Charlottesquare wrote:The accounting options would be (This is not what companies can do per the Standards but what might be possible to do re double entry) :
1.Treat as goodwill (you paid more than the asset value for the business) to reflect this "value" you acquired- what the Accounting Standards currently say you ought to do re a business combination. (caveated by impairment reviews)
2.Write off through I & E, perfectly possible but somewhat distorts results for the year, in addition in future years distorts ratios like ROCE as you have (in accounting terms) devalued the capital employed, this then flatters , in percentage terms, how hard the net business assets are being seen to work. It also would make comparing relative performance between two companies tricky, company A makes its profits due to long term organic growth, its relative return is based on earnings over capital retained, company B could squander millions on buying another business, have the earnings, write the acquisition cost against its capital employed reducing the denominator and on paper show itself a far better employer of capital, but that perception would be false as the cost of acquiring that extra business would have been ignored.
3. Write off against reserves, avoids the in year I & E hit, but the other issues in 2 remain.
4. Argue the extra paid was re the assets, but that wholly distorts those assets either carried in the balance sheet (Fixed) or say stock (which will impact cost of sales and gross profit in later I & E accounts)
There is a subjectivity but the difference does have to go somewhere, if you follow the Debits and Credits the extra Debit has to go somewhere, so treating the excess as goodwill is a solution, not perfect, but near enough acceptable.
It is still not perfect, in my example suppose company A paid out most of its past earnings in dividends but gradually it grew its customer base and earnings organically, it then shows a very high ROCE because the internally generated goodwill that exists (but is not shown in its balance sheet) is not recognised so its capital employed in economic terms is understated (though not in accounting terms due to internally generated goodwill not being included in the accounts per the Accounting Standards).
I wouldn't be surprised if some of the options you reveal above go part of the way toward explaining why we've found it very difficult to apply any coarse-drained analysis to the financial statements of some of the older companies, which, we guess have gone through several cycles of acquisitions and acquiring subsidiaries.
When I read your writings for option 2. i.e. "Write off through I & E, perfectly possible but somewhat distorts results for the year", I recollected the Income statements of Sage (SGE) and Dairy Crest (DCG) which we reviewed a while ago:
For Sage's 2017 Annual reporthttps://www.sage.com/corporate/investors/annual-report/
(then browse for the latest)
or this link may take you straight there:http://fr.zone-secure.net/11650/458628/#page=1
Income statement is on page 119
For Dairy Crest 2018 Annual reporthttp://www.dairycrest.co.uk/~/media/Fil ... t-2018.pdf
Anyway, whilst I appreciate that this is now a little off topic re. my OP, however I'm wondering if the some of the categorisations of the Income Statement could be explained by your above Option 2., Charlottesquare. On Sage's we see 3 columns for the P&L, i.e. "underlying, adjustments and statutory" and on DairyCrest's we see "before exceptional items, exceptional items and total". Both reports, then go on to split profit by "continuing" and "discontinued operations". To newbies, we found all this very confusing, and haphazard.
So the naive in the room, are wondering if (especially the reference to "discontinued") this is the way in which written-off parts of the business are being reported? That is, written off in I&E?
In particular, with these firms, as you mentioned earlier, it was easy in my analysis spreadsheet, by selection of differing figures for apparently the same datas to arrive at slightly more or less flattering values for margins, ROCE, cash flows etc.
Consolidations, Mergers, Business Combinations is not Accounting 101, student first learn and get very comfortable dealing with individual accounts for single companies/other business entities and then consolidation etc gets added in Acccountancy 102, the catch for you is you want to learn re quoted companies and they do, for myriad reasons, use groups/combinations as the way they operate, so I appreciate it is a steep learning curve especially if the underlying guidance re valuation issues is not firmly grounded.
You point re subjectivity may not be that well covered in basic textbooks which more tend to concentrate on what we do per current standards rather than what we ought to do. Years ago accounting magazines used to discuss journal articles re these issues (Students reading into the why as against the how) but these days it is tricky for me to point where you ought to go if you want to delve into the arguments re why. One possible useful source is say International GAAP 2018, I have not got it or read it but the old EY UK GAAP book I do have did touch on the whys as well as detailing and showing examples of the how, but it is a massive book (5360 pages-a reference not a read) and it assumes some existing knowledge re the basic debits and credits and is not cheap.https://www.amazon.co.uk/International- ... +gaap+2018
Yes, you are right about the learning curve. To be honest, I'm hoping that I can avoid that exact level of intellectual commitment, though I do think, that getting a rough idea of these matters is useful when delving into the books.