Financial Statements Analysis
MBA full time programme International Business Module: Financial statements Analysis
IMPACT OF REPORTING IN ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS AND INTERNATIONAL ACCOUNTING STANDARDS ON PSA PEUGEOT CITROËN PUBLISHED RESULTS Submitted by: 796112
March, 2006 Words count: 2690
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Financial Statements Analysis
- TABLE OF CONTENTS -
- INTRODUCTION -
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I.EFFECT OF REPORTING IN ACCORDANCE WITH IFRS / IAS
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I.1.Automobile division research and development expenditure (IAS 38)
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I.2.Faurecia Research and Development Expenditure and special tools (IAS18)
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I.3.Goodwill (IFRS 3)
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I.4.Property, Plant and Equipment (IAS 16 & 17)
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I.5.Impairment in Value of Long-Lived Assets (IAS 36)
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I.6.Sales with a Buyback Commitment (IAS 18)
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I.7.Interest Rate Hedging (IAS 39)
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II.SEGMENT INFORMATION AND SALES / REVENUE
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II.1.Segment information (IAS 14)
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II.2.Sales and Revenue (IAS 18)
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- CONCLUSION -
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- REFERENCES -
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Financial Statements Analysis
- INTRODUCTION -
As all European companies, PSA - Peugeot Citroën 2004 consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) issued by the International Accounting Standards Board (IASB) and the related interpretations in order to be in accordance with European Regulation 1606/2002 dated July 19, 2002. Before 2004, PSA - Peugeot Citroën financial statements were in accordance with French reporting standards.
There has been a lot of discussion about this change because being in accordance with IFRS and IAS may have a material impact on the financial statements and PSA - Peugeot Citroën wants to provide the financial community with some explanation of these changes. From the release of first-quarter 2005 sales on April 28, financial statements and results will be prepared using only IAS/IFRS.
This report will try to shed the light on the effects that reporting in accordance with International Accounting Standards (IAS) has had on the company’s published results. All the more, it will focus on segmental information and sales / revenue describing the accounting method chosen by PSA - Peugeot Citroën and its justification.
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Financial Statements Analysis
I.
EFFECT OF REPORTING IN ACCORDANCE WITH IFRS / IAS
We will focus on the main impacts that reporting in accordance with IFRS / IAS has had on PSA - Peugeot Citroën published results.
1. Automobile division research and development expenditure (IAS 38) IAS 38 specify, research expenditure shall be recognised as an expense, while development expenditure shall be recognised as an intangible asset only if, the enterprise can demonstrate: • Its intention to complete the intangible asset and use or sell it, as well as the availability of adequate technical and financial resources for this purpose; • That it is probable that the future economic benefits that are attributable to the development expenditure will flow to the enterprise; • That the cost of the asset can be measured reliably. Thus, to report in accordance with that standard, PSA - Peugeot Citroën have to recognise not only vehicle projects devolvement expenditures but also other expenditure (engine and gearbox projects) as intangible assets in its balance sheet. These assets will be amortised over 5 years for vehicles and 10 for other mechanical parts. The cost of the intangible asset includes expenses directly related to the project but also the cost of external service related to the project. Other research and development costs that do not respect the criteria above may be recognise as an expense.
2. Faurecia Research and Development Expenditure and special tools (IAS18) PSA - Peugeot Citroën used to recognise development costs in inventory and work-inprogress as soon as the order was passed whereas revenue was recognise when billing was done. When development costs are paid in proportion to parts delivered to the customer without any guarantee of the client upon the financing of all the expenses, revenue recognition criteria provided for in IAS 18 are not met. When there is no payment guarantee from the customer, development costs shall be considers as an intangible assets. If the payment is guaranteed, the development costs shall be recognised in inventory and work-in-progress. These changes in accounting standards have been considered by PSA - Peugeot Citroën. The application of IAS 18 also concerns Faurecia Special Tools. When special tools are paid for in proportion to parts delivered to the customer, IAS 18 revenue recognition criteria is not met and thus special tools cannot be considered as sold until the full payment have been guaranteed by the customer but shall be considered as Property, Plant and Equipment (PPE). Thus in 2004 financial statements, special tools with no guarantee recognised as inventory in 2003 are reclassified as PPE. In the IFRS income statement, the depreciation charge replaces the amount previously accounted for as an outward movement from inventory.
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Financial Statements Analysis
3. Goodwill (IFRS 3) Goodwill used to be amortised on a straight-line basis over 20 years. Under IFRS 3, Goodwill shall not be amortised anymore but its value shall be tested regularly and a loss must be recorded if necessary in the income statement. Thus the income statement will no longer be charged with goodwill amortisation, but earnings will be impacted by any impairment losses.
4. Property, Plant and Equipment (IAS 16 & 17) Before 2004, the current accounting practice for property, plants and equipments was to state them at their costs corresponding to “the purchase price plus directly attributable costs of bringing the asset to working condition” or to production cost. Borrowing cost was a part of the cost of the asset. Then, a straight line depreciation was calculated over the estimated useful lives of the asset. Some assets that were acquired under a finance lease were stated at their fair value at the beginning of the lease. IAS 16 & IAS 17 application results in change on PSA - Peugeot Citroën accounting practice about property, plants and equipment. Borrowing cost is recognised as an expense and not included in the cost of an asset. Some leases that were considered as simple leases are now recognised as finance lease and some costs that do not fit exactly the definition of “directly attributable cost” are excluded from the cost of an assets. Thus borrowing costs and cost that do not fit the “directly attributable cost” definition are eliminated from the net book value of the assets concerned and recorded as a deduction from retained earnings, finance leases previously accounted for as operating leases are recognised as an asset and a liability in the balance sheet.
5. Impairment in Value of Long-Lived Assets (IAS 36) One of the changes that has occurred in PSA - Peugeot Citroën and that has not had any impact yet (2004 financial statements’ balance sheet) on the group accounts is the application of IAS 36 over the impairment of assets. PSA - Peugeot Citroën shall assess whether there is any indication that an asset may be impaired at each balance sheet date. This test is done once a year for asset with indefinite useful lives. The group used to measure the goodwill impairment by the discounted cash flow method and if that value was less than the book value, a valuation allowance was recorded. For long lived assets, the difference between the value in use (measured based on the sum of undiscounted future cash flows) and book value was recorded by a depreciation or an amortisation charge. Under IAS 36 - Impairment of assets tests are performed at the level of Unités Génératrices de Trésorerie (UGT) i.e. cash generating units (CGU) defined as “the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets” and valued at the net present value of estimated future cash flows. For PSA Peugeot Citroën, each vehicle model is considered as a CGU with its own assets. PSA Finance Bank and each Faurecia development program are also considered as separate CGUs. If the value in use of CGUs is different than the CGU’s net book value, an impairment loss is allocated to the goodwill of the CGU (if any) or to the other assets of the unit.
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Financial Statements Analysis
6. Sales with a Buyback Commitment (IAS 18) Direct new vehicle sales with a buyback commitment used to be recognised as operating leases. The difference between the sale price and the buyback price is recognised on a straightline basis over the leasing period, up to the amount of the total profit arising from the transaction. Since the risks and rewards of ownership may not be transferred in the case of a sale with buyback commitment, IAS 18 do not recognise those as revenue whatever the duration of the buyback commitment is and even if the transaction is financed by PSA Finance Bank. The difference between the sale price and the buyback price is recognised as rental revenue on a straight-line basis over the duration of the buyback commitment. The vehicle is initially recognised at production cost in property, plant and equipment. Depreciation expense is calculated on the straight-line method. The consequence of this change in accounting policy is that a portion of the margin recognised on vehicles sold before January 2004 with a buyback commitment is recorded as a deduction from retained earnings. The restated net book value of the vehicles is recorded in property, plant and equipment and the revenue deferred is recognised as a long-term liability. The impact on the future financial statements is a reduction of the net sales and an increase of the rental revenues.
7. Interest Rate Hedging (IAS 39) Before 2004, derivative instruments for interest rates hedges are disclosed as off-balance items in the notes (not in the balance sheet). Accrued interest on the hedging instruments used to be recorded in the income statement. Under IAS 39, all the derivatives instruments are said to be recognise in the balance sheet at their fair value. Each change in this value shall be recorded in the income statement. Hedge accounting shall be applied if it is clear that the aim of the instrument is hedge and if the effectiveness of the instrument is demonstrated since the first use of that instrument. For assets and liabilities, changes in fair value are recognised in the income statement, neutralising the earnings impact of symmetrical changes in the fair value of the hedging instrument. The ineffective part of the change in fair value of hedging instruments is recorded directly in the income statement. PSA - Peugeot Citroën manage cash surplus at a group level, investing them on the financial markets at floating rates of interest. The group finance companies mainly supply wholesale and retail financing at fixed rate. Since the corresponding refinancing is generally at floating or adjustable rates the group set up swaps and purchased options to match interest rates. The impact of this derivative instrument valuation on the income statement is weak since Group use to value hedging instruments as either fair value or cash flow hedges. The re-measurement of hedging instruments in the balance sheet slightly increases assets and liabilities..
Now we have a snapshot of the main consequences of reporting in accordance with the International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS), we will focus on two items on the financial report: the segmental information and the sales / revenue. 6/11
Financial Statements Analysis
II. SEGMENT INFORMATION AND SALES / REVENUE 1. Segment information (IAS 14) Objective of IAS 14: The objective of IAS 14 (Revised 1997) is to establish principles for reporting financial information by line of business and by geographical area. It applies to enterprises whose equity or debt securities are publicly traded and to enterprises in the process of issuing securities to the public. In addition, any enterprise voluntarily providing segment information should comply with the requirements of the Standard. Business segment: A component of an enterprise that (a) provides a single product or service or a group of related products and services and (b) that is subject to risks and returns that are different from those of other business segments. [IAS 14.9] Geographical segment: A component of an enterprise that (a) provides products and services within a particular economic environment and (b) that is subject to risks and returns that are different from those of components operating in other economic environments. [IAS 14.9] Identifying business and geographical segments: IAS 14 presumes that segmentation in internal financial reports prepared for the board of directors and chief executive officer should normally determine segments for external financial reporting purposes. Only if internal segments aren't along either product/service or geographical lines is further disaggregation appropriate. The enterprise should determine whether business or geographical segments are to be used for its primary segment reporting format based on whether the enterprise's risks and returns are affected predominantly by the products and services it produces or by the fact that it operates in different geographical areas Source: http://www.iasplus.com
The PSA - Peugeot Citroen financial statements' segment information report the Group's manufacturing and sales operations around three main industry segments: • Automotive Activities: covering the design, manufacture and sale of cars and commercial vehicles under the Peugeot and Citroen brands. • Automotive Equipment: corresponding to the Faurecia group, which specializes in the vehicle interior, automobile seating, front-end and exhaust systems sectors. • Transportation and Logistics: corresponding to the Gefco group, which specializes in logistics and vehicle and goods transportation. This segment information inform on the main performance indicators such as “Net sales”, “Operating margin”, but also on the segment assets (”PPE”, “Intangibles assets”) for the period 2002 to 2004. It sounds logical for PSA - Peugeot Citroën to segment its activity in this way since they are noticeably different and can be analysed separately in spite of the fact that a general decrease of the car sales will impact on all of these activities. Thus, this segment information seems to give a true and fair view of the group activities. One of the thing that an investor would have expect to find enclosed in the “segment information note” is finance companies operations. The reason why there is almost nothing reported in this note is because this item is so important that the distinction between PSA Peugeot Citroën and its finance company is done throughout the whole report and especially in the statement of income, the balance sheet and the statement of cash flows. Indeed, even if 7/11
Financial Statements Analysis “revenues” from finance companies is only 2.6% of the group total revenue, it represent more than 30% of the group operating margin. All the more, the segment information also split the company result in geographic areas (secondary segments) providing only very rough information such as “Net sales”, “Intangibles assets” or “PPE” over a period of 3 year. This information is not very useful since it only provides general data on large areas such as “Western Europe”, “Rest of Europe”, “Latin America” and “Rest of the World”..
2. Sales and Revenue (IAS 18) Objective of IAS 18: The objective of IAS 18 is to prescribe the accounting treatment for revenue arising from certain types of transactions and events. Revenue: The gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary operating activities of an enterprise (such as sales of goods, sales of services, interest, royalties, and dividends). [IAS 18.7] Revenue should be measured at the fair value of the consideration receivable. [IAS 18.9] An exchange for goods or services of a similar nature and value is not regarded as a transaction that generates revenue. However, exchanges for dissimilar items are regarded as generating revenue. [IAS 18.12] Revenue arising from the sale of goods: should be recognised when all of the following criteria have been satisfied: [IAS 18.14] - the seller has transferred to the buyer the significant risks and rewards of ownership; - the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; - the amount of revenue can be measured reliably; - it is probable that the economic benefits associated with the transaction will flow to the seller; and - the costs incurred or to be incurred in respect of the transaction can be measured reliably. For revenue arising from the rendering of services: provided that all of the following criteria are met, revenue should be recognised by reference to the stage of completion of the transaction at the balance sheet date (the percentage-of-completion method): [IAS 18.20] - the amount of revenue can be measured reliably; - it is probable that the economic benefits will flow to the seller; - the stage of completion at the balance sheet date can be measured reliably; and - the costs incurred, or to be incurred, in respect of the transaction can be measured reliably. When the above criteria are not met, revenue arising from the rendering of services should be recognised only to the extent of the expenses recognised that are recoverable (a "cost-recovery approach". [IAS 18.26] Source: http://www.iasplus.com
PSA - Peugeot Citroën vehicle sales are recognised on the date of transfer of the risks and rewards of ownership. Most of the time it correspond to the delivery date (direct sales) or the date when the vehicles are made available to non-group dealers. The amount recognise is net net of the cost of certain sales incentive programs. New vehicle sales with a buyback commitment expiring within a maximum of three years are not recognised at the time of delivery but accounted for as operating leases (Cf I.6 - Sales with a Buyback Commitment). Finance company revenues correspond to interest income mainly from sales financing and financing-related service revenues. It seems that this way of recognising the revenue is in accordance with IASB requirements since at the date of transfer of the risks and rewards of ownership, it is probable that “future 8/11
Financial Statements Analysis economic benefits will flow to the enterprise and these benefits can be measured reliably” (IAS 18 Intro). At this time, not only most of the uncertainty about the final outcome of business activity has been alleviated but also all of the cost of generating revenue are known. For the sale of cars, it seems that there is not a lot of choice for PSA - Peugeot Citroën as far as revenue recognition date is concerned. Indeed, it seems not appropriate for such an industry to record a profit at the date of completion of orders. Nevertheless the company could have decided to record a profit as early as an order is received from the customer. The impact of such a policy would be to inflate slightly the revenue of the group. PSA - Peugeot Citroën could also have decided to record revenue for the total price of car without taking into account the cost of certain sales incentive programs. The impact would also have been to increase slightly the revenue stated in the income statement. Finally PSA - Peugeot Citroën could have decided to consider sales with more than 3 year buy-back commitment as revenue and not as lease. This policy would have increase the revenue in the income statement and decrease the amount attributed to leases in the balance sheet. In the automobile industry it seems that the revenue recognition is not really an opportunity for creative accounting. Indeed, there is a lot of other sectors where it is possible to manipulate the revenue such as e-brokers recording the revenue of sales when they should only be recording their fees…
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Financial Statements Analysis
- CONCLUSION -
In spite of the fact that International Financial Reporting Standards and International Accounting Standards are trying to create a “one best way” of reporting financial results, there is still opportunities for creative accounting for the companies such as PSA - Peugeot Citroën. Nevertheless, the work done by the International Accounting Standards Board remain meaningful since we have to recognise that the current way of reporting in accordance with these standards is giving a lot more true and fair view of a company’s activities.
Most of developed countries’ companies are now reporting in accordance with these standards which is a good thing not only for the investors which have a better knowledge of the companies but also for companies which benefit from more reliance from foreign investors. Thus every country should encourage its companies to use such standards. Most developed countries understood this and set up legislation about the way of reporting. PSA - Peugeot Citroën, along with all other European listed companies, is required to prepare consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) as from January 1, 2005 (European Regulation N°1606/2002 of July 19, 2002 on the application of international accounting standards) It is likely that soon all developing countries will require their companies to report in accordance with these standards.
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Financial Statements Analysis
- REFERENCES -
Books:
• Robinson T.R, Financial Statements Analysis: a global perspective (Pearson 2004) • Martin Fridson, Fernando Alvarez, Martin S. Fridson, Financial Statement Analysis: A Practitioner's Guide, 3rd Edition (Wiley Finance) • Jean-Yves Eglem, André Philipps, Christiane Raulet, Analyse comptable et financière (Dunod 2005)
Internet websites:
• http://www.psa-peugeot-citroen.com • http://www.focusifrs.com • http://www.iasplus.com/standard/ias38.htm • http://www.iasplus.com/standard/ias14.htm • http://www.iasplus.com/standard/ias18.htm • http://www.euronext.com • http://today.reuters.co.uk • http://today.reuters.fr • http://www.tutor2u.net/revision_notes_accounting.asp
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