 10 major points that every investors need to undertake before making the decision to invest in any company. All these points help investors to analyze the performance of the company and to come with the proper choice. All these points are defined in detail and are really helpful for the investors. In this report in order to explain all these points a case study 1 has been undertaken and various questions to case study has been answered. For case study company called Wesfarmers has been taken to explain the case study questions.

Executive remuneration is always the concern for the stakeholders as their pay increase year to year even in the situation of financial crises. In order to explain the reform undertaken to make changes on how the remuneration of the top management has to be calculated, the case study 2 has been taken and various questions has been answered.

 

Summary of Case Studies

  • Case Study 1: This study provides the 10 major points that every investors must review in context of any company chosen for investment purpose before making the decision of investment. In this regard Wesfarmers has been selected to explain the procedure.
  • Case Study 2: This study discusses the issues with the excessive executive remuneration in the United States and reforms to make changes in the calculation of the executive remuneration.

Analysis of Annual Report (Company Name: Wesfarmers)

Examining figures in financial statements

The financial statements developed by an entity aims to reflects its financial performance for supporting the decision-making of end-users. In this context, the ASIC (Australian Securities Investment Commission) has provided suggestions to the non-professional investors for evaluating the financial performance of a company through its financial statements analysis. The suggestions are provided on ASIC for protecting the interests of investors so that accurately interprets the financial information for making informed decisions for investing (Australia, 2011). The financial performance of Wesfarmers Limited, Australian retail giant, can be based from the financial statements net figures of income statement and balance sheet as per ASIC guidelines. The income statement analysis has depicted that the company has recorded a net increase in its profit in the year 2017 as compared to the financial year 2016. The underlying net profit has increased to 22.1 per cent in the year 2017 and has reached to $2,873 million. The earnings per share have increased to 21.6 per cent and return on equity has reported an increase to about 12.4 per cent in the year 2017 as compared to the previous financial year. The increased profitability of the company has resulted in raising the dividend per year from $1.86 per share to $2.23 per share in the year 2017 (Wesfarmers 2017: Annual Report). The increased cash inflow of the company on account of its improved return on capital has helped in to expand its business operations. As reflected from the director’s report of the company, its improved financial performance has resulted from its recent conglomerate structure. The company is presently emphasizing on its strategy of providing improved return to shareholders through realizing larger returns form its industrial businesses in Kmart and Bunnings.

Important Financial Figures in Understanding the Financial Performance of the Company

As analyzed from the case study, the ASIC has regarded the financial figures disclosed in the director’s report in order to gain an insight into the profit or loss realized by a company.  The directors of Wesfarmers have also discussed the financial performance of the company in the annual report through the help of some key financial figures (Hussey and Ong, 2005). The financial figures include profit after tax, earnings per share, return on equity and dividend per share. The financial figure relating to profit after tax depicts to the investors regarding the percentage of money earned on per dollar of revenue.  The investors can gain an insight into the net profit realized by a company after meeting its all tax related expenditure.    It enables the investors to analyze the profitability of a company without the impact of operating leverage thus the investors can actually predict its real financial condition. The earnings per share depict the amount of money earned by a company per every outstanding share of stock. It helps the investors to predict the financial profits that a company can provide to its shareholders. The return on equity provides a measure of the profitability of a company in comparison to the net investment (Wesfarmers 2017: Annual Report). The dividend per share of a company indicates the profits earned by the shareholders giants the number of outstanding shares. The key financial figures predicting the financial performance of Wesfarmers Limited can be depicted from its annual report are as follows:

Source: https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0

Management Opinion in the Report about the Financial Figures

The operating and financial review presented by the Director’s in the annual report the primary objective of the company is to provide good returns to its shareholders. The company aims to achieve strong financial performance in each of its divisional units that will be controlled by the divisional board of directors. The operating and financial review of the company has outlined the major risks and future growth prospects of the company as well based on its key financial figures. The financial performance of the year 2017 has represented the profitability of each of its divisional unit along with providing an analysis of its competitive environment through assessing the financial risk and prospects. The company recorded a net profit after tax (NPAT) of about 2,873 million in the financial year 2017 as compared to that of $1,946 million in the year 2016. Thus, it can be said that there is significant increase of $2,466 million in the current financial year of the company in net profit after tax.  The cash flows have also increased from $861 million to $4,226 million in the year 2017 (Wesfarmers 2017: Annual Report).

The increase in operational cash inflows indicates the higher earnings growth and adequate managing and controlling of each inventory in all of its retail segments. There is also a decrease in the capital expenditure of the company in the year 2017 to $218 million as compared to $1,681 million in the year 2016. As per the director’s review, the decrease in the capital expenditure is due to fewer openings of its retail stores and thus reduction in the operational expenditure across its industrial divisions. The company also has realized proceeds of about $947 million due to divestment of receivables from its Coles divisional unit. The balance sheet of the company has also strengthened mainly due to reduction in the net financial debt that includes interest rate swap assets to about $4,321 million in year 2017 as compared to $2,216 million in the year 2016. Also, there is a significant reduction in the financial cost of the company to about 14.3 per cent from that of the previous year. The management of the company has regarded the increase in its operating cash flows and return on equity on account of its adequate conglomerate structure and its emphasis on improving the cash generation and capital efficiency (Wesfarmers 2017: Annual Report).

 

Assessment of Financial Report in relation to Management Opinion

Management has elaborated the financial performance of the company through using the graphs and charts. As per the ASIC reports it is essential to examine the management viewpoint on the performance of the company and what actually has been reported in the financial statements prepared. For instance, the management of the Wesfarmers has point that the in the current year (2016-17) the profitability performance of the company has been increased and they are paying good returns to their shareholder’s. There is high amount of increase in the revenue of the company due to improvements made in retail and industrial business. It has been told by the managing director that cash generation was quite strong that reflects the company value to increase the return on capital invested in the business. Finance director has elaborated the operating financial position of the different units in the Wesfarmers and according to the report the net profit after tax has been $2873 million AUD which itself a record for the company (Dagwell, Wines and Lambert, 2015). On reinvestigating whole financial statements it has been found that there are no such discrepancies in the management disclosures of the financial performance and that reported under the audited financial statements. So it can be said that there is no change in the financial performance as reported by the management personals and as described in the financial statements of the company. There is major reason behind similarity of management disclosure and what has been disclosed by the audited reports of the company (Wesfarmers 2017: Annual Report). The reason is such that annual reports are prepared after financial statements have been audited and verified by the top management. Top management people provide their statements on the financial performance of the company after reviewing the audited reports of the financial statements so that true and fair picture of the financial statements can be presented in front of the users of the annual report (Henderson, 2015).

 

Analysis of the Wesfarmers as the potential investment

In order to analyze the company for its potential investment it is necessary to make the detailed interpretation of the financial performance so that investors can use such information to make the judgment regarding their investment in the company. Wesfarmers has varied potential that can attract the investors (Horngren, 2012). Wesfarmers works in different category of business such as retail segment, industry segment, home improvement segment and many others that made a different from other to make the investment. Company has diverse business operations and high growth balance sheet. The retail segment of the company has foreseen major improvement in recent years and it has been monitored by various changed made. Continuous improvements in merchandising and service; increase in customer satisfaction through regular change in interaction at the stores and online purchase; and investment proposals are some of the major highlights in the change of retail segment of the Wesfarmers (Bazley, Hancock and Robinson, 2014).

The whole group cash generation power has increased out rightly that has provided the management to manage the capital structure and to make the position of the balance sheet strong. Wesfarmers continuously take opportunities to create and to improve the shareholder’s wealth through proactively management of the portfolio and reviewing the strategies regularly so that business resources are put in high end growth segments of the company.

Coles the major segment of the business has faced high competition and pressure of increase sales margin. In this action, the plan is to focus on the budgeted plans and to further enhance the quality of the fresh offer and to improve the merchandising and availability, through driving the operational efficiencies in order to the support investments in the various services and values. There is expectation and budget driven approach to increase the performance of the Home Improvement segment of the business (Wesfarmers 2017: Annual Report).

Overall analysis of the part performance of the company shows that company has done exceptional well in year 2017 as compare to other previous year and it makes a valid choice for the investors to make investment in such growing company. The growth of the company is marked with many potential and valid proofs such as increase in dividend payout, high cash generation capacity, solid capital structure and plan to improve the further business segment. This made the Wesfarmers a strong competitor for the other companies in same segment and also for companies that are in competition as a potential investment for the investors (Wesfarmers 2017: Annual Report).

 

Recent Changes for Addressing Executive Remuneration in the United States

The given article ‘Reining in Executive Pay’ has addressed the need for developing implementing laws and regulations for addressing the excessive remuneration of the executives. In this context, the article has particularly examined the excessive pay provided to the executives in the United States. The executives are realizing higher pay in the United States as indicated from the fact that there is increase of about 42 per cent executive remuneration in the year 2008 despite of the collapse of the financial sector of the country.  There is significant growth in the executive pay over the consecutive years and thus there is higher need for developing financial reforms in relation to monitoring of pay of executives. In this context, the U.S government ha introduced a legislation knows as shareholder ‘say on pay’ to be followed by all the publicly traded U.S companies (Executive Compensation and Incentives, 2006). As per the legislation, the shareholders have a right to decide over the matters relating to executive remuneration that should be followed by the Board of Directors. In addition to this, the law has also stated that shareholders as per the SEC regulations can appoint their own directors candidates through ballots if the company’s present directors does not approve their decisions. Also, it is necessary for the U.S. companies to maintain the independency of the board of directors in appointing and developing the remuneration committee. The Board of Directors must also ensure that the corporations disclose all the relevant information regarding the executive pay and its relation o financial performance. The reforms introduced by the government in relation to monitor and control the excessive pay provided to the executive’s aims at preventing the increased rewards to executives. This is necessary because the increased rewards provided to executives can drive the misconduct in manager’s behaviour by manipulating the financial information for achieving higher pays when it is linked to the company’s financial performance.

Effectiveness of reforms on the Shareholders Assumptions to Act

The article has discussed the reforms introduced by the U.S. for monitoring the pay structure of executives in order to ensure that executives does not receive higher rewards that drive them to conduct unethical practices for achieving higher benefits. The reforms introduced by the U.S. government known as shareholder ‘say on pay’ has stated that all the public-listed companies in the country will decide the remuneration of the executives based on the shareholders opinions. Thus, as such it can be said that the effectiveness of the reforms is based on the assumptions that the shareholders will act ethically and right in deciding over the matters of executive remuneration (McDonnell, 2008). However, there are some barriers to effective shareholder control over the executive remuneration. The major obstacle faced by the Board of the company in this regard is developing an effective strategy for creating an effective communication channel for disseminating the information to the shareholders.  Thus, as such business entities need to induce changes in its business environment to promote effective communication of all the information related to executive remuneration policies to the shareholders. Also, it can be argued by the contract theory that corporations have contractual obligations with the shareholders and therefore they should act in favour of the shareholders to provide them larger returns (Finance Committee, 2016). Thus, the corporations can influence the decision-making power of shareholders in relation to executive pay through promising them larger retunes. Thus, as such shareholders have profit interest in the corporations and therefore the power provided to them for monitoring the executive pay cannot be stated to be right and just. The independency of the shareholders in deciding over the matters of executive remuneration is question of debate as stated in the present article. Therefore, as discussed in the given article there is need for introduction of more better regulations in the U.S. that provides authority to all the stakeholders of a busies corporation not only to shareholders for deciding and monitoring the executive remuneration.

Role of Taxation laws and Denying Contract Adoption for Addressing Executive Remuneration

The article has stated that shareholders decision in relation to executive remuneration cannot be regarded to be accurate as it is based on assumptions that they will act ethical and fair in deciding the executive pay. Thus, the article has stated that the reforms introduced should provide authority to all the stakeholders including consumers, workers and all the communities that are impacted by corporate operations. This is because the corporation’s activities’ can put all its stakeholders to risk and therefore the responsibility of the executive pay decisions should not be provided only to shareholders but to all the stakeholders. In this context, the tax dollars paid by the general public should not help in subsidizing the executive pay in excess. This can result in a significant reduction of millions form the income taxes that corporations pay as excessive executive remuneration.  In addition to this, there is need for developing a federal contract with the companies that provides remuneration to their executive 100 times more than that of their labour wages (Treanor, 2016). The contract would help in reducing the economic inequality as the contract would require that business companies in the U.S. should maintain a fair proportion of the remuneration between its executive and workers and should provide the ratio between the CEO compensation and the workers in their annual report as well. The introduction of such measures will help in developing the strong corporate governance practices for curbing the excessive executive remuneration (McDonnell, 2008).

Conclusion

It can be inferred from the overall analysis of the report that ASIC plays a major role in protecting the investors interest through providing them suggestions to analyse the annual report disclosures of various corporations. Also, the executive remuneration should not be linked to the financial performance of a company as this can result in occurrence of fraudulent financial activities in a business entity.

Recommendations

On the basis of the case study analysis, it is recommended to the investors that they should consider the suggestions provided by the ASIC while analysing the annual report of their selected company. This will help in securing the interests of amateur investors do not possess adequate knowledge about the annual disclosures of a company. In addition to this, as analysed from the second case study there is need for developing strong regulations that provides more power to the stakeholders  in deciding over the matters of executives remuneration.

 

References

Australia. 2011. Australian Corporations & Securities Legislation 2011: Corporations Act 2001, ASIC Act 2001, related regulations. CCH Australia Limited.

Bazley, M., Hancock, P. and Robinson, P. 2014. Contemporary Accounting PDF. Cengage Learning Australia.

Dagwell, R., Wines, G. and Lambert, C. 2015. Corporate Accounting in Australia. Pearson Higher Education AU.

Executive Compensation and Incentives. 2006. Retrieved 10 October, 2017 from https://www.lse.ac.uk/fmg/researchProgrammes/corporateFinance/corporateGovernance/pdf/executiveCompensationAndIncentives.pdf

Finance Committee. 2016. Recommendations and Decisions of the International Civil Service Commission to the General Assembly (including Changes in Salary Scales and Allowances). Retrieved 10 October, 2017 from https://www.fao.org/3/a-mq160e.pdf

Henderson, S. et al. 2015. Issues in Financial Accounting. Pearson Higher Education AU.

Horngren, C. et al. 2012. Financial Accounting. Pearson Higher Education AU.

Hussey, R. and Ong, A. 2005. International Financial Reporting Standards Desk Reference: Overview, Guide, and Dictionary. John Wiley & Sons.

McDonnell, B. 2008. Two Goals for Executive Compensation Reform. Retrieved 10 October, 2017 from https://scholarship.law.umn.edu/cgi/viewcontent.cgi?article=1168&context=faculty_articles

Treanor, J. 2016. Pay ratios could be made public as part of executive salary reform. Retrieved 10 October, 2017 from https://www.theguardian.com/business/2016/jul/25/pay-ratios-could-be-made-public-as-part-of-executive-salary-reform

Wesfarmers 2017 Annual Report. Retrieved 10 October, 2017 from  https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0

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