Analysing debt a case study (Carillion)

[moorfield]

How investors can spot the next Carillion. More insights from Phil Oakley for those interested.

https://moneyweek.com/how-investors-can ... carillion/

[johnhemming]

The visible borrowing on a balance sheet is often just the tip of the iceberg. Other debts include things such as pension-fund liabilities, money owed to trade creditors, rental liabilities, etc.

The purchase ledger balances should be on the balance sheet. Worries me about the article.

The issue of commitments to future payments is an interesting issue. If a business ends up in trouble it can end up cutting down its income and profit whilst maintaining future commitments.

[Charlottesquare]

I appreciate the point re operating lease commitments, and of course the annual charge was always disclosed, but if one starts thinking of these as a debt you really need to think of there being an asset on the other side (lease interests) which to me is a slippery slope re yet more intangible assets.

In addition why just contractual liabilities re leases, what about future contractual liabilities re staff salaries etc, why should these not be accounted for in similar manner, why are leases different/special, where is the accounting philosophy with the idea?

There is sound reason for pension liabilities to be disclosed, these liabilities relate to activities already passed, the company has already incurred the liability vis a vis its contractual relationship with the member of staff re time already elapsed, but re leases that is not the case. If I enter into a 25 year lift service contract should I record the total liability on day one and create an asset- to me there lies madness.

I can see an argument re disclosure in the notes, the figures not being part of the double entry within the books, but beyond that one is starting to really dismantle traditional accounting, the matching concept ex SSAP2 would be twirling in its grave.

Whilst I do not prepare accounts within the accounting frameworks used by our quoted plcs, beyond my paygrade these days, there are already too many weird and wonderful valuations/disclosures even within FRS102 used by smaller companies; preference shares treated as debt on the balance sheet, even if no redemption provision in their terms, the at times daft notion that if a company has had a loan from its director of say £100,000 and the interest he is charging is say 6% the debt, in the company's accounts, is no longer disclosed as £100,000 under FRS102 (Financial Instruments) instead its "fair value" is to be calculated instead.

Somewhere within accounting thought since the 1970s/1980s the lunatics took over the asylum so I am now away to find my book of WT Baxter essays to restore a little sense to my brain.

[Dod101]

I agree that accounts nowadays have moved so far from the traditional idea of a 'true and fair' statement of accounts as to be almost meaningless, both in respect of now sometimes overstating liabilities as well as understating them, although in the old days I think on the whole they erred on the side of caution.

With leases though I think we need to be careful. An airline for instance could well be leasing most of its assets, to wit the aircraft without which they have no business. it seems to me to be perfectly reasonable to include the liabilities under the leases as a liability.

Pension fund liabilities and assets are disclosed in company accounts as they should be and thus the surplus or deficit is also disclosed (although the methodology for arriving at the liabilities can be and bit hit and miss).

I read somewhere that Carillion owed the banks £760 million under the government's 'Early Payment Scheme' when they collapsed which was designed to improve the cash flow of small businesses to whom Carillion and others owed money. The small business owner could take his invoice to a participating bank who would pay him in full on the due date and then Carillion would repay the bank, except that did not. Carillion apparently called this 'other creditors' in their accounts and not 'debt'.

And of course I think it is not right that banks need to put the changes in the value of their own long term bonds through their P & L Account even although it has got nothing to do with their trading.

There is so much that is nowadays weird about company accounts that I seldom try to understand them and certainly never try to analyse them.

As usual with this type of article there is something in it but it in itself is simply yet another interpretation.

Dod

[tjh290633]

I think that most of the items mentioned would be found under "Accruals and Provisions" in most accounts.

Profits and income earned, invoiced but not yet received, would come under accruals. Payments to lessors or subcontractors, which will be due after the accounting date, and which have been invoiced or contractually agreed, would go under provisions. However these will only relate to the year in question.

Surely lease costs for the coming year, such as those paid by Train Operating Companies, or leases on premises, are not relevant to the current year's accounts. They are operating expenses, and will be accounted for as such.

As I understand it, provisions for payments in respect of pension funds relate to the amount which would be needed to purchase annuities for the liabilities of the pension fund, in the event of a sudden need to securitise the pension fund's commitments already made. The "Shortfall" is the difference between this sum and the actual assets of the pension fund. The amount of the shortfall depends on current annuity rates.

In the contracting business, the use of provisions to cover things like remedial work or cost overruns was, as I recall, a normal way of doing things.

TJH

[Alaric]

As I understand it, provisions for payments in respect of pension funds relate to the amount which would be needed to purchase annuities for the liabilities of the pension fund, in the event of a sudden need to securitise the pension fund's commitments already made. The "Shortfall" is the difference between this sum and the actual assets of the pension fund. The amount of the shortfall depends on current annuity rates.

It's usually somewhat looser than that. If the pension scheme were to continue, does it have enough sufficient assets to pay the benefits as they arise? If not, how much would need to be set aside to supply sufficient funds. That said, with the general move to closure of defined benefit schemes a securitised buyout is sometimes the operational strategy.

In days gone by, a pension scheme could be run on the basis of a 5% employee contribution and a 10% employer. Surpluses and shortfalls could be handled by offering and withdrawing discretionary pension increases. Legislation scuppered this approach by outlawing the short-changing of those who left the scheme many years before retirement and by insisting the inflation linked increases could no longer be discretionary.

[tjh290633]

In days gone by, a pension scheme could be run on the basis of a 5% employee contribution and a 10% employer. Surpluses and shortfalls could be handled by offering and withdrawing discretionary pension increases. Legislation scuppered this approach by outlawing the short-changing of those who left the scheme many years before retirement and by insisting the inflation linked increases could no longer be discretionary.

In days gone by the scheme managers could buy dated securities which matched their obligations for those already retired, but the current low interest rates make that impracticable. They could also run considerable surpluses and invest in diverse sectors, which provided adequate income to support the contributions. That is why so many were able to take contribution holidays. Then it became unlawful to hold a large surplus, which sounded the death knell for many previously well-funded schemes. The need to have a mandatory index-linking also killed off discretionary increases above the rate of inflation to pensions in payment.

TJH