Analyzing Financial Reports of Energy Companies

The assignment requires a critical analysis of the annual reports of two Australian energy companies, AGL Energy and Origin Energy. Students must examine the application of relevant accounting standards (IFRS), evaluate their diversification strategies, and apply agency theory to understand the relationship between management and shareholders. The analysis should draw upon provided resources including company annual reports and academic literature on financial reporting, agency theory, and corporate strategy.

Accounting Theory and Issues

Executive Summary
This report has been prepared for demonstrating the significance of using best
accounting policies and strategies for maximizing the value of a business entity. The
accounting quality of an ASX listed firm is assessed through evaluating the accounting
policies and estimates. The company selected for the purpose is AGL Energy Limited. The
analysis of the accounting quality of the financial report of the company has revealed that it
has adopted the best accounting strategy and policies. The quality of disclosure of the
company is as per the AASB standards and also has adopted some flexibility in its accounting
framework. The company needs to provide more disclosure in relation to the red flags areas
discussed in the report.

Introduction
The present report examines the accounting quality of a selected ASX listed company
through evaluating its accounting policies and estimates. In this context, the report evaluates
the accounting strategy of the selected business entity in the light of the various accounting
theories such as positive and normative theories of accounting. The accounting policies of a
business entity play a critical role in achieving its corporate goals and objectives through
promoting its long-term growth and development. The financial reports are developed in
accordance with the accounting policies that provide disclosure about the financial condition
of a firm to its stakeholders. Therefore, it is essential for a business entity to adopt the use of
standard accounting policies that provides all the necessary information to the end-users and
through adopting revealing accounting strategy. The accounting strategy is analyzed through
examining the flexibility in the accounting policies and comparing them with the competitor
policies (Mirza and Ankarath, 2012).
Also, the report identifies the major issues of concern in the financial report of the
selected company as red flags that require more disclosures. In addition to this, the
compliance of the company with the conceptual accounting framework principles is analyzed
through examining the relevancy, reliability and understandability of financial information
provided in the annual report. The influence of the political pressure on the accounting
standard-setting environment is also discussed in this report. The company selected for the
purpose is AGL Energy Limited, an Australian publicly-listed company involved in the
developing and retailing of electricity and gas both for residential and commercial purposes.
Section 1: Identify Key Accounting Policies
The AGL Energy Limited is an ASX listed company and as such complies with the
Corporations Act 2001 and accounting standards AASB for developing its financial reports
(ASX and Media Releases, 2016). The company has valued its fixed assets of property, plant
and equipment (PPE) at their cost through deducting the amount of net depreciation and
impairment losses. The cost of the assets includes the entire significant amount related to its
purchase and development. The income or loss realized from selling the fixed assets of PPE
is attributed to the profit and loss account through calculating the difference between the sale
proceeds and the carrying value of the asset. Thus, the accounting policy for measuring the
value of the fixed assets is developed by the company as per the AASB 116 standard. The
deprecation is calculated through the use of straight-line method. The intangible assets such

as goodwill are carried at their cost through deduction of any loss arising from their
amortization and impairment. The financial report is based on the principle of historical cost
with the major exception of derivative financial instruments that are identified and measured
at their fair value (AGL Annual Report, 2016).
Also, the company has adopted a corporate governance framework for effectively
managing the operational risks associated with the company operations. The governance
framework incorporates the use of energy hedging activities. The main objective of the risk
governance framework is to hedge effectively the market price exposure of the company
through operation of an integrated energy business. The hedging activity for minimizing the
risk includes decrease in the hedging costs through incorporating the use of different financial
instruments such as weather derivatives for optimizing the risk and return (AGL Annual
Report, 2015).
Section 2: Assessing the Accounting Flexibility
The company operates its business activities in a highly competitive sector and
therefore the managers have incorporated some flexible accounting policies for value
maximization. As such, the accounting of assets involving the expenses on exploration and
development of oil and gas is not covered under the AASB 116 standard. The overall
expenses relating to exploration is recognized as asset and the accumulated expenditure is
transferred to oil and gas assets. Also, the company has adopted a minimum shareholding
policy as per which the key management personnel of the company should hold specific
number of shares in order to align the shareholder interests with the executives. There is no
legislative requirement on the company for adopting such policies but it has maintained the
policy for improving the organizational commitment of its key management people (Jensen,
2001).
The accounting managers have also adopted the use of historical cost accounting
method rather than using fair value accounting approach for measuring the financial
instruments value. The IASB has directed all the business entities complying with IFRS
standards to integrate the use of fair value accounting for measuring the value of assets and
liabilities. However, the company is still adopting the use of historic cost accounting method
rather than using fair value accounting due to numerous problems associated with it such as
changing its tax structure value (AGL Annual Report, 2016). Thus, management as such
possesses authority to change the accounting policies for improving the profitability position

of the company. However, the board of directors of the company has ensured that the
accounting information is not distorted in any form for hiding the materialistic facts and
figures (Mumba, 2013).
Section 3: Evaluate Accounting Strategy
The company has adopted flexibility in its accounting policies for strategically
communicating the economic information to its stakeholders. The flexible accounting
policies are essential for staying competitive in the market through developing better
accounting strategies as compared to the competitors. The major competitor of the company
is Origin Energy that is also providing large returns and profitability to its investors. The
company for outperforming its competitors has implemented the accounting strategy for
improving the productivity of the company in order to realize greater returns (Annual
Report : Origin Energy, 2016). The accounting strategy of the company is aimed at
improving the capital allocation through divesting its non-core business segments for
enhancing its operational efficiency value (AGL Annual Report, 2016). In this context, the
company is carrying a review of its asset portfolio and is targeting to divest around $1 billion
under-performing assets at the end of the financial year 2017. This will help the company to
increase the performance of its core business area and thus realizing larger returns in
comparison to its competitors (Kenny, 2009).
The flexibility in the accounting framework adopted by the company can be explained
through the use of positive theory of accounting. The positive theory of accounting helps in
identifying the reasons that provides motivation to the managers for selecting particular
accounting policies. The theory argues that managers tend to adopt particular accounting
methods for improving the business efficiency such as improving the cash flows or the
selection of particular incentive plans for managers (Mintz, 2013). The company has adopted
incentive policy that is based on the strategic aligning the executive incentives with the
maximization of the shareholder value. The incentives provided to the key management
personnel are linked with the underlying profit of the company. The underlying profit is the
adjusted profit that is calculated through non-inclusion of significant items of revenue and
expenses that are no related with the performance of the company value (AGL Annual
Report, 2016). Thus, the linking of the incentives of manager with the underlying profit
ensures that they do not enjoy an undue advantage or disadvantage by the items that are not
under their control (Marley and Pedersen, 2015).

(Source:
http://www.annualreports.com/HostedData/AnnualReports/PDF/ASX_AGK.AX_2016.pdf)
Also, the company through incorporating flexibility in its accounting framework has
introduced a minimum shareholding policy for its executive and non-executive managers.
The policy motivates the KMP for holding some shares of the company in order to align the
interest of the managers with those of the shareholders. This helps in ensuring that managers
do not adopt the use of any fraudulent practice that distorts the financial performance of the
company for realization of higher incentives. The company has also implemented the use of
some amended standards that helps it to improve its operational efficiency for the present
reporting period. However, the company have maintained that the adoption of the amended
standards have not materially impacted the financial facts and figures disclosed in its
consolidated financial statements (Ordelheide, 2016). Therefore, it can be said that the
accounting strategy adopted by the company is revealing as it tends to disclose all the
information related to the financial condition of the company. The company has adopted a
flexible accounting strategy that is subjected to change as per the performance of the
company value (AGL Annual Report, 2015). However, the flexibility in the accounting
practices is as per the standard accounting rules and regulations and does not provide the
authority to the managers for distorting the company financial performance (Bamberg and
Spremann, 2012).
Section 4: Evaluation of the quality of disclosure of the information in the annual report
of the selected company

Disclosure requirements of the financial reporting are prescribed in the IAS 1: The
presentation of the financial statements. As per this accounting standard every public listed
company have to comply with the specific requirement to disclose sufficient information
regarding the performance of the company during the year. Disclosure requirement of other
accounting standards are provided in the specific IAS standards and it have to be strictly
followed. In this section of the assignment there is requirement to evaluate the disclosures
made by the AGL Energy Company in their annual report value (AGL Annual Report, 2016).
On analyzing the disclosures made by the AGL Energy regarding each accounting
standard seems to be adequate but there are some concerns that need to be addressed. As per
IAS 13 Fair value measurement, values of property, plant and equipment should be properly
calculated and disclosed in the separate notes to accounts. In this regards AGL Energy have
disclosed the information about the property plant and equipment in the separate notes to
accounts but the information disclosed in that note to accounts seems not be adequate.
Footnotes to financial statements are same as the notes to accounts and these helps to
evaluate the detailed information of the items presented in the financial statements. For
example, to show the information regarding how the values of intangible assets have been
generated there is needed to check the notes to account. The note to accounts related to
intangible assets provides the value of impairment loss on each intangible asset and also
disclose remaining life of the intangible assets. In relation to the AGL Energy proper notes to
account have been prepared and required information about each item to the financial
statements can be seen from them (AGL Annual Report, 2015).
As evaluated from the financial statements prepared by the AGL Energy, the financial
performance in current year seems to be good and it can be also be evaluated from analyzing
the notes to accounts. Notes to accounts are seems to address all the requirement defined in
the accounting standards and they are consistent with the current performance of the
company.
The Australian GAAP is derived from the joint combination of IFRS and some
guidelines by the Australian Board. Australian GAAP is made to address the requirement of
financial reporting and to make common channel where the entity performance can be seen
intact through analyzing the financial report. So it can be said that GAAP reflects the
appropriate measurement of key measures of success (Hussey and Ong, 2017).
Segment disclosure is given page number 68 of the Annual report of year 2016.
Segment information is reported on the same basis that is used for internal reporting
structure. Segment are determined in the manner in which products are sold either it is retail
or wholesale. The four main segments of the company are Energy Markets, Group
Operations, New Energy, and investments. So it can be said that proper disclosures are given
for the segment information (AGL Annual Report, 2016).
Segment disclosure by the AGL Energy Limited in their annual report:

(Source: https://www.agl.com.au/-/media/DLS/About-AGL/Documents/Investor-Centre/
160828_AR_1587084.pdf?la=en )

(Source: https://www.agl.com.au/-/media/DLS/About-AGL/Documents/Investor-Centre/
160828_AR_1587084.pdf?la=en )
Section 5: Identify Potential Red Flags
It has been analyzed from the financial report of the company that there are various
red flags that requires more disclosure. There are various unexplained accounting practices
such as adoption of some changed accounting policies in order to improve the operational
efficiency. For example, the company has applied amendments to the accounting standards in
order to improve its financial profitability but has not effectively disclosed the changes that it
has applied to the accounting standards. The changes are adopted by the company to improve
its financial performance that is declining in the recent years due to transformations in the
energy market of Australia. The inventory base of the company has also currently declined in
the recent years to about $6 million value (AGL Annual Report, 2016). The company is also
required to provide information relating to the significant decrease in the inventory value in
the recent reporting period (Pietra, McLeay and Ronen, 2013). The company annual report
has revealed it is also incorporating the use of strategic partnerships for expanding its
business. The company has strategically acquired Mosaic Oil and also entered into sale and
purchase agreement with Transfield services Limited fir acquiring its asset base. There is also
asset-write offs realizing from the sale of businesses and subsidiaries corresponding to$ 673m
in the financial year 2016. The company has also not provided relevant information regarding

its asset write-offs. Thus, these all are the potential red-flags present in the business entity
(AGL Annual Report, 2016).
Section 6: Complaint with Conceptual Framework
It has been analyzed from the annual report of the company that it has effectively
followed with all the principles of conceptual framework such as relevance, reliability,
comparability and understandability. The conceptual framework is developed on the basis of
normative theory of accounting that provides guidance to the managers regarding the
adoption of the accounting procedures that are most appropriate. The theory has identified
and proposed the qualitative characteristics that financial information should possess, that
are, relevance, reliable, understandable and comparable. The conceptual framework is
developed on the basis of these qualitative characteristics that seek to define the objective of
general purpose financial reporting. The company through has provided all the financial
information in its annual report as per the qualitative characteristics of the conceptual
accounting framework. However, the nature of the financial information is significantly
influenced by the various political factors as per the accounting standard-setting environment
(Wolk., Dodd and Rozycki, 2012). The reliable principle of conceptual framework requires
disclosure of the financial facts and figures that are appropriate and can be used by the
investors in decision-making processes (Bamberg and Spremann, 2012). However, due to
presence of country-specific issues, the company incorporates the use of historic cost rather
than fair value in valuing its financial assets and liabilities. The historic cost does not provide
realistic information about the assets and liabilities value as it does not incorporate the market
information (Horngren, et al., 2012).
Therefore, IASB has directed the accounting standard-setting bodies around the world
such as AASB to adopt the use of fair value accounting for meeting the needs of users of
financial statements. The company has also made some voluntary disclosure sin its annual
report such as disclosing the information related to the operating results realized from eco-
markets. The company has adopted the different accounting policies during the preparation of
its general purpose financial statements for improving its financial profitability (Langendijk,
Swagerman and Verhoog, 2003). This include use of historic cost accounting, straight-line
method for calculating deprecation, segment reporting and incorporating the use of principle
of consolidation for developed its concise financial statements. This is all done by the
company to meet the needs and expectations of its different stakeholders and thus achieve the

trust and confidence (AGL Annual Report, 2016). This will enable the company to survive in
long-term through realizing improved financial profitability (Hussey, and Ong, 2005).
Conclusion
It can be inferred from the overall discussion held in the report that accounting
policies adopted by a business entity plays a significant role in improving its financial
profitability. The business corporations should develop and prepare their financial reports as
per the qualitative characteristics stated in the conceptual accounting framework. However,
there is need for providing some flexibility in the accounting framework to the managers so
that they can adopt the best accounting practices as per the nature of business operations. The
discretion provided to the managers should not distort the financial performance in nay way.
The AGL Energy Ltd is complying effectively with all the conceptual accounting framework
principles through selection of adequate accounting policies and choices. It has also
implemented flexibility in its accounting policies for maximizing its operational efficiency
and linking the incentive plan of the KMP with the shareholders value. There area also some
issues of concern present in the annual report of the company that requires more disclosure.

References
AGL Annual Report 2016. [Online] Available at:
https://www.agl.com.au/-/media/DLS/About-AGL/Documents/Investor-Centre/
160828_AR_1587084.pdf?la=en
Annual Report 2015. AGL Energy. [Online]. Available
at:https://www.agl.com.au/-/media/DLS/About-AGL/Documents/Investor-Centre/
150826_AnnualReport_1466512.pdf?la=en [Accessed on: 23 September 2017].
Annual Report 2016. Origin Energy. [Online]. Available at:
https://www.originenergy.com.au/content/dam/origin/about/investors-media/senate-
submission-carbon-risk-disclosure-160331/Origin_Annual_Report_2016.pdf [Accessed on:
23 September 2017].
ASX and Media Releases. 2016. Annual Report. [Online] Available at:
https://www.agl.com.au/about-agl/media-centre/asx-and-media-releases/2016/august/2016-
annual-report
Bamberg, G. and Spremann, K. 2012. Agency Theory, Information, and Incentives. Springer
Science & Business Media.
Gray, I. and Manson, S. 2007. The Audit Process: Principles, Practice and Cases. Cengage
Learning EMEA.
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.
Hussey, R. and Ong, A. 2017. Corporate Financial Reporting. Springer.
Jensen, M.C. 2001. Foundations of Organizational Strategy. Harvard University Press.
Kenny, G. 2009. Diversification Strategy: How to Grow a Business by Diversifying
Successfully. Kogan Page Publishers.
Langendijk, H., Swagerman, D. and Verhoog, W. 2003. Is Fair Value Fair?: Financial
Reporting from an International Perspective. John Wiley & Sons.
Marley, S. and Pedersen, J. 2015. Accounting for Business: An Introduction. ed, 2. Pearson
Higher Education AU.
Mintz, S. 2013. Accounting for the Public Interest: Perspectives on Accountability,
Professionalism and Role in Society. Springer Science & Business Media.

Mirza, A. and Ankarath, N. 2012. Wiley International Trends in Financial Reporting under
IFRS: Including Comparisons with US GAAP, China GAAP, and India Accounting
Standards. John Wiley & Sons.
Mumba, C. 2013. Understanding Accounting and Finance: Theory and Practice. USA:
Trafford Publishing.
Ordelheide, D. 2016. Transnational Accounting. Springer.
Pietra, R., McLeay, S and Ronen, J. 2013. Accounting and Regulation: New Insights on
Governance, Markets and Institutions. Springer Science & Business Media.
Wolk, H.I., Dodd, J.L. and Rozycki, J.J. 2012. Accounting Theory: Conceptual Issues in a
Political and Economic Environment. SAGE.