Creative accounting and financial analysis of WM Morrison

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Introduction

The purpose of our article is to present the current stage of knowledge in the field of the creative accounting. In this view, we have used, first of all, the presentation of the nature of the creative accounting and motivations of creative accounting, to the identification of the differences between creative accounting and fraud. In the second place, we have reviewed, based on the specific literature, how accounting measurement issues have contributed to the current global financial crisis. In the third place, our scientific approach reviewed the case of Morrisons to thoroughlyanalyse themotivations and main approaches of creative accounting. The paper provides, in the end, some conclusions and suggestions for future research.

  1. The Nature of Creative Accounting
    1. The Nature of Creative Accounting

The development of social and economic activities and the stress of financial information users result in the innovation of accounting a necessity, and further the growth of the creative accounting and fraud.

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Creative accounting and fraud undoubtedlyconcernwith the various economic interest balance between the shareholders, creditors, managers, suppliers, auditors, government and other stakeholders. Creative accounting is seen as widespread in the United Kingdom due to the flexibility in accounting policies entitles the managers to select the optimal accountingtreatment to portray the accounts in favour of their own interest rather than the shareholders'. Moreover, the freedom of choosing an accounting treatment is granted by the accounting regulation. That is to say, the choice of accounting methods and accounting estimates can be seen as legal, which is the main distinction between creative accounting and fraud. Thus, the creative accounting can be defined as a process whereby accountants use approaches and room for freedom left in accounting regulation, withinthelimitsprescribedbythe laws or accounting requirements, to manipulate the figures in the account of a business.

  1. Motivation of Creative Accounting

Over the past two decades, a significant amount of academic research has been focused on the managers' motivation towards creative accountancy. The study of Hepworth in 1953 develops the claim that the taxation based on income and shareholders' and employees' expectation of stable profit could be the primary motivators of creative accountancy. Additionally, Managers could have the motivations for creative accounting, argued by Healy and Wahlen (1999), when significant capital market transactions are expected, and when there is a gap between forecasts of analysts and the actual profit and performance of the corporation.

In my opinion, the motivators for creative accountancy could be distinguished into personal incentives from which managers would directly benefitsuch, and market incentives arising from the stakeholders' expectations for the corporation's performance. Staff incentive policies related to corporation's performance, such as discretionary bonus and stock options could be the personal incentive of creative accounting. Equally, creative accounting might be motivated by the gap between the firm's actual condition and stakeholders' expectation of profitability, stability and sustainability.

  1. The Differences between Creative Accounting And Fraud

In practice, the boundary between creative accounting and fraud is ambiguous. The term of fraud could be defined as disclosure violation.More specifically, accounting fraud involves intentionally altering and defacing the true accounting information, or presenting and maintaining false accounting information. In practical application, the main methods of fraud are the fictitious transactions and the fraudulent appropriation of assets. Thus, though these illegal actions, as thetruesituationof the corporate performance would be concealed and serious financial problems could be hidden, thelegalrightsand interests of shareholders, creditors and other stakeholders might be infected. However, compared with accounting fraud, creative accounting, which are on the basis of actual financial information choosing the accounting methods and accounting estimates beneficial to the executives.

  1. How Accounting Measurement Issues Contributed To The Financial Crisis
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Accounting measurement provides varying views of how to compare and evaluate transactions and events in monetary terms. The different measuring methods would result in different view of the value and structure of the whole corporation. Recently, researches in financial crisis argues that inappropriate accounting measurement might exacerbate the globally financial crisis. In this paper, we address this question from three aspect: off-balance sheet financing, fair value accounting and use of financial instruments.

  1. Off-balance Sheet Financing

Off-balance sheet financing is an illegal sort of funding that enables a firm to obtain capital without reporting the according debt on the balance sheet. Though this form of financing, the firm could improve the liquidity shown in the financial statements, and reachsatisfactory debt ratios, which might be used by stakeholders to assess the financial leverage and risk of a firm.

First, relaxing the rules or giving management more flexibility to avoid potential problems of fair-value accounting in times of crisis also opens the door for manipulation and can decrease the reliability of the accounting information at a critical time.

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  1. Fair Value Accounting
  1. Financial Analysis

WM Morrison Supermarkets Plc (called Morrisons) is known as the fourth largest chain ofsupermarketsin the United Kingdom,with over 500 UK stores and online deliveries. In this article, Morrisons is taken as an example on the basis of the annual report of 2013 to thoroughlyanalyse themotivations and main approaches of creative accounting. Theanalysisof Morrisons will be ontwoaspectsthat the financial information and non-financial information such as accounting narratives and diagrams.

  1. Accounting Analysis
    1. Profitability

Over the past year, Morrisons total turnover of £17.68 billion was down £0.14 billion compared to the prior year. Furthermore, Morrisons reported a net lossof £0.24 billion in 2013/2014. As shown in (Chart 1, Profitability Analysis) the net profit margin and gross margin of Morrisons, in the fiscal year of 2013/2014, all decreased into negative values. Besides, the EBITDA margin reduceddrastically compared with the figures since the year of 2009/2010. However, although the whole profitability dropped greatly in this period, the gross margin kept in arelativelystablestatus (around 6%). The stability of gross margin showed that the recession in its profitability wasmainlydueto the increase in operating expenses, depreciations and interest expenses.

Chart 1, Profitability Analysis

RATIO

09/10

10/11

11/12

12/13

13/14

EBITDA Margin %

7.24

7.43

7.44

7.28

4.73

Gross Margin %

6.89

6.97

6.89

6.66

6.07

Operating Profit Margin %

5.89

5.49

5.51

5.24

-0.54

Net profit Margin %

3.88

3.84

3.91

3.57

-1.35

See Appendix I for all calculations

By this, through contrastive analysis on the Statement of Comprehensive Incomes in 2012/2013 and 2013/2014, we might discover that thedistinct differencewas the value of non-recurring exceptional costs in administrative expenses of £903 million in this period. According tohistorical annual reports of Morrisons, administrative expenses (Chart 2, Administrative Expenses) consisted of non-recurring exceptional costs, keeping in zero from 2009 to 2013, and recurring costs which was relatively stable. Additionally, the difference between the net profit in 2012/2013 and 2013/2014 were £885 million similar to the value of non-recurring exceptional costs.

Chart 2, Administrative Expenses

Whereas, according to the explanations of Morrisons, non-recurring exceptional costs was composedof £553million impairment of tangible and intangible assets, goodwill and brand, £ 335 million provisions of onerous contracts and other expenses of £ 15 million (Chart 3, Nonrecurring Exceptional Costs). The impairment relates to costs incurred on stores Morrisons no longer intend to open, organic food online offer which is no longer required, trading stores and assets of the Kiddicare business. The impairment charge reflects the Morrisons view of decrease in the value of traditional supermarket property under intensecompetitivepressuresmainly from the new entrants, which were German discountersAldi and Lidl, and online supermarkets. Actually, Morrisons rival-Tesco also took an impairment charge (about £1 billion) under the pressure from the no-frills supermarket.

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Itcomes to aconclusionthat the new rival such as no-frills grocery stores and online virtualsupermarket reduced the market share and margin profit of traditional chainsupermarket's, Morrisons need to adjust its estimate of the supermarket properties' value-in-use and recognized impairment charge. This impairment charge was the maincause of the slump in its profitability. In order to deeply understand Morrisons performance, the article will further analyse other accounting ratios of Morrisons from liquidity and financial health.

Chart 3, Non-recurring Exceptional Costs

  1. Liquidity and Financial Health

In terms of liquidity and financial health (Chart 4, Liability and Financial Health Analysis), Morrisons was relatively stable over the past five years. More specifically, its current ratio reflecting the company's short-term solvency has been kept about 0.5. However, its gearing ratio reflected the fact that Morrisons debtgreatly increased from £3099 to £3735 million in this period. As shown in (Chart 5, Debt in Morrisons), the growth of long-term debt more than five years and debt less than two years were majorfactorsin therapidgrowthof gearing ratio. Furthermore, knownfrom the annual report, Morrisons issued a €700m Euro bond (£569 million pounds) expiring June 2020 forlong-term development by purchasing tangible and intangible non-current asset. In conclusion, Morrisons liquidityratio indicated that thelevelof indebtedness was growth, but the debtprogram was still adequate.

Chart 4, Liability and Financial Health Analysis

RATIO

09/10

10/11

11/12

12/13

13/14

Current Ratio

0.55

0.57

0.58

0.5

0.53

Gearing Ratio

0.77

0.69

0.83

1.01

1.29

Chart 5, Debt in Morrisons[1]

  1. Change of Share Price

The stock price of Morrisons, at the beginning of this fiscal year, increased from 250.1p to 296.4p (Chart 6, Change of Share Price of Morrisons), due to its satisfied financial performance in the 2012/2013 Preliminary Results Announcement.

However, in May, after Morrisons issued the news that they signed a 25-year service agreement with online specialist retailer-Ocado, its share price began to dropconstantly. According to the contract, Morrisons paid Ocado £170 million to use its warehouses and platform which actually were not sufficient enough to support Morrisons further development. Besides, some investors and analysts suggested that as the online supermarkets' profitability was uncertain, this investment might be overvalued. Thus, some of Morrisons major shareholders' began to sell down its stakes such as Walter Scott andBlackRock.

Later, as Morrisons paid its final dividend of last year at 19th June, its share price began to rebound. Because of Morrisons cooperation with Ocado and its rapid growth plan of opening £200 M local stores till the end of 2014, some investors believed in its growth and profitability. The upward trend continued until 12th of September, when Morrisons issued its Interim results announcement. Actually, the performance of most traditional groceries, such as Sainsbury, Tesco and Morrisons, during the first half year of 2013/2014 were not satisfactory under the pressure from no-frills supermarkets. Furthermore, due to the publishing Christmas trading statement (6 weeks to 5 January 2014) at 9th of January, share price plungefrom 254.2p to 234.5p. Even if considering the decline in the traditional retailing industry, Morrisons experience over that Christmas and New Year period was dismal and unsatisfactory. Thus, by the end of this fiscal year, the share price did not show any signs of anupwardtrend. Whereas, at the beginning of the year of 2014/2015, Morrisons share price showedcontinuousdecrease status. As is shown in the Chart 6, at 13th of March 2014, Morrisons share price sunk to 205.2p because of the issuing of Preliminary Results of 2013/2014.

Chart 6, Change of Share Price of Morrisons

  1. Impression Management

Nowadays, as overabundant information is provided to users in the annual report, themeaningandimpactof important information would becomeobscured. However, the problem of informationoverflow also brings tremendousopportunityfor managers to package accounting ratios and emphasis the information in favour of their benefits. Impression management can be seen as a part of creative accounting .

There are three main forms of creative accounting- accounting narratives, graphs and photographs. This article will explore impressive management inpractice based on the annual report of Morrisons.

  1. Accounting Narratives

As accounting narratives are not audited, the managers can easily manipulate the information in this part. In Morrisons annual report , Chairman’s review ,Chief Executive’s review and Financial review consistsof the major of accounting narratives. Takeexamplefor the Chairman's review, it firstly mentioned the challenging grocery market , and then emphasized the importance of Morrisons strategic shift plan. Finally, it analysed Morrisons financial results such as asset turnover, finance cost and non-recurring exceptional costs in this year. However, this review ignored M internalfactors result in the decline in profit, and avoid the actual negative value of net comprehensive income. Therefore, in accounting narratives', the executives' of Morrisons puttheblameofthedrop in profitability onthe external factors like difficult economic conditions.Moreover, through stressing its future plan, Morrisons strengthened stakeholders' trust in its sustainabledevelopment and profitability.

  1. Graphs

Graphs are an indispensablepartfor annual report of most companies. This might be the most direct, effective and user-friendly method for stakeholders' to acquirefinancial information. These graphs created by managers voluntarily could misrepresent data and misguide users. In annual report of Morrisons, graphs were widely used to illustrate its financial performance.

In order to explain change in normal underlying , Morrisons management use the graph with misleading information. Firstly, according to Morrisons annual report of 2012/2013, the underlying operating profit in 2013 and 2012 were £950 million and £974 million[2] respectively, which were totally different from the figures in Chart 7. Secondly, there was selectivity in deliberately choosing data of graphs. Management generally compared the underlying profit with past four years financial data rather than only three years. This selectivity mainly resulted from the intention of presenting impression favourable to the company. Thirdly, Morrisons changed the ratio of this graph's dimensions in order to diminish the difference between different bars in the graph. It could be shown in the picture that, the height bar of 2011 was similar to the bar of 2014, and the differences between different bars were not notable.

Chart7, Underlying Profit of Morrisons

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Appendix I

RATIO

09/10

10/11

11/12

12/13

13/14

EBITDA Margin

1115/15410=7.24%

1224/16479=7.43%

1315/17663=7.44%

1297/18116=7.16%

837/17680 =4.73%

Gross Margin

1062/15410=6.89%

1148/16479=6.97%

1217/17663=6.89%

1206/18116=6.66%

1074/17680 =6.07%

Operating Profit Margin

907/15410 =5.89%

904/16479 =5.49%

973/17663 =5.51%

934/18116 =5.16%

-95/17680 =-0.54%

Net profit Margin

598/15410 =3.88%

632/16479 =3.84%

690/17663 =3.91%

637/18116 =3.52%

-238/17680 =-1.35%

Return on Assets

598*2/(8226+8760) =7.04%

632*2/(8760+9149) =7.06%

690*2/(9149+9859) =7.26%

637*2/(9859+10527) =6.35%

-238*2/(10527+10729) =-2.24%

Return on Equity

598/4949 =12.08%

632/5420 =11.66%

690/5397 =12.78%

637/5230 =12.18 %

-238/4692 =5.07%

RATIO

09/10

10/11

11/12

12/13

13/14

EBITDA Margin %

7.24

7.43

7.44

7.28

4.73

Gross Margin %

6.89

6.97

6.89

6.66

6.07

Operating Profit Margin %

5.89

5.49

5.51

5.24

-0.54

Net profit Margin %

3.88

3.84

3.91

3.57

-1.35

BIBLIOGRAPHY

Garner, B. and Black, H. (2004). Black's law dictionary. St. Paul, MN: Thomson/West.

Jones, M. (2011). Creative accounting, fraud and international accounting scandals. Chichester, West Sussex, England: John Wiley & Sons.

Bernoth, K. and Wolff, G. (2008). FOOL THE MARKETS? CREATIVE ACCOUNTING, FISCAL TRANSPARENCY AND SOVEREIGN RISK PREMIA. Scottish Journal of Political Economy, 55(4), pp.465-487.

WM Morrison Supermarkets plc, (2014). Annual Report and Financial Statements 2013/14. [online] Morrisons-corporate.com. Available at: http://www.Morrisons-corporate.com/Investor-centre/Financial-reports/# [Accessed 13 Mar. 2015]

WM Morrison Supermarkets plc, (2013). Annual Report and Financial Statements 2012/12. [online] Morrisons-corporate.com. Available at: http://www.Morrisons-corporate.com/Investor-centre/Financial-reports/# [Accessed 13 Mar. 2015]

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Crotty, J. (2009). Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’.Cambridge Journal of Economics,33(4), 563-580.

Laux, C., & Leuz, C. (2009).Did fair-value accounting contribute to the financial crisis?(No. w15515). National Bureau of Economic Research.

Véron, N. (2008). Fair value accounting is the wrong scapegoat for this crisis.Accounting in Europe,5(2), 63-69.

Pozen, R. C. (2009). Is it fair to blame fair value accounting for the financial crisis.Harvard Business Review,87(11), 84-92.

Courtis, J. K. (1997). Corporate annual report graphical communication in Hong Kong: effective or misleading?.Journal of Business Communication,34(3), 269-284.

BEATTIE, V. A., & JONES, M. J. (2000). Changing Graph Use in Corporate Annual Reports: A Time‐Series Analysis.Contemporary Accounting Research,17(2), 213-226.

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[1] (Wm Morrisons Supermarkets plc, 2014. p.103)

[2] (Wm Morrisons Supermarkets plc, 2013. p.12)