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Central Queensland University
Written Assessment 230% Assessment 2
Boden Abell – S0271465Unit Coordinator: John Mcgrath
ACCT11059: Using Accounting for Decision MakingDue: 16/01/2016
Step 1:
Blog Post: Reflection on Ch4: Restated financial statementsIntroductionLearning. Simply regurgitating facts is not an effective method of long term learning;
instead it involves understanding, applying, and engaging with materials as well as
interacting with others. Another aspect to learning is repetition; returning to topics
again and again acts as reinforcement of retention and understanding. However, at
some point we must broaden our horizons and learn something new. This week I am
excited because of the unknown; I can see that there is plenty of new content ready for
me to engage with just by skimming through some key points and headings.
Machiavelli’s quote on consulting the past to properly predict the future, normally
something I would brush over as an obvious fact, reminded me of my experiences in
finance. While it is not the first time I have heard it, there seems to be general
disagreement with people in finance and those in accounting. Early into my
employment I was told to move from the accounting career path simply because
“accountants are idiots who spend too much time looking into the past; they should
worry less about reporting on the past, get their heads out of the books, and look to the
future”. But how are many financial models formed, such as cash flow forecasts? The
answer is simple; they use the past, to the extent it is capable of, to make guided
predictions of the future. Take out the past and predicting becomes guessing. It is not
my intention to become a slave to the books; nor is it to become the accounting
equivalent of a weather forecaster. We all must seek a healthy balance between the
two; to work with what has been provided with us in the past, to learn.
Martin mentions two common methods for analysing the economic and business
realities of a firm; the discounted cash flow and economic profit techniques. I have
used the discounted cash flow models previously in both Company Finance and
Systems Analysis, although using the name net present value. A similar technique
also used in the financial planning of my workplace is the internal rate of return which
we use to value client portfolios.
At this point in the reading, I have the following questions regarding the restating
process:
Boden Abell – S0271465 ACCT11059 Page
What does it mean by ensure all earnings are included? Which earnings would
be missing? Does the statement of profit/loss and other comprehensive income
not include all earnings for the period?
What is genuine equity? Do we only include the share capital accounts and
retained earnings? Do we leave out the reserves?
Do we not have a separate classification for investing activities as we do with
the cash flow statement?
Section 4.1I find the statement, “All that equity investors receive from a firm are dividends”
somewhat misleading. There are other methods of distributing value to shareholders
such as share buybacks. Entities may also be specially designed as capital growth
firms which do not pay distributions or dividends, such as the Merchant Opportunities
Fund (MOF), a managed investment scheme for which I conduct administration tasks
for. However, I feel that these activities are also just value transfer techniques which
Martin discusses for both dividends and free cash flow.
It is easy to see why the free cash flow is not a good measure of value creation; if you
invest more in productive assets, you will have less cash available. But the idea
behind purchasing productive assets is that you expect a positive net present value,
meaning that the initial outlay of cash is less than the expect inflows discounted to
today’s value. This concept on how we add value to firms clicked in my mind after
learning of the time value of money in Company Finance. Applying this to Ausenco,
one of the cash flows from investing activities in 2014 was payments for property,
plant and equipment of $1.4 million which reduced the free cash flows. The
justification for this purchase is the expectation that it will result in greater cash
inflows in future periods. So value creation is not always immediate; it can be
deferred.
“Economic profit is based on a firm’s accounting profit for a period compared to its
cost of capital”. Again back in familiar territory, the cost of capital is an important
measure. Certainly, as investors we can only operate within our own means; we can
only invest using internally generated funds and debt via bank loans and similar
lending facilities. Business entities are no different; they are limited by their debt and
capital raising. Everything we do is restricted by resources and we can only use these
Boden Abell – S0271465 ACCT11059 Page
resources for one thing at a time. In business, we strive to employ our scarce resources
in activities that provide the greatest rate of return. But in doing so we create a new
cost which reflects the next best alternative return; the opportunity cost of capital.
Businesses must take note of this cost for multiple reasons, but consider the
following: you have $50,000 saved and you want to make an investment. You can
either invest this money in a term deposit with an interest rate of 10%p.a or company
X which has a rate of return of 12%p.a. All things being equal, the obvious choice is
company X. But if the rates were switched? As a potential investor, the term deposit is
now more desirable, and just as well the company itself would be better off ceasing its
operations and simply investing in a term deposit itself.
Section 4.2Martin answers my question of what constitutes as genuine equity from the
introduction. Preference shares which meet the definition of a liability under the
SAC4 should be reclassified from equity to a liability. SAC4 defines a liability
as: future sacrifices of economic benefits that the entity is presently obliged to make
to other entities as a result of past transactions or other past events (AASB, 1995, p.
4). It is hard for me to see the point of this exercise as surely the accountants of these
firms know the definition of a liability and will include preference shares as debt.
I really enjoyed Martin’s metaphor for the operating and financial activities of a firm
using the Kinder Surprise. Akin to this are information systems, which form part of
my current job through systems implementation. At the most basic form, an
information system consists of the user interface and the underlying database. While
most other staff are content with outer shell of the user interface, I am more interested
in the database core. The database stores all the data inputted through the system and
adds real value to the business. This is much like the operating activities which keep
the business ticking along. Financial activities are similar to the user interface; they
complete the picture of the entire firm or system, however they only transfer value
between business and its investors or between the user and the interface.
Section 4.3Martin’s demonstration of restating the financials of Ryman Healthcare has lead me to
question what all the fuss is about. It does not seem too difficult at face value if you
understand the firm’s activities and read the corresponding notes. However, I do think
Boden Abell – S0271465 ACCT11059 Page
that tax and some other comprehensive income items may be confusing at first for
some students.
Section 4.4It is not difficult to understand the concept of the profit margin ratio. But why do we
use comprehensive operating income over sales? It is simple; we want to know the
profitability achieved for the total number of sales made. I have used very similar
ratios for retail businesses, however I have never used it for strictly service providers.
How would I use this ratio for Ausenco? It is difficult for me to determine this as
Ausenco does not provides unique projects with their own costs and revenues. It is
also desirable to know exactly how many sales is produced by each dollar of net
operating assets and vice versa for efficiency analysis. Again, how would I rework
this ratio for Ausenco?
As a concluding note to this chapter, engaging with material is much easier and
enjoyable when the content is new. The key concepts and questions I have formed for
this chapter include:
Balance is needed between the needs of reporting on the past and making
predictions of the future.
The discounted cash flow and economic profit techniques are used for
analysing the economic and business realities of a firm.
Earnings can be split throughout the income statement, a statement of other
comprehensive income, and the statement of changes in equity.
Restating involves classifying activities as operating or financial. The cash
flow statement also includes investing activities, which I now realise are
lumped together as these activities reflect investments in operating assets.
Shareholders can have value distributed to them via many methods including
share buybacks and dividends; however, these activities only transfer value.
Free cash flow is not a good measure of value creation as investments in
operating assets do not often immediately create value; value creation can be
deferred.
Businesses are limited by resources and thus there is an opportunity cost to
capital.
Boden Abell – S0271465 ACCT11059 Page
Preference shares in the statement of changes in equity may be debt in disguise
if they meet the definition of a liability in SAC4.
Restating the financials requires a comprehensive understanding of the
business’ activities and careful perusal of the notes.
How do we use the profit margin ratio, asset turnover ratio, and ultimately the
return on operating assets ratio for project oriented service providers?
Step 2:
Blog Post: Reflection on restating processComing straight from reading chapter 4, I actually did not find restating Ausenco’s
financials to be difficult. The first step I took was classifying all of the statement’s
line items as operating or financial based on my judgement and understanding of
Ausenco’s activities gained from ASS#1. I note that I did not need to classify any
items on the statement of changes in equity as all earnings were reported in the
statement of comprehensive income and there are no preference shares. Starting with
the statement of comprehensive income, the only items I needed to check on in the
notes were the other income and other expenses as the name does not reveal what
these items are specifically for. The only question that I have from this statement is
how should the currency translation differences arising during the year and the net
investment hedge be classified? I believe that they should be operating as both of
these items are related to foreign exchange fluctuations as part of operating activities.
The balance sheet was no more difficult as all items seem to be relating to operating
activities except a portion of cash and borrowings. I did check the other current
assets/liabilities and other non-current assets/liabilities in the notes in the event they
related to financial activities however they did not seem to.
From here I printed Martin’s restated financials for Ryman Healthcare so that I could
follow his formatting. For the statement of comprehensive income, I had a little
trouble working out the tax benefit and when it should be negative and positive.
However, since I managed to return the same total comprehensive profit/(loss) in the
restated financials as the regular financials, I must have done something right. I also
wonder if I am supposed to divide up the income and apply the relevant tax rates for
each country/state of operation.
Boden Abell – S0271465 ACCT11059 Page
For the balance sheet all I needed to do was divide up the cash into operating and
financial activities. I have also combined the same line items which were separated by
their current and non-current classifications as they do not seem to be used in
restatement. As a final check, I compared my restated net assets against the regular
net assets and they were the same.
As a conclusion to this restatement process, I did not find anything too challenging
about this learning process. Martin clearly explains restatement in chapter 4 and I did
not struggle with reading this chapter. There really were no frustrations, except with
the fact that Ausenco in 2014 and 2013 did not provide many notes to their financials.
The only thing that confused me briefly was splitting out the tax benefit, which was
solved in a matter of minutes through trial and error. Overall, as I enjoy forming the
financials from ground up all the way to performing ratio analysis, I have found
restating Ausenco’s financials to be a pleasant experience. The only thing I wish I
could have done was calculate the profit margin, asset turnover, and return on net
operating assets ratio but I do not know exactly how to apply this to a service
provider.
Blog Post: Sneaky…Something I noticed from ASS#1 was that the other comprehensive income did not
match between the income statement and the statement of movements in equity. I had
no idea why this had occurred because Ausenco is a bit underwhelming with the use
of note references. So once I received my marked assessment back I saw that the
marker had found the note 21 included an extra line item “Foreign exchange
differences on abandoned operations” which did not appear in the income statement.
Why was this? Ausenco had instead decided to adjust this directly via equity. So my
previous post where I said I did not need to do anything to restate the statement of
movements in equity was false; I had to go in and dig out this item and add it to the
income statement.
The question I now ask is why did they transfer directly against equity? Was it to
display a more favourable total comprehensive income in the income statement?
Boden Abell – S0271465 ACCT11059 Page
Student DiscussionsRestating Ausenco’s financials was relatively straightforward so my comments were
based on helping others rather than asking questions.
Belinda Donaldsonhttps://beldonald.wordpress.com/2016/12/10/falling-with-style/comment-page-1/
#comment-34
Belinda had some trouble justifying her restated income statement. I attempted to
clarify some and made a recommendation or two as well.
https://beldonald.wordpress.com/2016/12/09/maintain-balance/comment-page-1/
#comment-35
I also took the opportunity to explain that goodwill is not reputation.
https://beldonald.wordpress.com/2016/12/04/the-power-of-the-exchange-rate/
comment-page-1/#comment-36
Queried Belinda about why she decided to allocate all tax on components of other
comprehensive income as an operating activity.
Adrian Peglerhttps://adrianpegler.wordpress.com/2016/12/08/operating-or-financing/comment-
page-1/#comment-31
Reviewed Adrian’s choice of operating and financial items for the balance sheet.
Courtney Honneryhttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=186388#p522993
Helping Courtney decide how to interpret here company’s line items.
Dion Echentillehttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=186410#p522994
Comment regarding why certain companies will have higher levels of cash than
others.
Boden Abell – S0271465 ACCT11059 Page
Nicole Olsenhttps://nicolsenblog.wordpress.com/2016/12/17/its-been-a-long-time-coming/
comment-page-1/#comment-15
Walking through how the income tax expense and benefit should be laid out in the
restated financials.
Lisa Litschauerhttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=185817#p523398
Discussion on whether to leave all cash and cash equivalents as operating or to split
into operating and financial.
Step 3:
Ausenco, as a service provider specialising in project management and consulting,
draws up contracts tailored to each client’s unique needs. Each client varies in size of
operations and service needs so prices are dependent on each contract. This makes my
task of pricing three products much more challenging than a retailing company who
provide purchase prices online for all customers.
Rather than completely guess all three of my product’s prices, I have researched some
related activities and hypothetical scenarios.
Product 1: High Voltage AuditSearching for high voltage audit cost lead me to Asia Inspection, a company which
specialises in inspections, supplier audits, and testing services (Asia Inspection,
2016). They charge $829 USD per man day for clients in Europe, Greater Asia, and
Brazil (Asia Inspection, 2016). Considering that electrical work is exposed to higher
levels of risk, I have increase the price to $950 USD per man day.
Major costs that I would expect out of the audit would be the licensed electrical
engineer’s wage, equipment, injury related insurance, and licensing fees. I assume that
equipment does not need to be replaced for each job so I have removed it from the
equation. That leaves the wage as the variable cost [VC]. I have assumed an 8-hour
working day and a wage rate of $46.25 USD, totalling to $370 USD per man day.
Boden Abell – S0271465 ACCT11059 Page
This leaves a contribution margin [CM] of 61%. Insurance and licensing are fixed
costs [FC] within the relevant range and do not count towards calculating the CM.
Product 2: Feasibility StudyI based the feasibility study service price on Paul Harper of AMC Consultants
discussion “What does a feasibility study cost?” Paul Harper links feasibility studies
costs for underground mining projects to be 5.7% of the project capital cost (Harper,
2008). So, if an underground mining project costs $100 million, the cost of the
feasibility study would be $570,000.
Feasibility analysis involves extensive research weighing up the costs and the benefits
resulting from the project. Thus, salaries will be the major cost of the project. Indirect
costs such as electricity for the building and rent of the office will also form part of
this project. I have estimated $170,000 in VCs which leaves a CM of 70%.
Product 3: Gas Pipeline ConstructionWhen the APA Group purchased the BG Group's liquefied natural gas project, the
book value of the pipeline was $1.6 billion (SMH, 2014). I will use this figure as an
example.
To construct the pipeline, materials must be purchased, transported, and affixed
together by engineers presumably on a wage. It would be reasonable to assume that a
large portion of the project’s costs will be VCs, thus I took a stab in the dark and went
with $950 million, leaving 41% as the CM.
Comparison & DiscussionProduct Price Estimated
Variable CostsContribution Margin ($)
Contribution Margin (%)
Product 1 $950 $370 $580 61%
Product 2 $570,000 $170,000 $400,000 70%
Product 3 $1,600,000,000 $950,000,000 $650,000,000 41%
As seen in the table, the three products chosen have varied CMs. There are many
reasons behind this and none apply in isolation. To encourage higher volumes of
Boden Abell – S0271465 ACCT11059 Page
sales, companies can lower the sales price [SP] and ultimately the CM. Of course, this
depends on the marketing strategy. Supermarkets are able to set low prices just above
the VC to produce a minute CM and reap the benefits of high turnover products such
as fruit and vegetables. Ausenco, on the other hand, knows that the demand for their
services is low so they tend to have higher contribution margins. Comparing product 1
and 2, perhaps it is expected that high voltage audits are sought after more frequently
than feasibility analyses. However, common sense suggests that gas pipeline projects
are far more infrequent than both high voltage audits and feasibility analyses yet the
CM is lower than both. Consider the formula for calculating the CM: SP – VC. The
CM is also dependent on the mix of VCs and FCs incurred while supplying the
product. Both product 1 and 2 have a higher proportion of FC than product 3. Since I
assumed that the feasibility analysis will be conducted by staff on a salary, this
dramatically decreases the total VCs as opposed to staff on a wage as is with the gas
pipeline. Also, the gas pipeline is very resource heavy in the materials while the other
products are based around labour which also explains the proportions of the VCs.
In the ideal world with no resource limits, companies would only produce the
products with the greatest CM. However, we do not live in such a world. There are
many restraints on Ausenco that contribute towards providing many services. First
and foremost is demand. Many of Ausenco’s products have a low turnover as demand
is low and infrequent. Companies in the commodities markets are not constantly
launching new project because projects have long completion times and often require
capital raising to meet excessive capital expenditure requirements. So in essence,
Ausenco can only provide as much is demanded for the product with the highest CM.
Another reason to provide a mix of products is that they may be complementary to
each other. It is important to remember that the CM is the residual amount after
covering VCs with the SP which attributes towards covering FCs and ultimately
making a profit. So if a firm can add more products that are in demand, completely
cover their own cost of sales (including the direct FC and indirect FC), and add a
positive CM to the sales mix then there is little harm in doing so. Ausenco provides a
full suite of project management services, from initiation to evaluation and
completion, so it makes sense that they also enlist these other products. Of course, the
firm needs to consider the resource constraints as well. For example, if a cheese
producer can make 3 different types of cheese with the same milk then they need to
Boden Abell – S0271465 ACCT11059 Page
consider the optimal amount to maximise the CM with demand for the shared
materials. This should not affect Ausenco to a large degree as all services have low
turnover.
Ausenco has many resource constraints imposed on it both directly within the firm
and externally indirectly. Internally, Ausenco faces a limit on staffing and labour
hours, cash flows for construction materials and wages, and materials themselves
among many others. Externally are where the real problems lie. Ausenco is adversely
affected by negative market conditions, both from a supply and demand position.
When demand is low, as it has been recently, rivalling service providers will compete
strongly for the contracts which can drop the bottom line of the firm if sales prices are
reduced to compensate or offers are lost. As Ausenco’s products are already low
turnover, a reduction in demand has severe impacts. Indirectly, Ausenco is very much
reliant on commodity prices. If they are low, clients have a hard time raising capital to
fund the projects which Ausenco could offer their services to. They will also look
towards in-house operations and cost cutting rather than employ Ausenco’s services.
When this happens, it no longer becomes a question of how many services should
Ausenco provide or sell; instead the focus turns to how much can be sold given the
demand. Ausenco is unlikely to cut out any of their services because demand has fell
as it bears no cost of offering it if they are not performed.
Boden Abell – S0271465 ACCT11059 Page
Step 4:
Feedback from: Boden AbellFeedback to: Stacey Walker
My Comments
Step 1
KCQs
It seems that you have linked your chapter 1 review rather than the chapter 4 in the document. You might want to fix that. I searched your blog and couldn’t find it so I am guess you have not done it yet. I am aiming to review it once it is done.
Step 2
Restated statement of changes in equity
Balance sheet
Income statement
Commentary and discussion with others
Again, the restated part is empty. I will review it when it is uploaded.
Do not forget to include your commentary and discussion with others in this step.
Step 3
Identify three products/services
Estimate selling price,
You have included three products and have shown where you have found the sales price. I would like to see how you determined the variable costs. Did you estimate? Did you use data from somewhere? The variable costs and contribution margins seem reasonable but I do think you need to justify them.
You have discussed the concept of globalisation and its effect on costing which was a nice extra to read. However, part of the task asked to compare why the different products have a different or similar contribution margins. I
variable cost & CMs
Commentary – CMs
Constraints –identify and commentary
would use the contribution margin ratio (contribution margin ($)/sales price) to do this.
You have made a comment on why companies should have a diversified portfolio of products. This has been justified well. Good job!
Some constraints have been identified and discussed but I think you could explore the topic a bit more. Maybe think about products with sugar and the need to reduce the sugar content.
Overall ASS#2 There wasn’t much for me to work with for this draft in terms of step 1 and 2. I will wait until you have done more on these before I make commentary on those. As for step 3, you have just a little more work to do to be finished with it. I have enjoyed what I have seen so far!
Boden Abell – S0271465 ACCT11059 Page 1 of 18
Feedback from: Boden AbellFeedback to:
My Comments
Usefulness of Feedback Received
Boden Abell – S0271465 ACCT11059 Page 3 of 18
References
Asia Inspection. (2016). Quality control pricing. Retrieved December 9, 2016, from
http://www.asiainspection.com/
Australian Accounting Standards Board (AASB). (1995). SAC4: Definition and
recognition of the elements of financial statements. Retrieved December 2,
2016, from http://www.aasb.gov.au/
Harper, P. (2008). What does a feasibility study cost?. Retrieved December 9, 2016,
from http://www.infomine.com/
The Sydney Morning Herald (SMH). (2014). APA secures $6 billion pipeline.
Retrieved December 9, 2016, from http://www.smh.com.au