IFRS-11 replaces IAS-31 IFRS-11 replaces IAS-31 - Aljazira Capital

IFRS-11 replaces IAS-31

July 2013

Special Report

Please read Disclaimer on the back

IFRS-11 replaces IAS-31 This report is mainly focusing on the change in the accounting policy for the treatment of joint arrangements (JA). Since the regional and local companies have several joint arrangements so، we believe it is necessary to educate the investors on the implication of the change. The new International Financial Reporting Standard (IFRS) -11 (joint arrangements) was published by International Accounting Standard Board (IASB) in May 2011 to replace IAS-31 effective from 01st Jan 2013.

What has changed? Effective from 1st Jan 2013, all the companies are obligated to adopt the new accounting standard IFRS-11 in place of the old IAS-31; where, the main purpose of both of these standards is to formulate the framework to recognize joint arrangement1 in consolidated financial statement. However, the key difference lies in the way to formulate the recognition of joint ventures.

Framework to recognize joint arrangement IAS -31

IFRS-11

Allowed the following two treatments for jointly controlled entities (JVs) in consolidation; • Proportionate consolidation.

IFRS-11 classification of JA is mainly based on the parties’ rights and obligations under a particular arrangement. According to the given information, the new standard has completely • Equity method accounting. eliminated the option of proportional consolidation of JVs (which In addition, accounting for jointly controlled operations2 and was permitted in IAS-31) with equity method (the mechanism 3 assets in IAS-31 required related parties to recognize (i) the assets will be explained in later stage). However, companies are they controlled (ii) liabilities & expenses they incurred and (iii) share required to recognize their respective (proportionate accounting; as practiced in IAS-31) shares in assets, liabilities, revenues and of revenues. expenses in those arrangement falling under JO categories. Source: Deloitte & Aljazira Capital

Key required adjustments Before

After

Required adjustments • De-recognize the equity method investment. • Recognize assets (goodwill if any) and liabilities arising from

IAS31 Jointly controlled entity accounted for using the equity method

the joint operation.

IFRS11 Joint operation

IAS 31 IFRS 11 Jointly controlled entity accounted for using proportionate Joint venture consolidation

• If the amount of net assets recognized exceeds the carrying

amount (calculated using equity method investment), the excess reduces goodwill to the extent it exists, with any remaining excess recognized against retained earnings; and • If the amount of net assets recognized is less than the carrying amount (calculated using equity method), the difference is recognized against retained earnings. De-recognize assets (including goodwill if any) and liabilities. Recognize equity method investment at the carrying amount of the net assets de-recognized; and Perform an impairment test and recognize the impairment loss, if any, as an adjustment of retained earnings. Source: Deloitte; IFRS in focus – IASB issues new standard on joint arrangement

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Analyst

Syed Taimure Akhtar

Saleh AlQuati

[email protected] +966-2-6618271

[email protected] +966-2-6618253

IFRS-11 (which superseded IAS-31) classifies JAs are those arrangements; where two or more parties have joint control.

• • •

Joint control (JC); agree to share the control of an arrangement and involvement of both parties are limited to make undisputed consent on a particular decision.

•

Separate vehicles (SV); a separate identifiable financial structure including separate legal identities or entities recognized by law, regardless of whether the entity has legal personality.

Joint operation (JO); a joint control arrangement whereby the related parties have claims on the assets and obligation of the liabilities related to the arrangement. Joint venture (JV); where the related parties of a joint control have rights to the net assets of the arrangement. Like; the JVs of Industries Qatar (IQ) i,e. Qatar Fertilizer Company (QAFCO), Qatar Petrochemical Company (QAPCO), Qatar Fuel Additive Company (QAFAC).

A joint arrangement; where, the assets and other resources of venture are used rather than the establishment of separate entity; as per IAS- 31. 3 A joint arrangement; where, the assets are jointly controlled and have joint ownership; where the assets are dedicated to the JV; as per IAS-31. 2

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Senior Analyst

© All rights reserved


July 2013

Special Report


Impact on the consolidated financial statement As explained earlier the new accounting standard disallowed the proportionate consolidation; hence, the related parties (having significant exposure to JVs) witnessed major impact on revenues, profitability margins, assets and liabilities. However, interestingly, the bottom line and equity remained unaffected due to equity method; but, the implication of new standard on minority interests is based on the nature of joint arrangement.

Example 1: Saudi Telecommunication Company – 1Q2013 financial statement (Millions of Saudi Riyals) Revenue from services Gross profit Net income Fix assets Total liabilities Total murabahas Shareholders equity

Post - Equity Method (Unaudited)

Pre-Equity Method (Unaudited)

11.067 6.329 2.521 80.621 31.574 11.471 49.053

14.679 8.435 2.521 115.977 59.340 30.553 49.053

These financial indicators remained unchanged; because of the recognition of share of net profit/loss income from JVs.

Source: STC 1Q2013 financial statement & Aljazira Capital # Kindly note that equity method is applied only on JVs; which is mandatory in IFRS-11.

Equity method calculation It is worthy to mention that the new standard only amends the recognition of JVs; but keeps the calculation for equity method as it was explained in IAS-31; where, the following treatments are required under equity method on balance sheet;

• Calculate the carrying value of ‘investment in JVs’; a new account on the balance; where value is based on the related parties interest in the respective JVs.

• Adjust the carrying value (opening) of investment in JVs with the share of profit/loss from respective JVs. • Reduce the amount of carrying value (opening) with dividend income from these JVs. On the other hand, implication of equity method on income statement is much simple i.e. the recognition of share of profit/loss from JVs.

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July 2013

Special Report


Example 2: Industries Qatar – 1Q2013 financial statement

Profit & loss statement (Millions of Saudi Riyals)

31-Mar2013 QR’000 Unaudited

Notes

Revenues

1,666,154

Direct costs

1,134,758

GROSS PROFIT

531,396

Share of result of joint ventures share of result of associates Income form Investment Other income, net Genral and administrative expenses selling and distributaion expenses finance cost

3 4 5 6

1,989,659 18,050 38,246 37,497 41,742 9,504 14,672 2,548,930

PROFIT FOR THE PERIOD BASIC AND DILYTED EARNINGS PER SHARE

4,21

11

Investment in JVs QAPCO QR'000

QAFCO QR'000

QAFAC QR'000

QSIC QR'000

QFA QR'000

Total QR'000

Investment balance as of 1 january 2012 (restated) Investment during the years Net profit for the year Dividend received during the year Fair value movements for the year

5,418,475 2,903,227 2,517,225 10,238

9,672,304 3,446,463 750,213 2,353

1,255,589 652,106 742,569) -

5,000 -

-

16,346,368 5,000 7,001,796 4,010 12,591

At 31 December 2012

5,814,715

12,370,907

1,165,126

5,000

-

19,355,748

Investment during the period Net profit for the period Dividend received during the period fair value movements for the period At 31 March 2013

762,586 6.577,301

1,037,811 2,175,000 2,859 11,236,577

190,153 100,100

-891 4,109

70 70

70 1.989,659 2,275,100 2,859 19,073,236

Balance sheet (Millions of Saudi Riyals) ASSETS Non-current assest Property, plant and equipment Investment properties Interests in joint ventures Investment in associations Available-for-sale investment Current Assets Inventories Accounts reseivable and prepayments Due form related parties Held-for-trading investments Bank balances and cash TOTAL ASSETS

3


Notes

7 3 4

8

1,255,197

31-Mar 2013 QR’000 Unaudited

3,110,320 148,032 19,073,236 1,483,564 659,173 24,474,325 1,370,299 1,362,293 134,654 6,411 6,034,096 8,907,753 33,382,078

Source: Industries Qatar 1Q2013 financial report & Aljazira Capital


July 2013

Special Report


Recommended valuation approach We at Aljazira Capital believe that the change in policy makes the valuation of affected company more challenging; because, (as explained earlier), the companies are required to adjust their cash flows accordingly. Hence, the valuation approach should focus more on sum of the parts (SOTP) in which all the de-recognized JV (previously considered in cash flows and profitability margins) from consolidated financial statement should be valued separately. However, the biggest challenge to follow the recommended valuation approach is the low disclosure of information of these de-recognized JVs by the respective company. It should be noted that we were using the same SOTP methodology for Industries Qatar (IQ) since our initial coverage; but we update the company’s each JV WACC as per the given information.

Our DCF based SOTP valuation methodology for IQ (after IFRS-11) WA CC - Qapco WA CC - Qafco WA CC - Qafac WA CC - Qasco

14.1% 12.4% 13.7% 13.8%

Amount in QAR’000’ Qapco - Net worth Qafco - Net worth Qafac - Net worth Qasco - Net worth Consolidated - Net worth

29.229.539 7.147.377 43.674.156 31.877.528

WACC of each JV is based on their respective capital structure; based on given information; where Qasco WACC is based on IQ since the company has not recognized Qasco as JV. In addition, we used cost equity of IQ since these JVs are not listed on exchange.

Calculations are based on the cash flows and discount rate of each JV.

111.928.601

Source: Aljazira Capital # It should be noted that the consolidated net worth of the company is based on SOTP-DCF based valuation; however, our 12-month price target is based on weighted average valuation technique.

IFRS-11 & Aljazira Capital coverage At the time of writing this report the research universe of Aljazira Capital is based on 34 local and regional companies. However, the new standard severely impacts (i) Saudi Telecommunication Company and (ii) Industries Qatar; where significant changes are witnessed in cash flows and balance sheet.

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RESEARCH DIVISION BROKERAGE AND INVESTMENT CENTERS DIVISION RESEARCH DIVISION

Senior Analyst

Abdullah Alawi

Syed Taimure Akhtar

+966 2 6618275 [email protected]


Senior Analyst

Analyst

Analyst

Talha Nazar

Saleh Al-Quati

Jassim Al-Jubran




General Manager - Brokerage Division Ala’a Al-Yousef

AGM-Head of international

Regional Manager - West and South Regions

and institutional brokerage

Abdullah Al-Misbahi


Luay Jawad Al-Motawa



Sales And Investment Centers Central Region

Area Manager - Qassim & Eastern Province

Manger

Abdullah Al-Rahit

Sultan Ibrahim AL-Mutawa



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