The History And Background Of Tesco Accounting Essay

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Tesco is one the UKs biggest food supermarket offering a variety of services for food and non-food products which include insurance, entertainment, electrical goods and many more. It employs over 500,000 people around the world with over 300,000 in the UK itself. It has around 3000 stores in the UK and a growing number of stores abroad in countries such as Thailand, China, Hungary, India and the United States. (Tesco website)

According to the company annual reports in 2011 Tesco made £72.0bn sales all over the world in which 66% was from U.K. It is rapidly reportedly the no 1 supermarket in U.K following by Sainsbury's, Asda and Morrison's. According to a survey done by 'Telegraph' it was believed that one pound in every seven that is spent in British shops goes through Tesco's tills. The main reason of selecting Tesco for the essay is its popularity among the consumers and its diversification from just being into groceries to starting their own financial services. Tesco was one of first stores to go global from U.K in terms of supermarket.

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This essay will discuss accounting policies of Tesco in relation to non-current assets and will compare them with the International accounting standards (IAS). Then it will draw a conclusion how they are important to company's performance and how assumptions and judgements made by management affect in measurement of its non-current assets. Also in the end the essay will discuss proposed changes in International Financial Reporting Standards and how they may affect the performance and position of Tesco.

Non Current Assets

IFRS defines an Asset as: "A resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise." Generally there are 2 types of Asset which include Current and Fixed or Non Current Assets. Non-current assets typically form a large proportion of the total assets of a company. The accounting policies and estimation techniques that are used in relation to non-current assets often have a material impact on the overall position and performance of a company.

Tesco prepare their financial statements in accordance with International Financial Reporting Standards and Company Act 2006. They are prepared on the historical cost basis, except for certain financial instruments, share-based payments, customer loyalty programmes and pensions that have been measured at fair value.

By going through the Tesco financial statements it has been observed that the company has the following Non Current Assets.

Goodwill and other intangible assets

Property, plant and equipment

Investment property

Investments in joint ventures and associates

Other investments

Loans and advances to customers

Derivative financial instruments

Deferred tax assets

The section below will discuss some points from above and will compare them to International accounting standards and determine the importance to the position and performance of the company.

Property, Plant and Equipment 

According to IAS 16 Property, Plant and Equipment draw the accounting treatment for most types of property, plant and equipment. The primary function in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognised in relation to them.

Characteristics

According to IAS 16 Property, plant and equipment are tangible items that:

are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes

are expected to be used during more than one period

Condition

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

There would be possible economic benefits from the item and which will flow to the entity

The cost of the item can be measured reliably.

Recognition

An item of property, plant and equipment that meet the requirements for recognition as an asset shall be measured at its cost. The cost of an item of property, plant and equipment should be recognised at the purchase date.

Measurement after recognition

There are two models available that a company can use in its accounting policy; the cost model or the revaluation model

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Cost Model - After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation or impairment. [IAS 16.30]  The deprecation should be based on year end residual value. There are 3 types of deprecation method which can be used. (Warren, Reeve and Duchac, 2009)

Straight line

Diminishing Balance

Unit of Production

Revaluation Model -The asset is carried at a re-valued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably. [IAS 16.31] 

Significance

Plant, Property and equipment doesn't count towards bricks and mortar only but plays a very significance role in accounting. Noncurrent assets are generally more profitable than current assets, but also carry more risk as they might be difficult to convert into cash.

In Tesco Property, plant and equipment is carried at cost less accumulated depreciation and any recognised impairment in value. Property, plant and equipment are depreciated on a straight-line basis to its residual value over its expected useful economic life. The following depreciation rates are applied for the Group:

Freehold and leasehold buildings with greater than 40 years unexpired - at 2.5% of cost

Leasehold properties with less than 40 years unexpired are depreciated by equal annual instalments over the unexpired period of the lease; and

Plant, equipment, fixtures and fittings and motor vehicles - at rates fluctuating from 9% to 50%.

For example it can be seen that the total cost of land & building and others are recorded at cost of £34,772 Million and Accumulated depreciation and impairment losses are charged at £8,172 Million to reduce down the figure to £25710 Million. In 2012 Tesco made a profit of £376 million on property from around £1 billion of disposals. The profit on properties has played a vital role in bringing up the profit to total £3,835 Million. Furthermore Tesco has purchased more Plant, property and equipment worth £3,274 Million for future trading purposes. (Tesco annual report, 2012)

Investment Property

Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both. [IAS 40.5]

Characteristics

According to IAS 40, Investment property is not considered as property if it

(a) Use in the production or supply of goods or services or for administrative purposes; or

(b) Sale in the ordinary course of business

Condition

A property may be classified and accounted for as investment property provided that:

(a) It meets the required standard in definition

(b) The operating lease is treated as a finance lease in accordance with IAS 17 Leases; and

(c) The lessee uses the fair value model set out in this Standard for the asset recognised.

Recognition

Investment property should be recognised as an asset when it is probable that the future economic benefits that are associated with the property will flow to the entity, and the cost of the property can be reliably measured. Investment property is initially measured at cost, including transaction costs. [IAS 40.16]

Measurement after recognition

IAS 40 allows the reporting entity to adopt either the fair value model or the cost model as its accounting policy for investment property.

A Fair value model- Under the fair value model the investment property is revalued to fair value. Any changes in fair value are recognized in profit or loss in period of change. Also no deprecation is recorded for the period.

Cost model- An entity using shall measure ALL of its investment property in accordance with IAS 16 Property, Plant & Equipment requirements for that model. Assets should be reported at cost less accumulated depreciation and accumulated impairment losses. Also depreciation expense should be recognised each period

Significance

One of the key investment essentials that a property investor needs to be aware of is the gross rental yield. The gross yield is a measure of the relationship between an investment properties income generating capacity; the rent it produces and its' capital value. (Welland Media Limited, 2012)

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Tesco uses cost model where Investment property assets are carried at cost less accumulated depreciation and any recognised impairment in value. The depreciation policies for investment property are consistent with those described for owner-occupied property. For 2012 the recorded cost for investment property is £2253 Million and the deprecation (also includes impairment losses) accounts to be £262 Million. The Net carrying value at end of the year which is £1991 can be seen in balance sheet. The estimated fair value of the Group's investment property is £4.3bn for 2012.This fair value has been determined by applying an appropriate rental yield to the rentals earned by the investment property. The total rental income Tesco received for 2012 is £605 Million which has contributed towards the continuous operation of the reporting.

Assumptions and estimates

Estimation, assumptions and judgements in the accounting policies play a very vital role while preparing the financial accounts for any company. The uncertainty factor can significantly change the actual results then the estimates made by the managers in the accounting policies. Some firms have used estimates and judgements to inappropriately manipulate their financial statements.

In Tesco the management makes all the judgements, estimates and assumptions while preparing the consolidated Group financial statements and its decision affects the policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Critical estimates and assumptions that are applied in the preparation of the consolidated financial statements include:

Depreciation and amortisation

The Group exercises judgement to determine useful lives and residual values of intangibles, property, plant and equipment and investment property. The assets are depreciated down to their residual values over their estimated useful lives.

i) Impairment of goodwill

Goodwill arising on business is not amortised but is studied for impairment on an annual basis, or more frequently if there are indications that goodwill may be impaired. Any goodwill which is acquired by any other business is being monitored by the management level for impairment.

Key definition [IAS 36.6]

Carrying amount: the amount at which an asset is recognised in the balance sheet after deducting accumulated depreciation and accumulated impairment losses.

Recoverable amount: the higher of an asset's fair value less costs to sell (sometimes called net selling price) and its value in use.

Fair value: the amount obtainable from the sale of an asset in an arm's length transaction between knowledgeable, willing parties.

Value in use: the discounted present value of the future cash flows expected to arise from:

The continuing use of an asset.

Its disposal at the end of its useful life.

Recoverable amounts for cash-generating units are based on the higher of value in use and fair value less costs to sell. Value in use is calculated from cash flow projections for generally five years using data from the Group's latest internal forecasts. The key assumptions for the value in use calculations are discount rates, growth rates and expected changes in margins. Management estimate discount rates using pre-tax rates that reflect the current market assessment of the time value of money and the risks specific to the cash-generating units. Changes in selling prices and direct costs are based on past experience and expectations of future changes in the market. The pre-tax discount rates utilized by the board to compute value in use scope from 6% to 17% (2011: 8% to 14%). On a post-tax basis, the discount rates fluctuated from 5% to 13% (2011: 6% to 12%) (Tesco annual report, 2012)

The example of goodwill being calculated can be seen in following countries.

Countries

2012

£m

2011

£m

China

Czech Republic

UK

US

622 73 681 102

582 34 645 78

ii) Impairment of assets

An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset. The Group has determined each store as a separate cash-generating unit for impairment testing. Where there are indicators for impairment, the Group performs an impairment test. Recoverable amounts for cash-generating units are based on the higher of value in use and fair value less costs to sell. Value in use is calculated from cash flow projections for five years using data from the Group's latest internal forecasts. Similar as impairment of goodwill above the key assumptions made by the management are discount rates, growth rates and expected changes in margins. The pre-tax discount rates used to calculate value in use range from 6% to 17% (2011: 6% to 14%). On a post-tax basis, the discount rates ranged from 5% to 13% (2011: 6% to 12%). (Tesco annual report, 2012)

The total deprecation and impairment charged for 2012 (2011) can be seen below:

Non-Current Assets

2012 £m

2011 £m

Property, plant and equipment

Investment Property

9062 1991

8172 1863

Pensions

In terms of discount rates used while in pensions it is assumed to be 5.2%. If this assumption increased/ decreased by 0.1%, the UK defined benefit obligation would decrease/increase by approximately £170m and the annual UK current service cost would decrease/increase by approximately £14m. It can be seen how assumptions and judgements can contribute towards the company accounts.

Proposed changes in International Financial Reporting Standards

There have been many major changes reported in financial reporting in the business world however; the most important proposed change is the convergence around International Financial Reporting Standards (IFRS). IFRSs are considered a "principles based" set of standards in that they establish broad rules as well as dictating specific treatments.

Below are some proposed changes in IFRS and how they will affect the company.

IAS 19 (Amended)

Recently the International Accounting Standards Board (IASB) has published a revision to the accounting standard for pension and employee benefits, IAS19. These changes apply to companies using International Financial Reporting Standards (IFRS), and are also relevant for those currently using UK GAAP. (PWC, 2013)

Most UK companies will see a higher reported pension expense in the profit and loss (P&L) statement as a result of these changes. Companies will no longer be able to take credit for probable investment out-performance of equities above corporate bonds. There will be greater balance sheet volatility for the minority of companies that currently apply the option to defer actuarial gains and losses, known as the corridor approach. (PWC, 2013)

The Company participates in the Tesco PLC Pension Scheme which is a multi-employer scheme within the Tesco Group. The changes in IFRS are implemented from the periods starting on or after 1 January 2013. In practice it will remove the corridor approach and all the actuarial gain and losses will require immediate recognition in the other comprehensive income. The interest cost and the expected return on assets elements of the P&L pension expense calculation will be combined in future. The impact will depend on the future position of the pension scheme and future actuarial assumptions, but the changes are not expected to have a material effect on the Group's reported profits or equity.

IAS 17 - Leases

The main proposed change that is under consideration by International Accounting Standard Board (IASB) is that leases would be recorded on the balance sheet and also discuss the classification and pattern of expenses in the income statement. (Ernst and Young, 2010)In Tesco the leases are not recorded in the balance sheet and as result introducing this change will have a significant impact on the balance sheet. For example, the operating lease

Total rental payable

Total rental receivable

2012 (£m)

2011 ( £m)

2012 ( £m)

2011 ( £m)

17,323

16,015

936

1,129

Showing these amounts in the balance can have substantial impact on how a shareholder looks at the balance sheet.

Conclusion

Tesco plays an important role in the modern British society by providing all the day to day necessities to the local people and is regarded as the one of the biggest food retailer in U.K. This essay examined Tesco's key accounting policies in relation to non-current assets and discussed how some of them are recognised and measured for book-keeping purposes. Also the non-currents assets which accounts a big part of Tesco group is not only a significant amount in the balance sheet but in addition represent the company as whole.

It also discussed the role of management in determining the estimates and judgments while preparing the financial statements. Any change in the assumption can have quite a major impact on profits. For example if company decided to write off goodwill and rate being used at the moment is 10% and the company decided to change it to 15%. That change can lead to affect the profits in the P&L account and then further the balance sheet.

In the last part of the essay it has been discussed the proposed changes in International Financial Reporting Standards and how they will affect Tesco once they are put into practice. Some rules like IAS 19 which will not have that greater affect on Tesco accounts because Tesco doesn't use corridor approach in their accounting and on another hand IAS 17 will show vast changes on balance sheets.