Next Plc.: Accounting Principles

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Table of Contents

Introduction
Critical Background
Next Plc. Annual Report 2008
Relevance
Reliability
Comparability
Understandability
Conclusion
List of References

Introduction

Is accounting profession entirely independent and dependable? This question was on every investor’s mind when a series of accounting scandals and frauds erupted in a small period of 3 years from the year 2000 to 2002. This period was marked as a crises period for investor trust in global entrepreneurships and the accounting profession itself. Many publicized business failures during this period such as that of Enron, Tyco and Worldcom (Tracy, p. 119) highlighted the mischief which was mainly due to embezzlement of funds, false declaration of profit by overstating revenues and understating expenses, amplifying the value of assets or understatement of liabilities. This typically involved companies’ defying directors with the assistance of offices in other corporations or affiliates (Albrecht, 2005). This takes us back to the critical evaluate and understand the objective of financial statements that is to provide information about the financial position, performances and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions (ASB, 1999). In this paper we would discuss the issues which make the conceptual framework lacking in the financial information of bankrupt companies yet so important for the users of financial statements, review a case of Next Plc. based on its financial statement year ended 26 Jan 2008 and finally draw our conclusions as to which qualitative characteristic of financial statement is by far most important one to its users.

Critical Background

The increasing number of frauds and misstatements led to a divisive debate over the information presented in the financial statements for the purpose of meeting the common needs of most users actually failed to fulfil its basic requirements. The content of financial statements show the results of stewardship of the management that is the accountability of the management for the resources entrusted to it (AT Foulks Lynch, 1998). The users of the financial information assess the performance of the management and develop their respective view of the company’s progress based on the disclosures made in the financial statements. Hence, it allows them to make their investment decisions if they believe that the company has performed well in the past or is expected to do well in the foreseeable future. The misuse of reporting principles and deliberate negligence by auditors allowed the management of many companies to manipulate the financial information and mislead users including equity investors, lenders, employees, business contacts, government and in general public. This resulted in billions of investors’ money being wiped out from the market and huge losses in terms of unemployment, loss of revenues to the governments and most importantly the damage it did to the accounting profession (Marnet, 2008).

Some may argue that the financial statements only contribute to the decision making to an extent limited by the fact that they are based on the past year results and may not be relevant to the time of decision. Further argument could be made regarding the users’ ability and understanding of the financial information when making their economic decisions. Carmichael, Whittington & Graham (2007) stated that both users’ characteristics and those characteristics which are inherent in the information are vital for the understandability of information. This is much more acceptable opinion as we review the guidelines laid out by various international and country wise regulatory bodies they all provide a conceptual framework which underpins certain qualitative characteristics of the financial statements. These characteristics either relate to the content or presentation of the financial statements. Those characteristics which relate to the content of the financial statements include ‘reliability’ and ‘relevance’ while those which relate to the presentation include ‘comparability’ and ‘understandability’. These characteristics will be discussed in detail when we analyse the financial statement of Next Plc. However, it is important to understand why regulatory authorities have emphasized over these basic requirements and that is to assist users to make timely and better decisions. If the accounting information is falsified for a company’s management’s own interest and if auditors cunningly overlook this then the essence of confidence and trust is lost and companies should no longer have the privilege to raise cheaper funds through capital markets. But in the present setup this is unavoidable and therefore, there is much more pressure on the standard setting bodies and regulators to ensure that the propagators of the uncertainty are controlled and closely monitored through strict due diligence and penalties.

Next Plc. Annual Report 2008

We will now discuss the above qualitative characteristics of financial statements in conjunction to our analysis of Next Plc Annual Report 2008. However, a brief introduction to the company is necessary to understand its business and the markets it serves. Next Plc. is a retailing business based in the UK which operates mainly through its own retail outlets in the UK and overseas. The company is active in different business segments including clothing, footwear, accessories and home decorations. The company prepares its financial statements for year ended under IFRSs adopted for use in the EU and in accordance to the Companies Act 1985 (Next, 2008). The IFRSs are issued by IASB which identified the conceptual framework for financial statements including their objective, qualitative characteristics and elements (Delloitte, 2008). The financial information is required to meet the threshold quality that requires inclusion of all information which may be material if its omission affects the economic decisions of users taken on the basis of the financial statements. The two information qualities which are essential for decision making needs of users are relevance and reliability and in the absence of any of these the purpose of financial statements could not be fulfilled. It is, therefore, eminent to include all information which adds to the relevance and reliability of financial statements however it is not possible at all times and some trade off between these two in reporting does tend to occur.

Relevance

The elements of financial statements including balance sheet, income statement and cash flow statement accumulates all past information which the company generates over a period of time. However, for this information to be relevant it should be able to influence the economic decisions of users by assisting them to evaluate past, present or future events or by confirming or correcting their past evaluations. The users of information form basis for predicting future financial position and performance and other matters concerning their investment decisions. A shareholder of Next Plc would primarily be interested in dividend and earnings per share which are disclosed in the notes 7 and 8 of the report. The information used for calculating these is derived from balance sheet and income statement and supplemented by directors’ report and business review. This allows shareholders to assess the value of their investments in company stocks and to make decisions whether to hold their investment or sell it off. Over the last 5 years the company has generated total shareholders’ return value of 108% and have returned £1.3bn to its shareholders through its shares buy-back program. In addition to this shareholders would be interested in information disclosed under different sections of financial statements e.g. impact of business on the environment, employee relationships and its community relationships. The company’s expansion plans which could increase debt servicing payments and interest costs (p. 15) implies less funds for distribution. Recent accounting frauds highlighted concerns of heavy pay offs and remuneration to the management of companies therefore remuneration report is important. A concern could be raised against Long Term Incentives which company’s offers to its directors where incentives are based on company’s performance compared to 20 listed companies. This could lead to misstatement of statements to receive more incentives. Furthermore, the current global financial crisis and depression in the UK economy where company’s major sales are could have an impact on the company’s future prospects which would require comprehensive planning and disclosure to shareholders. Thus, the predictive and confirmatory role of information along with its timeliness is essential for its relevance to shareholders.

Reliability

The reliability of financial information is achieved if it is free from bias and material error. From a shareholder perspective it is considered as the level of certainty that the information provided in the financial statements can be relied upon to an extent that it either purports to represent or could be expected to be represent correct and reasonable view of company’s performance. Next Plc prepares its reports in accordance with the international standards both for its subsidiaries and consolidation. The assurance regarding conformity to accounting standards and presentation of fair view regarding business progress and company’s position from the management does not completely remove inherent risks of misuse and misstatement by them. The role of the audit committee and external auditors Ernst & Young LLP should be scrutinised for their affiliations with the company and the role of audit committee. The process of awarding non-audit services is dependent on the decision of the audit committee however sufficient independence is maintained through open tenders for such rendering of such services (p.26). In order to add value to the financial information a suggestion could be made that a combined statement is made by both internal and external auditors where the weaknesses in the company’s accounting systems are highlighted and steps taken by the company to remove these incorporated. The company in review adopts high standards of corporate governance and has a continuous risk management however minority shareholders’ understanding of this information is of restricted as access to company’s documents in this regard is limited.

Comparability

Comparability is related to the presentation of the financial statements. The users must be able to compare financial statements of an enterprise over a period and identify trends in its financial position and performance. Furthermore, the financial statements should provided reasonable basis for comparison with other companies which would definitely require consistency in the accounting treatment and application of standards. For this purpose convergence to international standards has been recommended by regulatory bodies across continents. Next Plc Annual Report 2008 provides corresponding information for the last year and indicates the changes in different elements of the financial statement. In order to pursue company’s adaptation of IFRS the accounting policies, related to the recording and publication of financial statements, are enclosed. The areas of estimation and judgement are underlined related to cash flows from impairment of trade receivables, estimated selling prices applied in determining the net realizable values of inventories and the actuarial assumptions applied in calculating the net retirement benefit obligation. The company has adopted new accounting standards including IFRS 7 Financial instruments: Disclosures, amendments to IAS 1 Presentation of Financial Statements: Capital Disclosures, IFRIC 10 Interim Financial Reporting and Impairment with no significant impact on its accounting policies. Furthermore, new standards including IFRS 8 Operating Segments and IFRIC 11 IFRS 2 – Group and Treasury Share Transactions becoming effective in the coming periods are highlighted.

Understandability

The information in financial statements should be presented in a manner that it is readily understandable by its users. Next Plc. has prepared its annual report as going concern with detailed notes to the financial statements, its accounting policies with support details included in the Directors Report and Business Review and detailed Remuneration Report to enhance users understanding and adaptability of the information. However, this is rather subjective and users own ability to evaluate and conclude their economic decisions based on the information provided in the financial statements is an important factor. Same set of information can be viewed from different perspectives and can result in different investment decisions based on interpretations. Thus, care with due diligence is necessary to draw understanding from the given information.

Conclusion

From the above review of conceptual framework we agree that all four characteristics form a basis for conceptual primacy which is required for the financial statements (FASB, 2004). However, we consider reliability as the most crucial characteristic which covers the content of the statements. Any falsification in the elements of financial reporting could mislead shareholders. The objective of any business is to create wealth for shareholders and if businesses manipulate figures just to gain short term monetary gains then the reporting system would eventually collapse. It is therefore crucial that good corporate governance and accountability is implemented via tighter regulations to prevent directors and management from damaging confidence of various stake holders in the accounting profession. (WORD COUNT: 2,046)

List of References

Albretch, W. S. (2003, 2005). Business Fraud: The Enron Case. Brigham Young University. AICPA. [online]
Accounting Standards Board. (1999). Revised Exposure Draft — Statement of Principles for Financial Reporting, ASB Publications. [online]
AT Foulks Lynch (1998). Drafting Financial Statements (Industry & Commerce). AT Foulks Lynch Ltd.
Carmichael, D. R., Whittington R. & Graham, L. (2007). Accountants’ Handbook. 11^th Edition Volume No. 1. Inc.NetLibrary. John Wiley and Sons. [online] Web.
Dyson, J. R. (2007). Accounting for Non-Accounting Students. Financial Times Prentice Hall.
IASPlus.com (2008). The Framework for the Preparation and Presentation of Financial Statements. Delloite. [online] Web.
Johnson, L. T. ( 28 Dec 2004). Understanding the Conceptual Framework. Financial Accounting Standards Board. [online] Web.
Marnet, Oliver ( 2008). Behaviour and Rationality in Corporate Governance. Routledge. [online] Web.
Next Plc. (2008). Annual Report 2008. (p. 15 & p. 26). [online]
Tracy, J. A. (2004). How to Read a Financial Report: Wringing Vital Signs Out of the Numbers. 6th Edition. John Wiley and Sons. Web.

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