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A potential investor in Mitchells and Butlers plc (MB) does not understand the performance and position of MB as shown in its Financial Statements for the year ended 26 September 2015.  You have been approached for the following advice:

a) Calculate ratios for profitability, liquidity and gearing for the years 2015 and 2014.
b) Analyse the performance and position of MB based on the above ratios.
c) Evaluate MB’s reporting of property, plant and equipment with reference to IAS 16 Property, Plant and Equipment and IAS 36 Impairment of Assets and the Conceptual Framework.
    

This should be spread between the 3 sections a) to c) in proportion to the marks available.

In part  b) above:
Stating that a ratio has increased or reduced  attracts no marks.
Stating that a ratio has improved or worsened attracts marks but not a pass mark.
Listing generic causes of ratio changes unrelated to MB is worthy only of a basic pass mark.
Identifying specific causes and effects of ratio changes for MB attracts a good mark.
Precise analysis of issues in depth and placing ratios in context with one another attracts an excellent mark.

In part c) above:
Discuss the requirements of IAS 16 and IAS 36
Provide examples from MB of compliance with IAS 16 and IAS36
Provide examples from MB of compliance with the Framework and thus provision of useful information.
The format of your work would be better if the above 3 areas of work were integrated rather than written as separate sections.

Part (a) - Calculating Ratios

Mitchells and Butlers Plc generally deals in managing the restaurants and pubs. The main objective of the company is to make their guests comfortable and make them love to eat and drink with the brand. They deal in the large and fragmented UK eating and drinking out market (Mbplc.com 2017). The format and the portfolio of the company includes some big names like Browns, Toby Carvey, All Bar One, Harvester, Sizzling Pubs, Crown Carveries, Stone house, Miller & Carter and Ember Inns. As per the view of the company, food can be the primary item that can assure long term and sustainable growth for the company in the competitive industry of eating and drinking.

Computation of ratios

Ratio

Formula

2015

2014

Profitability ratio

Return on capital employed

Profit before interest and tax/(Equity + long term debt)

0.065

0.064

Return on equity

Profit after interest before tax/equity

0.099

0.104

Asset turnover

Sales/(equity + long term debt)

0.507

0.476

Gross profit margin

Gross profit/Sales

0.531

0.725

Operating profit margin

Operating profit/sales

0.129

0.134

Liquidity ratio

Current ratio

Current assets/current liabilities

0.556

0.553

Quick ratio

(Current assets - Inventory)/Current liabilities

0.518

0.510

Efficiency ratio

Debtor days

Average trade receivables/credit sales*365

0.521

0.463

Creditor days

Average trade payables/Credit purchases*365

35.908

61.956

Inventory ratio

Average inventory/Cost of sales*365

9.440

17.173

Gearing ratio

Interest cover

Profit before interest and tax/interest expenses

2.077

2.000

Earnings per share

Profit after tax and preference dividend/no. of equity shares

0.250

0.226

Price to earnings ratio

Share price /EPS

10.266

11.761

Ratio

Formula

2015

2014

Profitability ratio

Return on capital employed

Profit before interest and tax/(Equity + long term debt)

=270/(1271+2876)

=264/(1185+2952)

Return on equity

Profit after interest before tax/equity

=126/1271

=123/1185

Asset turnover

Sales/(equity + long term debt)

=2101/(1271+2876)

=1970/(1185+2952)

Gross profit margin

Gross profit/Sales

=1115/2101

=1428/1970

Operating profit margin

Operating profit/sales

=270/2101

=264/1970

Liquidity ratio

Current ratio

Current assets/current liabilities

=353/635

=342/618

Quick ratio

(Current assets - Inventory)/Current liabilities

=(353-24)/635

=(342-27)/618

Efficiency ratio

Debtor days

Average trade receivables/credit sales*365

=((3+3)/2)/2101*365

=((2+3)/2)/1970*365

Creditor days

Average trade payables/Credit purchases*365

=((100+94)/2)/986*365

=((84+100)/2)/542*365

Inventory ratio

Average inventory/Cost of sales*365

=((27+24)/2)/986*365

=((24+27)/2)/542*365

Gearing ratio

Interest cover

Profit before interest and tax/interest expenses

=270/130

=264/132

Earnings per share

Profit after tax and preference dividend/no. of equity shares

=103000000/412520626

=93000000/411637885

Price to earnings ratio

Share price /EPS

=366.5/35.7

=417.5/35.5

Profitability ratio – the company uses this ratio for evaluating the profit earning capability of the company and analysing various s operating as well as other associated costs during the accounting period ( Picker et al. 2016). Generally, the higher amount of profit is considered good and it indicates that the company is growing and achieving competitive advantages over the competitors.

  • Return on the capital employed– this ratio measures the efficiency and profitability of the company with which the capital of the company is employed. It can be identified that the company’s return on the capital employed is stable over 2014 and 2015 as the company’s profit before interest and tax and long term debts are stable and more or less same over the 2 years period ( Robinson et al. 2015).
  • Return on equity– it is the percentage of net income returned to the stakeholders. It measures the profitability of the company through revealing the profit that the company can generate with the invested amount of the shareholders. The return on equity of the company has been reduced from 0.104 to 0.099 in 2015 from 2014 as the amount of equity increased in 2015 as compared to 2014 whereas the amount of profit after interest before tax has not been increased proportionately.
  • Asset turnover– it measures the efficiency of the company with regard to the usage of the assets for the purpose of generating the revenue or income from sales. It reveals the generation of sales with each dollar of the company’s assets (Uechi et al. 2015). The asset turnover of the company has been increased from 0.476 in 2014 to 0.507 in 2015 as the sales of the company increased from 1970 in 2014 to 2101 in 2015.
  • Gross profit margin and operating profit margin– both the ratios recognizes the company’s financial status and long term sustainability through identifying the amount left with the company after meeting the cost of goods sold and meting the operating expenses of the company (Fridson and Alvarez 2011). Both the ratios have been reduced in 2015 as compared to the year 2014. The reason behind this was that though there is an increase in the sales revenue from 1970 to 2101 in the year 2015 from the year 2014, the cost of selling the goods as well as various operating expenses has been increased in the year 2015 as compared to the year 2014.  

Liquidity ratio – under accounting, the liquidity term is stated as the company’s ability to meet the financial obligation on becoming due and it measures the ability of the organization to pay the short-term debts of the company. Current ratio measures the current assets of the company as compare to the current obligations of the company, whereas, the quick ratio does not take into consideration the inventories while measuring the amount of current assets of the company.

It has been identified that much changes were not there in the current ratio as well as the quick ratio of the company over the years of 2014 and 2015. The reason behind this was that there was not much change in the current asset as well as current liabilities of the company from 2014 to 2015. The current liabilities of the company were increased from £ 618 million to £ 635 million whereas the current assets of the company increased to £ 4,429 million from £ 4,429 million. Therefore, it can be found that significant increase or decrease were not there with regard to the current assets as well as current liabilities over the year 2014 and 2015. Further, the company has current assets that are only able to pay 55% of its liabilities. The shortage was mainly because of big part of the fund owed by the company is towards the liabilities related to tax and trade payables.

Part (b) - Analyzing Performance Based on Ratios

Efficiency ratio – the efficiency ratio is used by the company for assessing the ability of the company to use the liabilities as well as the assets. The efficiency ratio measures the receivable turnover and the days required for collecting the receivables, repayment of the payables and time required for the payment of the dues and uses of the inventories.

  • Debtor days– it reveals the efficiency of the company with regard to the collection of its receivables from the debtors. If the company takes more time to collect the debts, the debtor days will be more whereas if the company takes less time in collecting the debts the debtor days will be less and the company will be regarded as more efficient. It can be seen that the debtor days of the company has been increased from 0.463 to 0.521 and the probable reason behind that may be loosening the credit period by the company or the debtors failed to pay on time.
  • Creditor days- it reveals the efficiency of the company with regard to the payment of its payables to the creditors. If the company takes more time to pay the debts, the creditor days will be more whereas if the company takes less time in paying the debts the creditor days will be less and the company will be regarded as more efficient. It can be seen that the creditor days of the company has been significantly reduced from 61.96 days to 35.91 days and the probable reason behind that may be the creditor tightened the credit period or the company was able to pay the payables before the due date (Mazzi, Liberatore and Tsalavoutas 2016).
  • Inventory ratio– it reveals the company’s efficiency with respect to inventory management comparing with the cost of sales. As the inventory ratio of the company has been significantly reduced from 17.17 in 2014 to 9.44 in the year 2015. The reduction may be owing to the reason that the entity is not able to sell their inventories in short period for the increase competition in existing market, reduction in the demand or availability of the substitute product in the market at lower prices (Melville 2015).

Gearing ratio – it is the fundamental evaluation of the company’s long-term debt as compared to the equity capital of the company (Lapointe-Antunes and Moore 2013). It indicates the financial risk of the company as the excessive amount of debt can expose it to various financial risks.

  • Interest cover– it is the efficiency of the company to pay off the interest payable on the debts from the amount of operating profit. As the interest coverage ratio of the company is more than 2.00 for both the years it indicated that company can meet the interest obligation efficiently. It indicates that the company has enough income from operation to pay off the expenses of interest.
  • Earnings per share– it can be identified from the calculation that the company’s earnings per share went up from 0.23 in 2014 to 0.25 in 2015. It indicates that the company’s efficiency has been increased with regard to the generation of shareholder’s return which in turn will influence the new investors to invest their money in the company (Helfert 2011).
  • Price earnings ratio– it is identified that the price earnings ratio of the company is decreased from 11.76 in 2014 to 10.27 in 2015. The reason behind that is the reduction of share price of the company from 417.5 to 366.5. It will reduce the interest of the investors to invest their money in Mitchell and Butler Plc.

As per IAS 36 for the impairment of assets the company’s asses shall not be carried out in the balance sheet which is more than its recoverable amount. The recoverable amount is determined as the higher of faire value of the asset less the cost of disposal and the value in use. Except for few intangible asset and goodwill, the company shall periodically check for the impairment of the assets if any indication for impairment is found (Tsalavoutas, André and Dionysiou 2014). At the end of each accounting period the organization shall find out whether there is any indication for impairment or any chance is there for the impairment of any particular asset. Further, impairment test shall be conducted for the CGU (cash generating unit) if it is not possible to get any cash inflow from the particular asset and the asset is independent from other asset. IAS 36 listed various external as well as internal indications that can be used to assess if there is impairment for any asset (Bodie, Kane and Marcus 2014).  However, if any indication for impairment is found then the recoverable amount of the asset is measured. Internal indication for impairment can be obsolescence or physical damage of any asset, asset is held for disposal, part of the asset is not suitable for use any more or part of the asset is being restructured or the performance of the asset is not as per the estimation. On the other hand, the external indication for the impairment is the unfavourable changes in the markets, laws, economy or technology, reduction with regard to the market value or the net asset value of the company is more than the market capitalization.  

However, for few assets, the company shall compute the recoverable amount annually for evaluating the fact that there is any indication of impairment or not. The assets are –

  • Goodwill acquired under business combination (Bekaert and Hodrick 2017)
  • Intangible assets not available for use yet
  • Intangible asset that has not any definite useful life.

Part (c) - Evaluating Reporting of Property, Plant and Equipment

On the other hand, as per IAS 36 for plant, equipment and property, the major issue arises with the recognition of asset, measurement of their carrying value and the application depreciation method and amount of depreciation. Another issue is that the identification of the impairment and the amount of impairment. The recognition method of plant, equipment and property with regard to the cost is applicable to all the costs incurred at the time of incurring. The cost recognised are all the costs incurred for acquiring the asset, restructuring the asset, repairing the asset and various subsequent costs expensed that includes the cost associated with servicing, adding  or replacing the asset (Brigham and Ehrhardt 2013). Further, the asset is recognized as asset while it is expected that the future benefit from the asset will inflow to the organization and the cost of asset can be measured reliably. IAS 16 recognizes 2 cost models for accounting purposes –

  • Revaluation model – as per the revaluation method asset is recorded in the balance sheet at revalued amount. The revalue amount is the asset’s fair value less the amount of depreciation and impairment, if any. However, fair value will be considered if it can be measured reliably (Elliott and Elliot 2015).
  • Cost model – under the cost model the asset is recorded in the balance sheet at the amount of cost less the amount of depreciation and impairment, if any (Avallone and Quagli 2015).

It has been identified from the financial statement and related disclosures of Mitchell and Butlers Plc that the company follows IAS 36 for the purpose of computation of impairment related to plant, equipment and property. For example, the impairment loss is recognized by the organization while it is found that the carrying amount of plant, equipment and property is more than the recoverable value. Further, the company considers the recoverable amount as the higher between the fair value of the asset less the selling cost and the amount of value in use. This requirement was as per the requirement of IAS 36 (Atrill and McLaney 2016). Moreover, the company uses the revaluation model for valuing the plant, equipment and property which is the amount of revaluation less depreciation and impairment, if any.

Further, the company recognizes the plant, equipment and property as per IAS 16. For example, plant, equipment and property is recognised as asset while it is expected that the future benefit from the asset will inflow to the organization and the cost of asset can be measured reliably.

Reference

Atrill, P and McLaney, E., 2016. Accounting and Finance for Non-Accounting Specialists (10th edition), Pearson,

Avallone, F. and Quagli, A., 2015. Insight into the variables used to manage the goodwill impairment test under IAS 36. Advances in Accounting, 31(1), pp.107-114.

Bekaert, G. and Hodrick, R., 2017. International financial management. Cambridge University Press.

Bodie, Z., Kane, A. and Marcus, A.J., 2014. Investments, 10e. McGraw-Hill Education.

Brigham, E.F. and Ehrhardt

Elliott, B and Elliot J., 2015. Financial Accounting and Reporting, Pearson

Fridson, M and Alvarez, F., 2011. Financial Statement Analysis, a practitioner’s guide, Wiley

Helfert, E., 2011. Financial Analysis tools and techniques: a guide for managers, McGraw-Hill

Lapointe-Antunes, P. and Moore, J., 2013. The Implementation of IAS 16 and IAS 41 at Andrew Peller Limited. Accounting Education, 22(3), pp.268-281.

Mazzi, F., Liberatore, G. and Tsalavoutas, I., 2016. Insights on CFOs’ perceptions about impairment testing under IAS 36. Accounting in Europe, 13(3), pp.353-379.

Mbplc.com. 2017. Mitchells & Butlers - Home. [online] Available at: https://www.mbplc.com/ [Accessed 30 Nov. 2017].

Melville, A., 2015. International Financial Reporting a practical guide, Pearson

Picker, R., Clark, K., Dunn, J., Kolitz, D., Livne, G., Loftus, J. and Van der Tas, L., 2016. Applying international financial reporting standards. John Wiley & Sons.

Robinson, T.R., Henry, E., Pirie, W.L. and Broihahn, M.A., 2015. International financial statement analysis. John Wiley & Sons.

Tsalavoutas, I., André, P. and Dionysiou, D., 2014. Worldwide application of IFRS 3, IAS 36 and IAS 38, related disclosures, and determinants of non-compliance.

Uechi, L., Akutsu, T., Stanley, H.E., Marcus, A.J. and Kenett, D.Y., 2015. Sector dominance ratio analysis of financial markets. Physica A: Statistical Mechanics and its Applications, 421, pp.488-509.

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