Accounting changes distort earnings season results

Monday, 23 August 2010 1 Comment

"The bizarre impact on certain companies is so material that their financial statements will arguably not present a "true and fair view" as the market perceives that term."

They say difficulties arise from the elimination of tax deductions for depreciation on buildings with an expected life of 50 years or more.

The NZ equivalent of International Accounting Standard 12 "Income Taxes" requires a deferred tax liability to be set up representing the difference between the carrying values of buildings for accounting purposes and the value for tax purposes - now being zero. Thus an existing building in the books at, eg, $10 million will require a deferred tax charge to current profit (at the new corporate tax rate of 28%) of $2.8 million and the setup of an equivalent liability in the balance sheet.

"Many professional directors do not regard this accounting entry as a real liability in an economic sense."

Companies with large property portfolios such as retailers, listed property trusts, industrial entities and utility operators are required to make significant "non-cash" adjustments to balance sheets and earnings statements when reporting results for accounting periods ending after budget date.

In the past week a number of listed companies have emphasised "normalised" results excluding the adjustment.

These include the "backing out" of liabilities by SkyCity ($40m), Port of Tauranga ($10m), M&C Hotels ($26m) and Freightways ($6m).

Listed property entities which report later in the year are required to provide for much larger liabilities.

Frankham and Challinor says attempts to address the problem are being made, however such changes take time and need a period of consultation.

"The danger is that many people will not understand that the deferred tax liabilities are merely accounting entries to comply with the rigid application of the international accounting standards that New Zealand companies are obliged to use."

"The deferred tax liabilities required say nothing about the company that is useful to shareholders, potential investors, directors or managers. They are pointless in the sense that they are measuring something that has no practical application or purpose. They are non-cash, have no relevance to underlying or future performance and will not affect the ability to pay dividends.

"Worse than that, their effect is misleading. They create charges at the level of NPAT which will seriously distort the earnings of many companies.

"The combined effect on New Zealand companies will be in excess of $1 billion in terms of reported bottom-line earnings. Estimates of the effect on the reported earnings by companies that have so far advised the market, total over $900 million- and this is an incomplete list as it excludes state owned enterprises and private companies.

"This is a serious understatement of the performance of corporate New Zealand, which is likely to be misunderstood and misreported, and thus mislead investors and others. We think it impacts the credibility of the accounting profession."

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