Discuss about the Financial and Quantitative Analysis for CIMIC.
Business presently face an ever increasing array of accounting issues. The financial reporting landscape needs to be regularly explored by a business to identify issues that matter most. The issues arrange from audit issues, accounting as well as regulatory alterations, and how such issues affect the business or the industry in general. To understand the effects of contemporary issues in accounting, the paper uses the case of Leighton Holding Company (CIMIC) to acknowledge and analyze the contemporary theories along with models in accounting, examining their application to the CIMIC situation.
The major premise of this report is on the current issues in Australian accounting anchored on the CIMIC. The models and theories in accounting have been identified and their respective application to solve the accounting issues facing CIMIC Company has been given. Some of the key issues facing the Company have been noted as poor governance, lack of disclosure of cash flows and high executive pay packages or remuneration. Three recommendations have also been given in line with both contemporary issues and the issues identified as salient in CIMIC.
Objectives of General Purpose Financial Reporting
The objective of general purpose of financial reporting is to provide information to the relevant users such as potential investors, lenders, and some creditors on the entity’s financial position, performance and cash flow.
Leighton Holdings Kickback Scandal
CIMIC’s success in relation to a high number of public infrastructure projects winning like WestConnex remains worrying. The high rates of winning where the market dynamics remain competitive in general correlate historically with low prices of bids, at very least characteristically implying taking more risks.
Nevertheless, this might not be true of current situation of CIMIC as it is noted that industry feedback continues to indicate that the firm has been aggressively bidding, may be raising the risks that certain bids have been underpriced. Morgan Stanley has in the past queried the troubled Middle Eastern joint venture of CIMIC called Al Habtoor Leighton Group. It warned that this joint venture had increasingly failed to pay interest on the loans from the Australian construction group this suggesting the need to review the book value of the loans of CIMIC.
The Morgan Stanley has target price of 12.4 dollars on CIMIC. The bank subsequently decreased its calendar 2016 forecast for the net profits after tax of CIMIC by fourteen percent to 420.90 million dollars and further dropped CIMIC’s 2017 and 2018 profit forecasts. CIMIC that report half annual results on July 20, has further guided investors to anticipate net profit in a range of 520-580 million dollars in complete year (Qiong and Jianjun 2011).
The senate inquiry has been called to probe CIMIC engagement in 16.8 billion WestConnex project. The former executive, Stephen Sasse has given a damning evidence regarding the corruption that took place within the CIMIC’s offshore arm, Leighton International. The firm’s board failed to act on the whistleblower’s concerns of 2008-2009 relating to its foreign executives. CPB Contractors, CIMIC subsidiary has won billions of dollars’ worth of joint contracts from the NSW administration to construct WestConnex motorway.
- Issues of poor disclosure
- Exaggerated profits
- Failure to
- Poor corporate governance
- Generous executive remuneration
- Corruption/bribery issues in winning the construction projects
- Failure to generate the underlying cash flow
Breach of Code of Ethics
The issues raised is that CIMIC seemed to have failed to generate the underlying cash flow notwithstanding reporting net profits after tax of 130 million dollars. The analyst failed to be convinced because the contractors failed to show the same levels of seasonality despite attributing cash out flows of about 327 million dollars to ‘seasonality’.
The cash flow size was never proportionately declining in line with revenue as it was increasing. Therefore, it is exceedingly hard to adjust for this, however, it might suggest that the reported profit surpassed the underlying supporting cash flow by thirty percent excluding seasonality.
The information published by CIMIC contradicts the accounts of CIMIC’s controlling shareholder Hochtief (Sun and Shin 2014). The Stanley Morgan’s assessment of Hochtief’s accounts meant that operating cash for the Asia Pacific mainly consisting of activities of CIMIC deteriorated about 19% annually contrary to the CIMIC’s comments of 28.5% improvement in operating cash flow at first quarter.
Corporate Governance failure
From agency theory viewpoint, corporate governance describes the process of supervision as well as the control aimed at ensuring that the management of the company acts according to the shareholder's interest. According to ASX principle, remuneration requires that companies need to make sure that remuneration level and composition is adequate as well as reasonable and have a clear linkage to performance.
Executive compensation or compensations is a mechanism through which corporate governance ensures that shareholders interest is achieved since remuneration should only be done as a stimulator to performance. Only when the compensation is understood as a stimulant to a performance by the management will the goals of corporate governance be achieved and thus an important influence in business.
It can be recommended with regards to the corporate governance for a change. It is noted from the above discussion that CIMIC has poor corporate governance. Therefore, there is an increasing need for the company to adopt the new and contemporary models of corporate governance by linking compensation to performance. The Company should engage in various internal reorganization and align its governance with the current practices.
Annual Report Analysis
The analysis revealed that margins of CIMIC were defying the descending pattern witnessed at other construction firms, increasing 7.8% in 1st quarter, despite disturbed projects like Macau’s Wynn Palace that could see CIMIC hit with liquidated damages along with Royal Adelaide Hospital that was behind schedule.
It is questionable how CIMIC managed to report its best margin in a minimum of ten years when all external signs indicating that it potentially had material project issues. It is, however, a self-evident truth that more problem projects fall short of having equal record margins even when portion of the project portfolio remain performing.
As reflected in the lack of disclosure of in CIMIC of underlying cash flow, this contemporary disclosure is important. In line with the IASB’s January 2016 release of the IAS 7 statement of cash flow amendments, AASB in March 2016, gave AASB 2016-2 Amendments to AAS-disclosure initiative to AASB 107. This change is relevant to solving the issues noted in CIMIC relating to the non-disclosure of underlying cash flows. This is because the amendments now makes it mandatory to disclose changes in the financial liabilities of the entity emerging from both cash flow alongside non-cash flow items.
The chairman’s report indicates that CIMIC is doing well. The chairman has appreciated everyone in the firm for being of great significance to the firm. He has given them a motivation to continue with their efforts to contribute to the firm.
The directors should ensure that the issues raised above are solved to avoid the negative effects they will have on the reputation of the firm. This is because they are salient issues and will thus affect negatively on the reputation of the firm. As has been witnessed in the discussion, the shares has decreased by 17% which is not good for the development of the business. Issues relating corruption, poor governance, disclosure, and executive pay remuneration identified in CIMIC are weighty and hence will give the rivals an added advantage if the directors do not take serious their duties (Fraser et al. 2013).
The primary aim of remuneration is to stimulate performance to ensure the shareholder's interest by attracting the right executives, retaining the right executives as well as motivate executives to maximize long-term firm value. Executive remuneration is, however, misused by some incompetent and opportunistic managers in who use remuneration systems as a motivator to fake the earnings of the firm they manage.
Accordingly, remuneration is important since the effects of remuneration systems on performance as well as corporate governance is critical. ACC unit supports this issue by suggesting that remuneration systems which correlate salary of the management the salary of management with financial performance have been acknowledged as a motivator to the management thus increasing financial performance (Kumar and Rabinovitch 2013).
Management will, however, be unable to forge the accounts in the long term and since there is an assumption of incompetence in management in the long-run, the positive correlation between financial performance and compensation is less probable. It is; therefore, important understand the link between executive remuneration and corporate governance to correct the deficiencies in corporate governance, decision analysis as well as judgment (Evans 2013).
The shares in thirteen billion construction giant CIMIC Group Ltd has declined 17% following Morgan Stanley analyst reportedly questioned its headline accounting numbers. It has been reported that the firm’s reported profits might surpass cash profits by thirty percent. The statutory or reported net profits for firms frequently fail to reflect the underlying cash flows of the business since they reflect the non-cash items (Kumar and Zattoni 2016).
The veracity of the financial accounts of CIMIC have thus been put into question by Morgan. The stock slumped $5.99 or sixteen percent, to close at $30.25. This followed the revelation by Nicholas Robinson that he could not reconcile cash flows in the first quarter of the company’s financial accounts thereby lowering earnings forecasts for 2016-2018.
Additional analysts have further questioned disclosure of CIMIC before along with its poor corporate governance as well as generous salary package for the executive Marcelino Fernandez Verdes, that gains from an increasing stock price. The executive has 1.2 million ‘share appreciation rights’ which provide him a cash payment thereby reflecting the share price of CIMIC increase from a base price of 17.710 to the price on the trading day before executing the rights that commenced vesting in March.
As reflected in the case of CIMIC above, executives are paid high packages besides stock options. Nevertheless, grants of stock options and restricted stock have been discovered in current compensation models not to be free of cost to the firms and they have been failing to produce desired impact of making top management increasingly vested in long-term objectives. The contemporary practice require executives to buy and hold stock with after tax dollars and variants with similar impacts.
Corporate Social Responsibility
From the above case, it is now possible to identify the contemporary models and theories linked to executive remuneration, disclosure of profits and underlying cash flow as well as governance and show how they apply to the CIMIC’s situation as identified above. The AASB has issued amendment for Australian disclosure initiative on extra cash flow statements disclosure.
The contemporary cash flow reporting models or ISA 7 will be used to compel the CIMIC to present a cash flow statement as integral component of the firm’s primary financial statement. This will help understand whether the profit reported by the firm was really actual or exaggerated as noted by Stanley Morgan. In this case, the CIMIC will be required to classify and present cash flow into operating undertakings based on direct or indirect method, investment undertakings and financial undertakings, with the latter 2 classification generally presented on the basis of gross.
Another contemporary accounting issue facing CIMIC relates to the executive compensation. There is a need to link compensation to corporate governance. There is an increasing controversy over the executive pay packages. However, what remains clear is that executive compensation along with corporate governance remain inextricably connected and significant effort as well as cost are needed to effectively align incentives and decrease opportunism of every corporate stakeholder.
The CIMIC needs to employ the current issues of relating to disclosure by including the cash flow statements as an integral part of the primary financial report. This will make it possible for the analysts like Stanley Morgan to reconcile the cash follows. By doing this, the firm will be able to regain its reputation by clearing the negative image already created.
The other recommendation relates to executive remuneration should be reviewed to be in line with the contemporary practice. Giving the executive such a huge high package alongside stock option only makes the executives to engage in short run project at the expense of the organization. This is because the executive will not be interested in the interest of the business owner but rather his own interest. Accordingly, he will engage in practices that increase the stock prices so as to get more compensation.
Evans, T. G. 2013. Accounting theory: contemporary accounting issues. Mason (Ohio), Thomson/South-Western.
Fraser, I.A., Henry, W.M., House, C.A. and Yards, H., 2013. The future of corporate governance: Insights from the UK. Edinburgh: Institute of Chartered Accountants of Scotland.
Kumar, P. and Rabinovitch, R. 2013. CEO entrenchment and corporate hedging: Evidence from the oil and gas industry, Journal of Financial and Quantitative Analysis, 48: 887–917.
Kumar, P. and Zattoni, A., 2016. Executive Compensation, Board Functioning, and Corporate Governance. Corporate Governance: An International Review, 24(1), pp.2-4.
Qiong, H. and Jianjun, D., 2011. Research on Critical Issues in Contemporary Accounting. In Proceedings of the 7th International Conference on Innovation & Management.
Sun, Y. and Shin, T. 2014. Rewarding poor performance: Why do boards of directors increase new options in response to CEO underwater options?, Corporate Governance: An International Review, 22: 408–421.