Financial Ratio Analysis Example

The assignment presents a financial dataset and guides the user through calculating several essential financial ratios. These include Net Leverage Ratio, Current Ratio, and Asset Turnover Ratio. The calculations are illustrated step-by-step, providing a clear understanding of how each ratio is determined and its significance in assessing a company's financial health.

REPORT ON AASB 16

Abstract
Leasing constitutes an important activity for various organizations and is a strong way to get
access to the assets in terms of procurement of finance. It is important for the user of the
financial statements to have clear cut knowledge of the leasing activities of the organization. The
report stress upon the concept of AASB 16 leases. This standard will be applicable from 2019.
The old model was put to criticism for the deficiency on their part to cater to the need of the
financial statement users. The report touches upon various matters of AASB 16 and for this
Speedcast International Ltd based in GICS sector is selected.
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Contents
Introduction.................................................................................................................................................4
1. Change in leasing standard and its impacts.........................................................................................4
2. Effect of AASB 16 on Financial Statements..........................................................................................5
3. Reporting on the environmental and social aspects of the leased assets............................................6
4. Usefulness of AASB 16 to the users of financial statements of the lessee company...........................7
5. Summary of the total report to be presented to the Chief Executive Officer......................................9
Conclusion.................................................................................................................................................10
References.................................................................................................................................................11
Appendix...................................................................................................................................................13
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Introduction
AASB 16 shall be effective from 1st January 2019 onwards, the main objective of which is the
recognition of all kinds of leases that are above 12 months in the financial statements. Under this
standard, the lessee shall recognize the right to use an asset on the assets side and the liability to
pay the lease payments on the liability side of the balance sheet. Further, the lessee shall also
record the depreciation of such leased asset and the interest on lease liability in its income
statement (AASB, 2016). Also, the cash flows shall show the cash repaid portion of lease
payments and bifurcate it into interest and principal. This shall be common for all types of leases
whether operating lease or finance lease. Hence, the application will cater to both types of leases.
We shall elaborate the above points with regard to a company in GICS Sector – Speed Cast
International Limited, a leader in the field of network service from the perspective of a
stakeholder, say the Shareholders of the company.
1. Change in leasing standard and its impacts
i. Amendments in the lease standard
The leasing standard has been changed due to the reason that the earlier model
required to classify the lease into operating lease and finance lease but did not require
the lessee to show the leased asset and its liability in its financial statements in case of
the operating lease (AASB, 2016). Due to this the users and stakeholders of the
financial statements of the lessee were not finding a satisfactory presentation of the
lease transactions in the financial statements of the lessee in case of an operating
lease. Hence the concerned boards have decided to make the requisite amendments to
the leasing standards (Porter & Norton, 2014).
ii. Disclosures in the income statement
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The change will be that the lessee will have to record the right of use of the asset in
the balance sheet and consider it as a depreciable asset and also show the obligation
to pay off the lease payments as liabilities in the balance sheet (Northington, 2011).
Further, the depreciation of the said asset and interest on the lease payments shall be
disclosed in the income statement.
iii. Distributable profits
The above said changes will have an impact on the net incomes shown in the income
statement of the lessee as the interest on lease payments as well as depreciation will
be added to the expenses in the income statement. Hence the net incomes will get
reduced. Such as reduction in net distributable incomes shall affect the shareholders
of the company as the distributable profits will reduce and thus the earning per share
will reduce. Therefore, it will impact the wealth of the shareholders since there will
be a reduction in the profits of the company.
iv. Decision making ability
The benefits to the shareholders will be that after the new lease standards are adopted,
the shareholders will have a transparent picture of the lessee company’s financial
leverage and capital employed and as such a better comparison can be made as to in
which company they should invest further. The decision-making ability of the
investors will undergo an immense change. The disadvantage shall be the reduced
portion of their profits in the form of dividends and also a reduction in total equity.
2. Effect of AASB 16 on Financial Statements
Recognition of lease effects
First, we shall ascertain the effects of the new standard on the lessee company’s financial
statements that is Speedcast International Limited. The changes in the recognition of lease effects
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will change the related ratios such as net profit ratio which was 2.70 % for the year ending
December 2016, Net Leverage Ratio which was 8.67% and other such ratios (Melville, 2013).
The N.P Ratio will decline due to increase in the interest and depreciation expense. The Net
Leverage Ratio will show an increase due to rise in borrowings which are the lease payable
(Speedcast International Ltd, 2016).
Other ratios such as interest coverage ratio, Earning per share will also show a downfall due to
increase in expenses and decrease in net profits. When the expenses are on a surge and the
Earnings and dividends
The effect on the stakeholder’s financial statements will be that as the earnings and dividends
will reduce from the lessee company and such it will reduce the net profit of the stakeholders
also. Further, due to a reduction in dividends and earnings per share, the market price per share
may reduce and thus the total value of investments may reduce which is shown in the balance
sheet.
3. Reporting on the environmental and social aspects of the leased
assets
Regulatory requirements
When it comes to reporting regarding the environmental and social aspects such as energy use
and efficiency, carbon emissions, etc of the leased assets, it should be the responsibility of that
entity which has got the right to use that asset and is actually using it. The reason behind this is
that as the asset is no longer in the hands of the lessor as the lessee has legally taken the right to
use the asset and is using the asset for the business operations (Bodie et. al, 2014).
For our chosen stakeholder that is the shareholders, there are no regulatory requirements for such
reporting as the lessee company is using the assets for its business use and the shareholders are
not using the assets for their individual use.
The following points are reported:
a. Whether or not the emissions from the leased asset are creating any health hazard to the
environment.
b. Whether or not the regular pollution control and checking are done for the leased asset.
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c. Whether or not the user of leased assets is fulfilling the requirements of reporting to the
regulatory authorities within time.
d. Other such related points which are important to ensure that the society and environment
as a whole are not being harmed by any leased asset.
Hence, the lessee should ensure that the society or the environments are not affected by the lease
arrangement. For example- water or air pollution, soil erosion, cutting of the tree, emission of
harmful gases, loss of jobs. This is required as this will adversely affect the society and
environment which shall have long-term ill effects (Shah, 2013). On the other hand, if the lease
arrangements give back advantages to the society, it will be advantageous in both short and long
run for the owner or user as well. Hence, it will create a positive impact that will help the
organization, as well as the society at large.
4. Usefulness of AASB 16 to the users of financial statements of the
lessee company.
The overall reporting after the AASB 16 comes into effect shall be more beneficial and
informative to the users of financial statements.
The changes in reporting and its use by the users of financial statements can be summarized in
following points:
a. Change in the financial metrics
The new standard that will be effective from the year 2019 shall almost eliminate the
reporting of the leases off balance sheet and the lease transactions will be shown on the
balance sheet and income statement. Earlier and at present also the financial lease is
shown in the income statement and balance sheet but the operating lease is being shown
outside the financial statements in the notes to accounts (Libby et. al, 2011). The
proposed change will help in redefining of the financial metrics such as the financial
ratios like gearing ratio, and other such ratios (KMPG, 2016). It means that the effect of
operating lease and their effect on the ratios will also be known to the users of financial
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statements. The benefit of this will be ease of comparison with other companies in the
industry but the disadvantages are also there as the net profitability of the company will
go down further affecting the creditability, the finance costs and also the perception of
the stakeholders.
b. Disclosures of the profitability segment and the asset base of the company
The users of the financial statement will better know the asset base of the company once
this standard comes into effect as the assets that are being used by the company whether
owned or leased will be reflecting in the balance sheet (Damodaran, 2012). At present the
assets under operating lease are shown as off-balance sheet item (KMPG, 2016). The
users are generally aware of the financial statements and do not go into in-depth study in
the notes to accounts and other information.
c. Disclosures necessary for the financial institutions imparting loans to the lessee
company.
The information regarding the net worth of the company, the existing borrowings, the
profitability of the company and such matters are of utmost importance for the financial
institutions from which the company seeks financial assistance (Parrino et. al, 2012).
When the operating lease is not recognized in the financial statements although the right
to use the asset is vested in the company, this does not give the correct picture of the
financial position of the company to the financial institutions (KMPG, 2016). Hence with
the implementation of the AASB 16, the financial institutions will have a clear image of
the financial position before imparting any more loans and advances.
d. Investing decisions
The users of the financial statements of the lessee will now determine whether they want
to further invest in the company or not. This is due to the fact that the company shall
show the interest and depreciation expenses in the income statement which will for sure
bring down the profitability (BDO 2016). Further, this will impact the earnings per
share/dividends to the shareholders and may be a reduction of the market price per share.
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This may result in a reduction in the number of investors of the company as they will
start getting lower returns on their investments (Speedcast International Ltd, 2016).
5. Summary of the total report to be presented to the Chief Executive
Officer
The total concept of AASB 16 shall be summarized through following precise points:
a. Lease recognition
As per the earlier and present standards on leasing, the leases are classified in the
financial statements as operating lease and finance lease. With the coming of the new
standard, all the leases will be recognized in the same manner and there will be no
difference in the operating and finance lease with regard to their recognition in the
financial statements (AASB, 2016).
b. Ratio analysis
The new standard will affect almost all the financial ratios such as gearing ratios or net
leverage ratios, current ratio, asset turnover ratio, interest coverage, net profit/ margin
ratio. Other financial metrics will also be affected such as EBITDA, Net Profits, earning
per share, dividend per share, operating cash flows, etc (BDO 2016).
c. Changes in the standard
The changes in the standard will affect the perspective of the stakeholders of the
company such as shareholders, investors, government, employees, financial institutions,
etc. as there will be changes in the credit ratings, borrowing costs, net asset values,
earnings per share of the company which directly or indirectly affect the stakeholders
(Needles & Powers, 2013).
d. New standard for new standards.
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The implementation of the new standard will increase the total expenses of the lessee
company as the lease rentals will be replaced by interest on the lease was taken as well as
the depreciation on the right to use assets (Williams, 2012). The main effects will be that
due to the large assets such as ships, aircraft, big machinery, etc. and not small assets
such as computers, laptops, small equipment, etc.
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Conclusion
Going by the overall discussion it can be commented that the new standard will be highly
beneficial to the organization and eliminate the lease reporting and will thereby appear on the
balance sheet. Hence, a level of an enhanced transparency will be witnessed. From the
amendment and updating point of view, it can be said that the new standard will altogether
bring a vast change in the reporting mechanism in respect to the operating leases which was
treated as an off-balance sheet item. Hence, the shareholders will be able to get a better grasp
of the lease operations which was not possible earlier. Though there are certain problems but
in totality the mechanism will be highly beneficial and bring widespread transparency.
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References
AASB 2016, Leases, viewed 19 September 2017
http://www.aasb.gov.au/admin/file/content105/c9/AASB16_02-16.pdf
BDO 2016, New leases standard requires virtually all leases to be capitalised on the balance
sheet, viewed 19 September 2017 https://www.bdo.com.au/en-au/accounting-news/accounting-
news-february-2016/new-leases-standard
Bodie, Z., Kane, A. & Marcus, A. J 2014, Investments, McGraw Hill
Damodaran, A 2012, Investment Valuation, New York: John Wiley & Sons.
KMPG 2016, AASB 16: A fundamental overhaul of lessee accounting effective 2019, viewed 19
September 2017 https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-fundamental-
overhaul-lessee-accounting.html
Libby, R., Libby, P & Short, D 2011, Financial accounting, New York: McGraw-Hill/Irwin.
Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson,
Education Limited, UK
Needles, B.E. & Powers, M 2013, Principles of Financial Accounting, Financial Accounting
Series: Cengage Learning.
Northington, S 2011, Finance, New York, NY: Ferguson's.
Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ:
Wiley
Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas:
Cengage Learning
Shah, P 2013, Financial Accounting, London: Oxford University Press
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Speedcast International Ltd 2016, Speedcast International Ltd Annual Report & Accounts 2016,
viewed 19 September 2017 https://www.speedcast.com/speedcast-reports-full-year-2016-results/
‘
Williams, J 2012, Financial accounting, New York: McGraw-Hill/Irwin.
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Appendix
Appendix – 1
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Appendix – 2 Ratio Analyses
There are lot of ratios that will be affected with the implementation of AASB 16. Few of them
are
calculated below for the company Speedcast International Limited on the basis of annual data
for year ending December 2016 :
1) Net Profit Ratio = Net Income after taxes/ Total Turnover
= $ 5,897 / $ 2,17,991 = 2.70%
2) Net Leverage Ratio = Net Debt / EBITDA
EBITDA = Net Income + Interest/
Finance Cost +
Taxes + Depreciation+ Amortisation
Expenses
= $ 39558
Net Debt
= Total Borrowing - Cash & Cash
Equivalents
= $ 368310 - 25341 = $ 342969
Net Leverage Ratio = $ 342969/ 39558= 8.67%
3) Current Ratio= Current assets/ Current Liabilities
Current Assets= 517048 $
Current Liabilities= 72139 $
Current Ratio= 517048/72139 $
7.17
4) Asset Turnover Ratio = Assets / Total Turnover of the Company for the year.
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Assets= 737049 $
Turnover= 217991 $
Asset Turnover Ratio=
737049/
217991 $
3.38
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