Marks and Spencer’s accounting choices Essay

Question 1 Exhibits 1 and 2 report the income statements and excerpts from the notes to Marks and Spencer’s financial statement for the fiscal years ending between March 31, 2005 and March 31, 2009. Critically analyze M&S’s accounting choices. What choices may have helped the company to overstate its net profits between 2005 and 2009? * M&S recognize many software development costs as intangible assets. In fact they recognize all costs related to software costs. This includes direct cost of material and services, payroll related costs for employees who are directly associated with the project. This may help M&S overstate its profits because normally only the direct costs associated with the software are recognized as an asset. The payroll costs for employees should not be considered to be an asset but as direct costs and should immediately reduce profits of M&S. Because this isn’t done, profits can be overstated. This is reflected by the large increase in computer software under development which was 5.6 million in 2005/2004 and was 178.8 million in 2009/2008. This is a stunning increase of 3192%. Besides there isn’t any amortization of the computer under software development and is only subjected to impairment. * Another thing which should be considered when reading the report is that there is a large amount of goodwill which may lead to overstatement of assets. In those five years there isn’t any impairment loss recognized or depreciation on that goodwill. Goodwill should be every year be subjected to impairment and it’s unlikely to remain constant over five years. This may lead to overstatement of assets. Warning signs of delayed write-downs on non-current assets can be a declining non-asset turnover or a declining return on assets below weighted average cost of capital. * Another point of discussion about the accounting methods M&S use, is the large depreciation rates they use on fixtures, fittings and equipment which can vary from three years to 25 years depending on the estimates life of the asset. This should be done on basis of useful economic life instead of the estimated life of the asset. This way they can spread the costs over a larger amount of time which overstates profits. * In 2005-2009, every year there are a large amount of additions, other than acquisitions. This is the case with land and buildings, fixtures, fittings & equipment, goodwill, computer software and computer software and development. Our opinion is that this comes from an increase in value of the asset. This is strange because there is an addition in goodwill which suggests that the value increased with no particular acquisition in 2007/2006 and 2008/2007. Also land and buildings and fixtures fittings & equipment increase because of additions while there is economic downturn in 2008/2007 and 2009/2008. * They also requalify their pension liability as equity because they sold it to a joint venture with its pension fund. This liability was then leased back from the joint venture so because they fully control this operational liability, they can qualify this as equity. This seems to be an accounting trick to state liabilities as equity. M&S also receives exceptional pension credit from this transaction in 2009/2008 and 2008/2007. Question 2 Exhibit 3 provides information about the liability that Marks and Spencer reclassified as equity. Do you agree with the decision to reclassify? What will be the effect of this decision on future financial statements? The reclassification of the liability of Marks and Spencer’s as equity seems to be an accounting trick. Marks & Spencer’s group had a liability of 496.9 million to M&S UK pension scheme. Because they did not want that the liability influenced their financial reports in 2007, they sold it to a joint venture of M&S group with M&S UK Pension scheme. The partnership then leased the properties of the partnership to the M&S plc. This reclassifies the liability because of the operational lease as equity while M&S group still has to pay the money to the pension scheme. When the pension fund has not got the money to pay their employees, the group still has to bring up the money. The effect of this decision on future financial statements is that a large amount of liabilities is classified as equity which distorts the equity/liability ratio and is not an actual reflection of the financial health of the organization. The future financial statements will give off a wrong impression of the liabilities owed to the pension scheme.