Impact of IFRS 16 on Financial Statements

This assignment examines the effects of IFRS 16 on a company's financial statements compared to IAS 17. It analyzes how the recognition of lease liabilities under IFRS 16 impacts operating expenses, finance costs (interest expense), and depreciation. The document discusses the presentation of these items within the financial statements and highlights key differences between the two standards.

2019Financial Reporting for Businesses
Financial analysis of
UNITE GROUP.

Contents
Profitability............................................................................................................................................2
Return on equity:...............................................................................................................................2
Gross Profit margin:...........................................................................................................................2
Operating Profit margin:....................................................................................................................2
Asset Turnover:.................................................................................................................................3
Liquidity.................................................................................................................................................3
Current ratio......................................................................................................................................3
Acid Test Ratio...................................................................................................................................3
Efficiency...............................................................................................................................................4
Inventory Days...................................................................................................................................4
Debtor Days.......................................................................................................................................4
Creditor Days.....................................................................................................................................4
Gearing..................................................................................................................................................5
Investor’s Return...................................................................................................................................5
Interest cover....................................................................................................................................5
Earning per share...............................................................................................................................5
Profitability............................................................................................................................................6
Liquidity.................................................................................................................................................6
Efficiency...............................................................................................................................................7
Gearing..................................................................................................................................................7
Investor’s return....................................................................................................................................8
Lease......................................................................................................................................................9
THE BASICS OF REPORTING LEASES UNDER IAS17 ARE......................................................................9
PROBLEMS WITH IAS17.....................................................................................................................9
LEASES UNDER IFRS 16......................................................................................................................9
EFFECTS OF IFRS 16 ON UNITE GROUP..................................................................................................9
Bibliography.........................................................................................................................................11
1

a) Calculate ratios for profitability, liquidity, efficiency
and gearing for the years 2018 and 2017
Profitability
Return on equity:
Profit before
interest and tax
Equity + Debt
Year 2018 Year 2017 Change
163.50 × 100
------------------ = 6%
2098.8 + 603.3
155 × 100
---------------- =6.8%
1754.2 + 519.9
6.8 – 6 × 100
--------- = 12%
6.8
Profit before
interest
Equity
245.8 × 100
--------- = 11.7%
2098.8
223.8 × 100
------------- =
12.76%
1754.2
12.76 – 11.7 ×
100
------------- = 8.3%
12.76
Gross Profit margin:
Gross Profit
Sales
Year 2018 Year 2017 Change
88.1 × 100
------- = 68.67 %
128.3
78.2 × 100
------- = 65.55 %
119.3
65.55 – 68.67
×100
---------------=4.76%
65.55
Operating Profit margin:
Operating Profit
Sales
Year 2018 Year 2017 Change
64.5 ×100
------ = 50%
128.3
51.3 ×100
------ = 43%
119.3
43 – 50 ×100
--------- = 5%
43
2

Asset Turnover:
Sales
Equity + Long
term debt
Year 2018 Year 2017 Change
128.3 ×100
---------- =
4.77%
2098.8 + 591.3
119.3 ×100
-------- = 5.27%
1754.2 + 511.5
5.27 – 4.77 ×100
------------ = 9.5 %
5.27
Liquidity
Current ratio
Current assets:
current liabilities
Year 2018 Year 2017 Change
220.80:147.4=
1.5:1
138.6:157.5=
0.88:1
0.88 – 1.5 ×100
----------- = 70%
0.88
Acid Test Ratio
Year 2018 Year 2017 Change
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Current assets-
inventory: current
liabilities
220.8-
9.1:147.4=1.43:1
138.6-
4.5:157.5=0.85:1
0.85 – 1.43 ×100
-------------- = 68%
0.85
Efficiency
Inventory Days
Avg. Inventory
×365
------------------
cost of sales
Year 2018 Year 2017 Change
9.1 × 365
----------- =83 days
40.2
4.5 × 365
----------- =40 days
41.1
83-40 ×100
------------- =108%
40
Debtor Days
Avg. T/R ×365
-------------
Credit sale
Year 2018 Year 2017 Change
22.8 ×365
------- = 74 days
112.7
19.4 × 365
---------- = 71 days
99.7
71 – 74 ×100
-------- = 4%
71
Creditor Days
Avg. Trade
payable×365
--------------------
credit purchases
Year 2018 Year 2017 Change
26.6 × 365
---------- = 242
days
40.2
19.7 × 365
---------- = 175
days
41.1
175 – 242 × 100
----------- =38%
175
4

Gearing
Long term debt
×100
Equity
Year 2018 Year 2017 Change
603.3 ×100
------- = 22.3%
2702.1
519.9 ×100
------= 22.8%
2274.1
22.8 – 22.3 ×100
------------ =2%
22.8
Investor’s Return
Interest cover
Profit before interest and
tax
Interest expense
Year 2018 Year 2017 Change
163.5 + 95.8
---------= 19.2
times
13.5
155 + 103.1
---------- =9 times
28.7
9 – 19.2 ×100
--------=113.3%
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Earning per share
Profit after tax
---------------
No. Of equity
share
Year 2018 Year 2017 Change
237300000
-------------- =91.1p
260294000
223800000
----------- =93.9p
238130000
93.9 – 91.1 ×100
--------------=2.98%
93.9
5

b) Analyse the performance and position of The Unite
Group plc based on the above ratios
Financial planning and management are important in order to run a
business effectively. Financial ratios are critical to understand financial
statements, to know if the business is going in the right direction.
Lenders and investor rely heavily on ratios analysis to know the state of
the business before making any lending or investment decisions.
Profitability
The ROCE is underperforming by 12% even though the operating profit
has increased 5% by compared to year 2017. Cost of sale is almost the
same as there is no significant change in it. As IAS 40 allows the rise in
value of investment property to be included in profit whether it sold or
not yet. UNITE uses fair value method in which it doesn’t have to
depreciate the asset value. IAS 17 stop reporting lease liabilities which
results in increase in percentage of ROCE.
By looking at figures, there is a decrease in joint ventures profit even
though the joint venture investment has increased from £793.5 million in
2017 to £819.7 million by £26.2 million increase. One of the main reason
for this is decrease in value of net valuation gain which was £65 million
in year 2017 has come down to £58.1 million. Another factor which
contributed in less profit is selling property on loss of £6.8 million.
Another reason in decrease profitability is rise in investment property
which means UNITE has more non-current assets. The other component
of ROCE is asset utilization which is measured by net asset turnover. The
decrease of 9.4 % in asset turnover ratio shows that there is emptier or
under developed building which are not generating rent resulting in less
profit. On the other hand, it is beneficial for UNITE to own more property
which will generate more income as company will have to invest less
amount of money in future.
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Liquidity
UNITE group has a higher level of cover for its current liabilities. It
current ratio for year 2018 is 1.5:1 compared to 2017 0.88:1 increased
about 70% which mean it has more cash available to cover its current
liabilities. Its cash deposit is £123.6 million compared to £51.2 million.
This has helped by a successful rights issue.
Liquidity ratios decrease primarily due to additional current liabilities
that from lease accounting under IFRS 16 (IAS17) and Employee benefits
under IAS 19. UNITE group use DEFINED CONTRIBUTION PENSION
SCHEME which results in higher finance cost but no pension cost in its
balance sheet.
Some of this rights issue appear to have been used to reduce the bank
loan. It has put more money aside to clear the outstanding debts
resulting in decrease in trade payable which is good for investor point of
view. The increase in the cash at bank helped by successful rights issue
increase of 5.7 % which is a sign of shareholders support and confidence
in the future.
Efficiency
As UNITE Group has relatively low inventory levels this means it must
also have relatively low levels of trade payables which can confirm the
creditor ratios. UNITE has apayable period of 242 days is a clear
indication of supplier being generous with the credit period they extend
to UNITE group.
Efficiency ratios in UNITE tells the management team is effective in
using the minimum amount of assets in relation to a given amount of
sales. These ratios don’t always give a clear picture of the business. A
low rate of creditor’s turnover could be related to deliberate payment
delays which could affect its credit reputation. Desire to achieve higher
asset ratio could make the management to reduce the required
investment in fixed assets purchase.
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Gearing
Gearing, a primary measure of risk calculation taken from using fixed
interest capital at 2% is lower than year 2017. The interest rate for year
2018 is 4.4% which is low than the Return on capital employed of 6%.
But UNITE group has taken the advantage of low interest rate as most of
the money to financed its projects is from the owners which result in
increase in the cost of debt and more expensive in respect of interest rate
than borrowing it from banks or other financial institutions.
It will be inefficient if UNITE group has large assets and earning a stable
profit but it borrows money from its owners. As UNITE is making stable
profit so it should go ahead with borrowing money from external lenders.
Another factor which will affect the gearing ratio is implementation of
IFRS 16 which will result in increase or decrease in assets and liabilities.
Lease assets are more quickly reduce as compared to liabilities. This will
results in the reduction in equity compared to IAS 17 for UNITE which
will effects the financial analysis for the group.
Investor’s return
UNITE’s interest cover is up by 113.3% compared to 2017 which
indicates investors has more confidence in lending money and its debt
management.
UNITE’s share of debt grew by £53million to £856million in 2018. The
majority of property and development expenditure was financed by
shares offering and disposal of old properties along-with asset value
appreciates which directly affect the loan to value to 29% compared to
2017. With the implementation of IFRS 16, equity figure will increase
compared to IAS and will gave different result. It can change the investor
approach in financing the future projects.
Earnings per share has decreased even though UNITE has less cost of
sale and operating expense this year. But it has issued more shares to
increase its equity which has been used to finance the ongoing projects,
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most of its projects are still in pipeline which will increase its revenue in
coming years.
Based on the company development pipeline and existing properties, it is
believed the firm has the potential to pay out 34.1p per share in
dividends this year, giving a potential dividend yield of 3.2%.(Elliot and
Elliot, 2007)
c)Analysing the changes in lease accounting rules from
IAS 17 to IFRS 16 leases
Lease
A lease involves one party (lessee) obtaining the use of an asset from a
supplier (lessor). The asset is not paid fully but rather it is agreed to pay
the supplier in the future via instalment.
There are two different types of lease agreements. In FINANCE lease, all
major risks and rewards are transferred to the lessee. The payments
normally last the length of the useful life of an asset, thus no one else will
get to use the asset. Lessee can gain legal ownership of an asset at the
end of lease.
In OPERATING lease, lessor retain the legal ownership and risks and
reward of asset. At the end of the lease the asset is handed back to the
lessor.
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THE BASICS OF REPORTING LEASES UNDER IAS17 ARE
In finance lease, the lessee reports the asset and also a liability to pay for
it. Instalments are partly repaying the liability and partly interest
expense for the lessee. In Operating lease, the lessee merely rents the
asset and does not report the asset on its balance sheet or have need to
show a liability to pay for it. Instalments are rent expense for the lessee.
PROBLEMS WITH IAS17
In IAS 17, a lessee (and lessor) required to report that it owned all of an
asset (finance lease) or none of it (operating lease). There was no
possibility of reporting that a portion of the asset was owned. Operating
lease leaves liabilities out of reports, inconsistent rules.
LEASES UNDER IFRS 16
Under IFRS 16, the lessee required to account for all leases on their
balance sheets, including those which had previously been treated as
operating leases and accounted for in P & L account as an “in-year”
expense.(Vlearulondon.org, 2019)
EFFECTS OF IFRS 16 ON UNITE GROUP
1) UNITE group will reclassify leasehold improvements which were
previously treated as items of PPE and depreciated on a straight
line basis to sale and lease back right of use assets.
2) The new standard will make a right-of-use resource and
a risk for end of the least rent instalments. This standard will have
the greatest effect on UNITE deal and leaseback portfolio which
comprises 3,147 beds over 10 properties. These properties were
sold by the Group between 2004 and 2009 as there The properties
have pay secured by designations agreements to offset
the rent instalment to the regulation owners. On move,
net resource esteem is anticipated to extend by £10-£15 million.
(smith, 2019)
3) UNITE under IFRS 16 implementation will result in an increment in
lease resources and budgetary liabilities. The
carrying sum of rent resources will typically reduce
more rapidly than the carrying sum of lease liabilities. This will
result in a decrease in reported value compared to IAS 17 for group
with material off balance sheet leases. This is often similar to
the impact on equity value that emerges from financing the buy of
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an asset, either through a former on balance sheet lease or a credit.
(IFRS, 2016)
4) Profit measures before interest and tax, such as EBIT or operating
profit, will also increase applying IFRS 16. This is because those
measures applying IFRS 16 exclude interest on lease liabilities
whereas, applying IAS 17, they included the entire expense related
to off balance sheet leases.
5) For UNITE Group that has material off balance sheet leases, IFRS
16 is anticipated to result in higher profit
before interest (for example, operating profit) compared to
the sums detailed applying IAS 17. This is because, applying IFRS
16, a company presents the certain interest in rent instalments for
former off balance sheet leases as portion of finance costs. On the
other hand, applying IAS 17, the whole cost related to
off balance sheet leases was included as portion of operating
expenses. The measure of the increase in operating profit, and
finance costs, depends on the importance of leasing to the
company, the length of its leases and the discount rates applied.
(IFRS, 2016)
6) Unlike IAS 17, for all leases (counting previous off balance sheet
leases), IFRS 16 requires a company to
recognise interest on lease liabilities separately from depreciation
of rent assets. A company is expected
to show interest cost as portion of finance costs,
and depreciation within a same line item to that in which it
presents depreciation of property, plant and equipment. Applying
IAS 17, lease instalments for off balance sheet leases
were generally presented within operating expenses.
Bibliography
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Linking Financial Statement Notes to the FASB and IASB
Conceptual Frameworks, Issues in Accounting Education, Nov
2013, Vol.28,issue 4,pg 1009 -1029
3. Unite-group.co.uk. (2018). Annual Report 2018 | Unite Group.
[online] Available at:
http://www.unite-group.co.uk/investors/annual-report-2018
[Accessed 11 Oct. 2019].
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https://vlearulondon.org/pluginfile.php/97657/mod_resource/conten
t/1/ifrs16-effects-analysis.pdf [Accessed 22 Oct. 2019].
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http://www.unite-group.co.uk/sites/default/files/2019-02/Preliminar
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