Golden Bay profit: $4.1 million or $2.6 million loss?

Press, 12 May 1984, Page 23

Golden Bay profit: $4.1 million or $2.6 million loss?

By

CHARLES CARSLAW,

a senior lecturer in accounting at the University of Canterbury

The disparity between the profit of Golden Bay Cement Company, Ltd, for the year ended December 31, calculated on a histori-cal-cost basis and the profit calculated on a current-cost basis is substantial. On a historical-cost basis the group reports a profit of $4.1 million, whereas on a current-cost basis there is a

reported loss of $2.6M. The principal cause of this difference in reported profits arises because of the extra depreciation that the group has to provide in the current-cost accounts because the charge for depreciation is now based on the replacement cost of the fixed assets rather than their original cost. This results in an immediate adjustment to the historicalcost profit of SB.3M. This adjustment alone wipes out the historical-cost profit two times over. Accountants cannot decide what is the true depreciation figure that should be reported in financial accounts: the $3.6M included in the historical-cost accounts or the $11.9M in the current-cost accounts. Possibly the answer is neither of them. A true figure may be somewhere in between, but it is clearly one of the uncertainties that detracts from the value of accounts and accountants at present. At least Golden Bay gives both figures in its accounts so that the user can get some idea of the potential exposure of the group to this problem. Presumably this year’s increased adjustment for depreciation arises mainly from the completion of the new Portland plant conversions that the company has been undertaking over the last three years. Normally, one would expect the current cost of such new assets to be about the same as their actual cost, but because this project is long

term it has presumably been appreciating as it has been in process. Certainly, the cost projections have risen substantially over the term of the contract. The estimated cost when the contracts were let in 1980 was S3SM, and this had risen to S4BM by the time the plant was operational. There is still some argument with contractors about $11.5M of contract costs. Presumably, the replacement cost of this work is now well in excess of the original S3SM and the actual cost of S4BM. Offsetting the depreciation adjustment in the cur-rent-cost accounts is the item called the gearing adjustment, which represents the benefit to shareholders of financing fixed-asset purchases with other people’s money in the form of borrowings. This adjustment reduces the current-cost loss by SI.9M, but the reason why this beneficial adjustment arises is not clear from the current-cost accounts. The gearing adjustment is calculated by taking a proportion of the increases in the capital maintenance reserve. On a rough calculation I would have expected the capital maintenance reserve to have shown an increase, mainly because asset revaluations of about SIOM, to give a positive gearing adjustment of SI.9M. Instead, the capital maintenance reserve has declined $35.5M. Perhaps this S46M discre-

pancy has something to do with the fact that the revaluation element of the old plant has now been eliminated. That is not clear from the accounts and the reason for doing so is also far from clear. Possibly coupled with this is another anomaly. In the retained-profits reserve of the current-cost balance sheet, last year’s retained profits amounted to $5.4M, and one would expect to deduct from this the loss for the year of $2.6M and the dividends paid of $3.4M and the odd transfers of SIM showing in the historicalcost accounts, to obtain the retained profits at the end of the 1983 year of about minus SI.6M. In fact, the current-cost accounts show the retained profits to be plus SB.IM, and there is therefore an unexplained difference of $9.7M. Whether this has something to do with gains on sales of assets or a scaling down of operations is again not clear but certainly they are unexplained items of considerable significance when compared with the total profits for the year. Maybe they are also connected with the unusualness of the auditors’ not stating whether the current-cost accounts were drawn up in accordance with the Society of Accountants standards (such a statement in an audit report is normal practice where current-cost accounts are produced). Before being over-critical of the current-cost accounts

as being arbitrary and of no value as claimed by many of their critics, one should spare a thought of how arbitrary and flexible are traditional historical-cost accounts. It would not be hard for one to change the reported profit figures of the group merely by adopting different accounting policies, all of which are quite normal and acceptable. For example, it would be quite normal to charge all interest against profits rather than adding it on to the cost of new plant purchased in the period. That would reduce profits SI.2M. One could also require that the good will written off should be charged against profits. That would reduce profits $500,000. Adoption of the new lease accounting standard for the lease of the ship the Golden Bay would probably cause an extra charge of about $500,000 against profits. Adoption of deferred-tax accounting would reduce profits by $200,000. Correctly accounting for the disposal of the subsidiary company would reduce profits $140,000, and so on, and so on. Then, of course, the assets could be revalued and that could be done arguably up to their replacement cost and that would result in the full depreciation adjustment of SB.3M that resulted in the current-cost accounts. Historical-cost accounting, as practised at present, would therefore allow a profit to be reported at some figure between plus S4M and about minus S6M. Hardly very precise.

Let me hasten to add that there is nothing wrong with the company’s choice of accounting methods, and the amount of information given by the accounts is, in general, very good, particularly where there are areas where differing accounting policies could have been used. The presentation of the current-cost information is useful although in this group’s case it presents as many questions as answers.