Central Queensland University

Written Assessment 230% Assessment 2

Boden Abell – S0271465Unit Coordinator: John Mcgrath

ACCT11059: Using Accounting for Decision MakingDue: 16/01/2016

Step 1:

Blog Post: Reflection on Ch4: Restated financial statementsIntroductionLearning. Simply regurgitating facts is not an effective method of long term learning;

instead it involves understanding, applying, and engaging with materials as well as

interacting with others. Another aspect to learning is repetition; returning to topics

again and again acts as reinforcement of retention and understanding. However, at

some point we must broaden our horizons and learn something new. This week I am

excited because of the unknown; I can see that there is plenty of new content ready for

me to engage with just by skimming through some key points and headings.

Machiavelli’s quote on consulting the past to properly predict the future, normally

something I would brush over as an obvious fact, reminded me of my experiences in

finance. While it is not the first time I have heard it, there seems to be general

disagreement with people in finance and those in accounting. Early into my

employment I was told to move from the accounting career path simply because

“accountants are idiots who spend too much time looking into the past; they should

worry less about reporting on the past, get their heads out of the books, and look to the

future”. But how are many financial models formed, such as cash flow forecasts? The

answer is simple; they use the past, to the extent it is capable of, to make guided

predictions of the future. Take out the past and predicting becomes guessing. It is not

my intention to become a slave to the books; nor is it to become the accounting

equivalent of a weather forecaster. We all must seek a healthy balance between the

two; to work with what has been provided with us in the past, to learn.

Martin mentions two common methods for analysing the economic and business

realities of a firm; the discounted cash flow and economic profit techniques. I have

used the discounted cash flow models previously in both Company Finance and

Systems Analysis, although using the name net present value. A similar technique

also used in the financial planning of my workplace is the internal rate of return which

we use to value client portfolios.

At this point in the reading, I have the following questions regarding the restating

process:

Boden Abell – S0271465 ACCT11059 Page

What does it mean by ensure all earnings are included? Which earnings would

be missing? Does the statement of profit/loss and other comprehensive income

not include all earnings for the period?

What is genuine equity? Do we only include the share capital accounts and

retained earnings? Do we leave out the reserves?

Do we not have a separate classification for investing activities as we do with

the cash flow statement?

Section 4.1I find the statement, “All that equity investors receive from a firm are dividends”

somewhat misleading. There are other methods of distributing value to shareholders

such as share buybacks. Entities may also be specially designed as capital growth

firms which do not pay distributions or dividends, such as the Merchant Opportunities

Fund (MOF), a managed investment scheme for which I conduct administration tasks

for. However, I feel that these activities are also just value transfer techniques which

Martin discusses for both dividends and free cash flow.

It is easy to see why the free cash flow is not a good measure of value creation; if you

invest more in productive assets, you will have less cash available. But the idea

behind purchasing productive assets is that you expect a positive net present value,

meaning that the initial outlay of cash is less than the expect inflows discounted to

today’s value. This concept on how we add value to firms clicked in my mind after

learning of the time value of money in Company Finance. Applying this to Ausenco,

one of the cash flows from investing activities in 2014 was payments for property,

plant and equipment of $1.4 million which reduced the free cash flows. The

justification for this purchase is the expectation that it will result in greater cash

inflows in future periods. So value creation is not always immediate; it can be

deferred.

“Economic profit is based on a firm’s accounting profit for a period compared to its

cost of capital”. Again back in familiar territory, the cost of capital is an important

measure. Certainly, as investors we can only operate within our own means; we can

only invest using internally generated funds and debt via bank loans and similar

lending facilities. Business entities are no different; they are limited by their debt and

capital raising. Everything we do is restricted by resources and we can only use these

Boden Abell – S0271465 ACCT11059 Page

resources for one thing at a time. In business, we strive to employ our scarce resources

in activities that provide the greatest rate of return. But in doing so we create a new

cost which reflects the next best alternative return; the opportunity cost of capital.

Businesses must take note of this cost for multiple reasons, but consider the

following: you have $50,000 saved and you want to make an investment. You can

either invest this money in a term deposit with an interest rate of 10%p.a or company

X which has a rate of return of 12%p.a. All things being equal, the obvious choice is

company X. But if the rates were switched? As a potential investor, the term deposit is

now more desirable, and just as well the company itself would be better off ceasing its

operations and simply investing in a term deposit itself.

Section 4.2Martin answers my question of what constitutes as genuine equity from the

introduction. Preference shares which meet the definition of a liability under the

SAC4 should be reclassified from equity to a liability. SAC4 defines a liability

as: future sacrifices of economic benefits that the entity is presently obliged to make

to other entities as a result of past transactions or other past events (AASB, 1995, p.

4). It is hard for me to see the point of this exercise as surely the accountants of these

firms know the definition of a liability and will include preference shares as debt.

I really enjoyed Martin’s metaphor for the operating and financial activities of a firm

using the Kinder Surprise. Akin to this are information systems, which form part of

my current job through systems implementation. At the most basic form, an

information system consists of the user interface and the underlying database. While

most other staff are content with outer shell of the user interface, I am more interested

in the database core. The database stores all the data inputted through the system and

adds real value to the business. This is much like the operating activities which keep

the business ticking along. Financial activities are similar to the user interface; they

complete the picture of the entire firm or system, however they only transfer value

between business and its investors or between the user and the interface.

Section 4.3Martin’s demonstration of restating the financials of Ryman Healthcare has lead me to

question what all the fuss is about. It does not seem too difficult at face value if you

understand the firm’s activities and read the corresponding notes. However, I do think

Boden Abell – S0271465 ACCT11059 Page

that tax and some other comprehensive income items may be confusing at first for

some students.

Section 4.4It is not difficult to understand the concept of the profit margin ratio. But why do we

use comprehensive operating income over sales? It is simple; we want to know the

profitability achieved for the total number of sales made. I have used very similar

ratios for retail businesses, however I have never used it for strictly service providers.

How would I use this ratio for Ausenco? It is difficult for me to determine this as

Ausenco does not provides unique projects with their own costs and revenues. It is

also desirable to know exactly how many sales is produced by each dollar of net

operating assets and vice versa for efficiency analysis. Again, how would I rework

this ratio for Ausenco?

 As a concluding note to this chapter, engaging with material is much easier and

enjoyable when the content is new. The key concepts and questions I have formed for

this chapter include:

Balance is needed between the needs of reporting on the past and making

predictions of the future.

The discounted cash flow and economic profit techniques are used for

analysing the economic and business realities of a firm.

Earnings can be split throughout the income statement, a statement of other

comprehensive income, and the statement of changes in equity.

Restating involves classifying activities as operating or financial. The cash

flow statement also includes investing activities, which I now realise are

lumped together as these activities reflect investments in operating assets.

Shareholders can have value distributed to them via many methods including

share buybacks and dividends; however, these activities only transfer value.

Free cash flow is not a good measure of value creation as investments in

operating assets do not often immediately create value; value creation can be

deferred.

Businesses are limited by resources and thus there is an opportunity cost to

capital.

Boden Abell – S0271465 ACCT11059 Page

Preference shares in the statement of changes in equity may be debt in disguise

if they meet the definition of a liability in SAC4.

Restating the financials requires a comprehensive understanding of the

business’ activities and careful perusal of the notes.

How do we use the profit margin ratio, asset turnover ratio, and ultimately the

return on operating assets ratio for project oriented service providers?

Step 2:

Blog Post: Reflection on restating processComing straight from reading chapter 4, I actually did not find restating Ausenco’s

financials to be difficult. The first step I took was classifying all of the statement’s

line items as operating or financial based on my judgement and understanding of

Ausenco’s activities gained from ASS#1. I note that I did not need to classify any

items on the statement of changes in equity as all earnings were reported in the

statement of comprehensive income and there are no preference shares. Starting with

the statement of comprehensive income, the only items I needed to check on in the

notes were the other income and other expenses as the name does not reveal what

these items are specifically for. The only question that I have from this statement is

how should the currency translation differences arising during the year and the net

investment hedge be classified? I believe that they should be operating as both of

these items are related to foreign exchange fluctuations as part of operating activities.

The balance sheet was no more difficult as all items seem to be relating to operating

activities except a portion of cash and borrowings. I did check the other current

assets/liabilities and other non-current assets/liabilities in the notes in the event they

related to financial activities however they did not seem to.

From here I printed Martin’s restated financials for Ryman Healthcare so that I could

follow his formatting. For the statement of comprehensive income, I had a little

trouble working out the tax benefit and when it should be negative and positive.

However, since I managed to return the same total comprehensive profit/(loss) in the

restated financials as the regular financials, I must have done something right. I also

wonder if I am supposed to divide up the income and apply the relevant tax rates for

each country/state of operation.

Boden Abell – S0271465 ACCT11059 Page

For the balance sheet all I needed to do was divide up the cash into operating and

financial activities. I have also combined the same line items which were separated by

their current and non-current classifications as they do not seem to be used in

restatement. As a final check, I compared my restated net assets against the regular

net assets and they were the same.

As a conclusion to this restatement process, I did not find anything too challenging

about this learning process. Martin clearly explains restatement in chapter 4 and I did

not struggle with reading this chapter. There really were no frustrations, except with

the fact that Ausenco in 2014 and 2013 did not provide many notes to their financials.

The only thing that confused me briefly was splitting out the tax benefit, which was

solved in a matter of minutes through trial and error. Overall, as I enjoy forming the

financials from ground up all the way to performing ratio analysis, I have found

restating Ausenco’s financials to be a pleasant experience. The only thing I wish I

could have done was calculate the profit margin, asset turnover, and return on net

operating assets ratio but I do not know exactly how to apply this to a service

provider.

Blog Post: Sneaky…Something I noticed from ASS#1 was that the other comprehensive income did not

match between the income statement and the statement of movements in equity. I had

no idea why this had occurred because Ausenco is a bit underwhelming with the use

of note references. So once I received my marked assessment back I saw that the

marker had found the note 21 included an extra line item “Foreign exchange

differences on abandoned operations” which did not appear in the income statement.

Why was this? Ausenco had instead decided to adjust this directly via equity. So my

previous post where I said I did not need to do anything to restate the statement of

movements in equity was false; I had to go in and dig out this item and add it to the

income statement.

The question I now ask is why did they transfer directly against equity? Was it to

display a more favourable total comprehensive income in the income statement?

Boden Abell – S0271465 ACCT11059 Page

Student DiscussionsRestating Ausenco’s financials was relatively straightforward so my comments were

based on helping others rather than asking questions.

Belinda Donaldsonhttps://beldonald.wordpress.com/2016/12/10/falling-with-style/comment-page-1/

#comment-34

Belinda had some trouble justifying her restated income statement. I attempted to

clarify some and made a recommendation or two as well.

https://beldonald.wordpress.com/2016/12/09/maintain-balance/comment-page-1/

#comment-35

I also took the opportunity to explain that goodwill is not reputation.

https://beldonald.wordpress.com/2016/12/04/the-power-of-the-exchange-rate/

comment-page-1/#comment-36

Queried Belinda about why she decided to allocate all tax on components of other

comprehensive income as an operating activity.

Adrian Peglerhttps://adrianpegler.wordpress.com/2016/12/08/operating-or-financing/comment-

page-1/#comment-31

Reviewed Adrian’s choice of operating and financial items for the balance sheet.

Courtney Honneryhttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=186388#p522993

Helping Courtney decide how to interpret here company’s line items.

Dion Echentillehttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=186410#p522994

Comment regarding why certain companies will have higher levels of cash than

others.

Boden Abell – S0271465 ACCT11059 Page

Nicole Olsenhttps://nicolsenblog.wordpress.com/2016/12/17/its-been-a-long-time-coming/

comment-page-1/#comment-15

Walking through how the income tax expense and benefit should be laid out in the

restated financials.

Lisa Litschauerhttps://moodle.cqu.edu.au/mod/forum/discuss.php?d=185817#p523398

Discussion on whether to leave all cash and cash equivalents as operating or to split

into operating and financial.

Step 3:

Ausenco, as a service provider specialising in project management and consulting,

draws up contracts tailored to each client’s unique needs. Each client varies in size of

operations and service needs so prices are dependent on each contract. This makes my

task of pricing three products much more challenging than a retailing company who

provide purchase prices online for all customers.

Rather than completely guess all three of my product’s prices, I have researched some

related activities and hypothetical scenarios.

Product 1: High Voltage AuditSearching for high voltage audit cost lead me to Asia Inspection, a company which

specialises in inspections, supplier audits, and testing services (Asia Inspection,

2016). They charge $829 USD per man day for clients in Europe, Greater Asia, and

Brazil (Asia Inspection, 2016). Considering that electrical work is exposed to higher

levels of risk, I have increase the price to $950 USD per man day.

Major costs that I would expect out of the audit would be the licensed electrical

engineer’s wage, equipment, injury related insurance, and licensing fees. I assume that

equipment does not need to be replaced for each job so I have removed it from the

equation. That leaves the wage as the variable cost [VC]. I have assumed an 8-hour

working day and a wage rate of $46.25 USD, totalling to $370 USD per man day.

Boden Abell – S0271465 ACCT11059 Page

This leaves a contribution margin [CM] of 61%. Insurance and licensing are fixed

costs [FC] within the relevant range and do not count towards calculating the CM.

Product 2: Feasibility StudyI based the feasibility study service price on Paul Harper of AMC Consultants

discussion “What does a feasibility study cost?” Paul Harper links feasibility studies

costs for underground mining projects to be 5.7% of the project capital cost (Harper,

2008). So, if an underground mining project costs $100 million, the cost of the

feasibility study would be $570,000.

Feasibility analysis involves extensive research weighing up the costs and the benefits

resulting from the project. Thus, salaries will be the major cost of the project. Indirect

costs such as electricity for the building and rent of the office will also form part of

this project. I have estimated $170,000 in VCs which leaves a CM of 70%.

Product 3: Gas Pipeline ConstructionWhen the APA Group purchased the BG Group's liquefied natural gas project, the

book value of the pipeline was $1.6 billion (SMH, 2014). I will use this figure as an

example.

To construct the pipeline, materials must be purchased, transported, and affixed

together by engineers presumably on a wage. It would be reasonable to assume that a

large portion of the project’s costs will be VCs, thus I took a stab in the dark and went

with $950 million, leaving 41% as the CM.

Comparison & DiscussionProduct Price Estimated

Variable CostsContribution Margin ($)

Contribution Margin (%)

Product 1 $950 $370 $580 61%

Product 2 $570,000 $170,000 $400,000 70%

Product 3 $1,600,000,000 $950,000,000 $650,000,000 41%

As seen in the table, the three products chosen have varied CMs. There are many

reasons behind this and none apply in isolation. To encourage higher volumes of

Boden Abell – S0271465 ACCT11059 Page

sales, companies can lower the sales price [SP] and ultimately the CM. Of course, this

depends on the marketing strategy. Supermarkets are able to set low prices just above

the VC to produce a minute CM and reap the benefits of high turnover products such

as fruit and vegetables. Ausenco, on the other hand, knows that the demand for their

services is low so they tend to have higher contribution margins. Comparing product 1

and 2, perhaps it is expected that high voltage audits are sought after more frequently

than feasibility analyses. However, common sense suggests that gas pipeline projects

are far more infrequent than both high voltage audits and feasibility analyses yet the

CM is lower than both. Consider the formula for calculating the CM: SP – VC. The

CM is also dependent on the mix of VCs and FCs incurred while supplying the

product. Both product 1 and 2 have a higher proportion of FC than product 3. Since I

assumed that the feasibility analysis will be conducted by staff on a salary, this

dramatically decreases the total VCs as opposed to staff on a wage as is with the gas

pipeline. Also, the gas pipeline is very resource heavy in the materials while the other

products are based around labour which also explains the proportions of the VCs.

In the ideal world with no resource limits, companies would only produce the

products with the greatest CM. However, we do not live in such a world. There are

many restraints on Ausenco that contribute towards providing many services. First

and foremost is demand. Many of Ausenco’s products have a low turnover as demand

is low and infrequent. Companies in the commodities markets are not constantly

launching new project because projects have long completion times and often require

capital raising to meet excessive capital expenditure requirements. So in essence,

Ausenco can only provide as much is demanded for the product with the highest CM.

Another reason to provide a mix of products is that they may be complementary to

each other. It is important to remember that the CM is the residual amount after

covering VCs with the SP which attributes towards covering FCs and ultimately

making a profit. So if a firm can add more products that are in demand, completely

cover their own cost of sales (including the direct FC and indirect FC), and add a

positive CM to the sales mix then there is little harm in doing so. Ausenco provides a

full suite of project management services, from initiation to evaluation and

completion, so it makes sense that they also enlist these other products. Of course, the

firm needs to consider the resource constraints as well. For example, if a cheese

producer can make 3 different types of cheese with the same milk then they need to

Boden Abell – S0271465 ACCT11059 Page

consider the optimal amount to maximise the CM with demand for the shared

materials. This should not affect Ausenco to a large degree as all services have low

turnover.

Ausenco has many resource constraints imposed on it both directly within the firm

and externally indirectly. Internally, Ausenco faces a limit on staffing and labour

hours, cash flows for construction materials and wages, and materials themselves

among many others. Externally are where the real problems lie. Ausenco is adversely

affected by negative market conditions, both from a supply and demand position.

When demand is low, as it has been recently, rivalling service providers will compete

strongly for the contracts which can drop the bottom line of the firm if sales prices are

reduced to compensate or offers are lost. As Ausenco’s products are already low

turnover, a reduction in demand has severe impacts. Indirectly, Ausenco is very much

reliant on commodity prices. If they are low, clients have a hard time raising capital to

fund the projects which Ausenco could offer their services to. They will also look

towards in-house operations and cost cutting rather than employ Ausenco’s services.

When this happens, it no longer becomes a question of how many services should

Ausenco provide or sell; instead the focus turns to how much can be sold given the

demand. Ausenco is unlikely to cut out any of their services because demand has fell

as it bears no cost of offering it if they are not performed.

Boden Abell – S0271465 ACCT11059 Page

Step 4:

Feedback from: Boden AbellFeedback to: Stacey Walker

My Comments

Step 1

KCQs

It seems that you have linked your chapter 1 review rather than the chapter 4 in the document. You might want to fix that. I searched your blog and couldn’t find it so I am guess you have not done it yet. I am aiming to review it once it is done.

Step 2

Restated statement of changes in equity

Balance sheet

Income statement

Commentary and discussion with others

Again, the restated part is empty. I will review it when it is uploaded.

Do not forget to include your commentary and discussion with others in this step.

Step 3

Identify three products/services

Estimate selling price,

You have included three products and have shown where you have found the sales price. I would like to see how you determined the variable costs. Did you estimate? Did you use data from somewhere? The variable costs and contribution margins seem reasonable but I do think you need to justify them.

You have discussed the concept of globalisation and its effect on costing which was a nice extra to read. However, part of the task asked to compare why the different products have a different or similar contribution margins. I

variable cost & CMs

Commentary – CMs

Constraints –identify and commentary

would use the contribution margin ratio (contribution margin ($)/sales price) to do this.

You have made a comment on why companies should have a diversified portfolio of products. This has been justified well. Good job!

Some constraints have been identified and discussed but I think you could explore the topic a bit more. Maybe think about products with sugar and the need to reduce the sugar content.

Overall ASS#2 There wasn’t much for me to work with for this draft in terms of step 1 and 2. I will wait until you have done more on these before I make commentary on those. As for step 3, you have just a little more work to do to be finished with it. I have enjoyed what I have seen so far!

Boden Abell – S0271465 ACCT11059 Page 1 of 18

Feedback from: Boden AbellFeedback to:

My Comments

Boden Abell – S0271465 ACCT11059 Page 2 of 18

Feedback from: Boden AbellFeedback to:

My Comments

Usefulness of Feedback Received

Boden Abell – S0271465 ACCT11059 Page 3 of 18

References

Asia Inspection. (2016). Quality control pricing. Retrieved December 9, 2016, from

http://www.asiainspection.com/

Australian Accounting Standards Board (AASB). (1995). SAC4: Definition and

recognition of the elements of financial statements. Retrieved December 2,

2016, from http://www.aasb.gov.au/

Harper, P. (2008). What does a feasibility study cost?. Retrieved December 9, 2016,

from http://www.infomine.com/

The Sydney Morning Herald (SMH). (2014). APA secures $6 billion pipeline.

Retrieved December 9, 2016, from http://www.smh.com.au