If you ever wanted a tutorial on the workings and impact of goodwill and impairment rules in accounting standards, then John Stokdyk recommends spending a little time with Tesco’s preliminary 2014 results announcement.
There are a couple of explanations for the blanket coverage accorded to Tesco’s results announcement this morning. The opportunity to hail the UK’s biggest ever single year retail loss was too good to miss for most of the headline writers - the £6.4bn posted puts it in the all time top 10, but still way behind RBS’s £24.1bn loss in 2008.
Second, last Setpember’s accounting scandal and corporate implosion around how the company was recognising suppliers’ promotional payments put everyone on alert about just how badly Tesco had been cooking its books.
When Tesco announced last September that it was appointing Deloitte to investigate irregularities around accelerated recognition of commercial income and delayed accrual of costs, it estimated the impact on the interim results at £250m.
The full year results pretty much confirm that figure, estimating that overstated profits at £53m for the year to 22 February 2014, and £153m in the previous years. A restatement of the prior years was not deemed necessary as the amounts were corrected in the year to 22 February 2015.
This approach - and the little matter of another £7bn in property impairment charges reported in the 2015 accounts, prompted suggestions that Tesco CEO Dave Lewis and his finance chiefs were indulging in what the corporate world calls “kitchen sinking” - announcing all the bad news at once to make any subsequent upturn look more impressive.
City Index analyst Ken Odeluga told The Independent. “[I] see fair evidence that Tesco’s freshened management team under CEO Dave Lewis sought to bundle several further impairments and write-offs into 2014 finals beyond the property write down, in order to clear the decks for their turnaround plan proper.”
The most spectacular impact on the year’s profits originated in a reasonably strict application of asset impairment rules. The results statement explains that Tesco reviews the carrying value of its stores every year. Each store is viewed as a cash-generating unit and the reviews are based on the higher of value in use or fair value less costs of disposal.
“Challenging industry conditions and the decline in profit over the last year have resulted in an impairment charge of £3.8bn against our trading stores. We have also written down the value of work-in-progress by £925m, primarily reflecting the decision we announced in January 2015 not to proceed with 49 sites in our property pipeline,” the company said.One or two more cynical observers suggested that while the impairment reviews are a sensible way to get damaged assets out of the picture, if trading recovers to the point that the carrying values go up again, the impairments can always be reversed to make the results look even rosier.
Lending some weight to the kitchen sink analysis, further impairments of goodwill and other assets added another £878m to the balance sheet revaluation, including £630m written down on the company’s investments in a China project and £198m on UK joint ventures. Throw in £570m in stock-related forward provisions, £168m in costs capitalised to inventories and some £360m in one-off restructuring costs and before you know it you’re looking at a £7.4bn money pit with just £961m in annual operating profits to offset it.
Did anyone mention a deficit on the pension scheme? The company’s actuaries estimate this at £2.8bn and it has agreed with trustees to boost its contribution to £270m a year meet the anticipated shortfall.
The increased disclosures around property valuations are part of Tesco’s commitment to “rebuilding trust and transparency” according to a final note, which also mentioned new guidelines introduced to put less emphasis on the that pesky “commercial income” and simplify how it is reported.
The management team acknowledged that the fundamental changes it in place are likely to lead to an increased volatility in short-term performance, but said they should deliver “sustainable value” to shareholders.
In a What the analysts say round-up by The Grocer, the vibe was that the tough decisions Lewis and his new management team had made were already having a beneficial impact on the chain’s prospects. But John Ibbotson of Retail Vision declared the end of the Tesco era and that the results confirmed the “decadent retail dynasty” had come to an end.
Does this look like a cynical bit of executive window dressing, or the application of prudent fair value accounting policies? If you have ever faced a situation that bears any resemblance to the Tesco scenario how did you handle it?