Introduction of selected companies
Shell is one of the biggest and amongst the most recognized energy and petrochemicals companies in the world. The company has employs as much as 101,000 employees in its operations in more than 90 countries worldwide. The innovations that the company has undergone in the past few years have helped it to take up as many challenges in the field of energy that comes by in the future. The company has its headquarters in The Hague in the Netherlands. The company has the strategy that aims to keep them at the apex in the oil and gas industry and also be able to prove the best possible shareholders' return and be able to fulfil the energy demand globally. The company has been focusing incessantly on exploring the new oil and gas reserves and also adds to the current value of the firm by developing major projects. The company has the basic fundamental of finance in mind as to generate as much from the existing assets and also participate equally in the investments for the growth of the market. (Royal Dutch Shell plc (ADR) financials, 2010)
With the objective for be a leader of energy sector TAQA was founded in 2005. Today the workforce of TAQA is more then 2800. Their business is spread all over the global energy sector and they present themselves as a company which is fully integrated in its operations. The company is also interested in power generations, water desalination, combined heat, upstream oil etc.
TAQA is formally known as Abu Dhabi National Energy Company, is one of those companies that make vital contribution in fundamental development of the country. This can be well understood from the fact that it provides about 98% of the basic prerequisites like electricity and water in whole Abu Dhabi region. Thus various interests of this company are utmost priority for the state hence making financial aspects of this company significant. All the diversified perspectives of this company will be taken into account thus making it possible to get an overall picture about company's functioning in an inter-related format. It is also possible that financial risk is related to the performance of the company along with defining its management with respect to internal and external analysis. Also another important aspect of operations will be analyzed in terms of corporate finance that tends to maximize the productivity of the company by optimizing its financial structure. Present cash status, previous profits, and predicted cash flows can be termed as the main reason that governs financial policies of the organization in best possible manner. This can again be referred to as main feature in which stakeholders and shareholders are interested in along with defining the present position of the company among in the market. (Abu dhabi national energy, 2010)
Reason for selection
There is a biggest reason for selecting Shell Company. This is due to its steady growth in comparison to TAQA Company from the previous year to this year. Also there is a number of differences in the accounting policy of both the companies which would be helpful in comparison of the different accounting standards also in terms of their efficiency. Also another major reason for selection of both these companies is the availability of data. The financial data of both these companies is easily available on internet which makes them ideal for comparison as both are in same industrial segments too.
Identification of difference in accounting policies
Both the companies have adopted the different accounting policies. Which are:-
The TAQA's accounting policies is IFRS. Important features of IFRS:
For Shell important financial reporting standard is GAAP. This standard is very popular in US and western countries. GAAP through very popular is not been universally adopted by economies in the world. In terms of principle, GAAP is significantly different from that of IFRS. GAAP is also set of various standard procedures to business recording and balance sheet. The significance reason of GAAP for the Shell Company is providence of general information with uniformity for the calculation of financial ratios. Its give the answers of the classification of the balance sheet items and calculation of various outstanding measurements. With the GAAP policy, critical problems of balance sheet are also solved. For not only its transparency of company finance but also for the easy comparison between the businesses, GAAP plays a significant role among the company. That's the reason why GAAP is only applied to the US corporations among the various major countries. GAAP provide the advantages to the Americans company where the investors have intimate understanding about the business.
Identification of different accounting treatment and figures
Both the company used different kinds of accounting policies. So their major difference between the accounting treatment in respect of accounting policies are following; -
In IFRS, inventory choice is bases on real or physical flow of inventory where as in GAAP it follows last in first out mechanism (LIFO).
Property and Equipment:
IFRS permit the upward revaluation of property and equipment where as this is not permitted in GAAP.
For a joint venture firm, IFRS recommends employment of proportionate consolidation whereas GAAP suggests equity method for this.
Both the IFRS and GAAP do not provide any systematic involvement in Income statement.
Property assets are upward revaluated in IFRS whereas in GAAP, it is not allowed
Non-financial liabilities are considered as provision whereas GAAP does not permit provisions.
The definition of revenue in GAAP and IFRS is a bit different.
Construction constraints: In GAPP, a construction's percentage of completion method of recognition of revenue is fine for contracts having extension beyond one accounting period whereas IFRS, such estimation of project completion is not permitted.
Depreciation: In GAAP, tangible assets apart from land are depreciated.
Impact of different treatment on tax and share price
As there is a lot of difference in the way a company can count certain things as assets or liabilities etc like the construction cost, goodwill, provisions etc as mentioned in the above part, there can be a huge shift in taxes and share prices.
IFRS standards (that is used by TAQA) will affect the taxation in ways like:
- The standard allows a capital allowance on capital gain instead of deducting of loss on the deal.
- There are number of expenses and incomes which are tax free, for accounting profit is needed to be recalculated.
The share price has less to do with the standard of accounting use. Share price shows the perception of the people on the performance (present and future) of the company. Accounitng policies can shwo enhanced profit by window dressing and other means but cannot change the real value of the company.
Talking about shell the argumnets for the ralation between the share price and the accounting policies are sames as that for TAQA.
The taxaztion of Shell has follwing features:
- The company is allowed to offset the loss on any capital investment subjected to previosu financial year in this year's capital gain.
- Any illegal expence is added back to taxable income.
Treatment used under each standard
We already described various treatment of accounting above. The major changes made in the system approaches in different accounting treatment are made chiefly in direct approaches. The shell company assumes its major cost is tied up to the manufacture sectors while the accounting treatment of TAQA is not limited only up to direct approach and also includes various indirect factors while they make measurement of the goods.
Thus in short we can conclude that there are various differences between the TAQA and Shell. Both company used different accounting policies and the accounting treatments are also different of each company which make different growth rate for the both company.
Changes in TAQA's accounting policies:
The TAQA company has adopted IFRS which is called international financial reporting standard. The company adopts these policies because they just want to follow the guidelines given by the directors. From year 2008 to 2009, there are certain amendments that have been made which are as follows:
- Uses of customers royalties programmers
- They used the revised borrowing cost method
- Changes in assets from the customers
- Presentations on financial statement, financial instruments etc
- Agreement for the real estate construction
All above amendments are effective from the January 1, 2009.but this adoption does not affect any kind of material effectiveness.
Difference in accounting treatment
The TAQA has made various changes in accounting between 2008 and 2009. These changes can be identified in revenue recognition, taxes purchases method, management of foreign transaction, and management of fixes and intangible assets etc.
If we talk about revenue recognition then the revenue received from the oil and gas, gas storage, etc are now recognized as they are physically transfer to the customer. The revenue recognized from water and energy is now realized after giving the delivery to the off taker. The calculation of tax in now based on effective interest rate method in 2009.
In 2009, a number of adjustments have been made for different kinds of taxes. Like direct income tax is calculated on the basis of difference between the assets and liabilities. Differed taxes are now liable on the all temporary difference between the taxable assets and liabilities. Also differed taxes is recognized only when asset become available for realization.
The accounting treatment are made by keeping various things like date of exchange, equity instruments issued, fair value of the assets, liabilities incurred etc. but in intangible assets like goodwill is calculated after reducing the accumulated impairment losses.
Also the calculation of intangible assets cost now require both: the fair market value and the date of acquisition of the asset which is year 2009 was based only on the fair value of the asset.
The management of foreign investment is made in functional currency like all other monetary liabilities and assets. Also assets and liabilities are converted into AED on the basis of rate of exchange on the reporting date. If there is any goodwill arise from the foreign operation then they will be translated at the closing rate.
If there is any lease agreement then that will be calculated on the difference between the charges of finance and the lease liability. The payment of operating lease is now (in 2009) is treated as an expenses in the income statement on the basis of straight line basis in the whole lease period which was in 2008 was calculated on the basis of written down method.
The depreciation method for equipment has again revised. For example for different kind of assets (equipments) different kind of depreciation methods are now used. Except for oil and gas the company is now using straight line depreciation method which is calculated on an average life of the asset of approx 20 to 40 years. (Royal Dutch Shell plc (ADR) financials, 2010)
The fair value of the assets is recognized by the initial fair value with the adjustment of profit or loss made on it.
Changes in accounting treatment for Shell
The company has made changes in the treatment of inventory method. Now (2009) the company used weighted average method for inventory management. The cost incurred on the inventory is also added in the value of inventory.
In the monetary term we can see the following difference made in the accounting treatment between the two year 2008 and 2009.
Accounting policies used
Shell has also followed IFRS (international financial reporting standard) as accounting policies for its consolidated accounts but has restricted to GAAP in its US market. There are number of differences visible in the national and consolidate statements of the company
Different accounting treatment
The shell company has also made various changes in the accounting treatment, like for example all purchase costs including suppliers cost and cost related to the intermediary and finished good are now included in to the direct cost and the cost related to the selling and distribution, manufacturing cost, operating expenses and other expenses are includes into the indirect expenses. The cost of goods sold consists of various factors like the method used for the inventory control (LIFO, FIFO). The estimation of the tax effect and the return on the capital is also calculated after deducting the interest expenses, tax etc.
The shell company calculates its total equity by adding various reserve like capital redemption reserve, unrealized gain or losses share premium reserve, and other security reserve etc.
By adopting the GAAP policies there is a requirement to find out the derivatives in the financial statement. We can see the differences between the physical inventories due to timely difference between the gains and losses between the reporting periods. Like this the long term income gain is now also identified as an income from realization.
As we already describe that the profitability ratio indicates that how the company is able to earn the profit which measures the efficiency of any company. (Abu dhabi national energy, 2010) It gives the benefits for doing comparison between the companies on bases of data of various year or we can also compare it with another company. The shell company's profits ratios and their interpretation are as follows.
Gross profit ratio
The shell company's gross profit ratio in the year 2008 was 21.55% and in the year, it was 27%. It indicates that the company has earned more and has improvement from the previous year which is a good indication of the performance of the company.
Operating profit ratio
The operating ratio for the year 2008 was 11.09% and for the year 2009 was 7.56% for shell. It shows that the company was more able in controlling overall operating expenses and more efficient but in the year 2009 its fail in improving the activity like business and daily activity etc.
Net profit ratio
As we know that net profit is obtain removing the expenses from the operating profit like depreciation, taxes interest etc. We calculated the net profit of the shell company in the year 2008 and 2009 was 5.78% and 4.58% respectively. It means and shows that how that the company is not efficiently controlling the expenses which we already describe. This can be due to several reasons like the mismanagement, external environment etc.
Liquid as the name shows will be related to the short term. The liquid ratio shows that how the company is able to fulfill its short term requirement. For the shell company we have calculated following liquid ratio.
Inventory to net working capital ratio
This ratio shows that how much part of working capital should invested in the inventory. By this ratio we can know about the level of inventory also. The shell's company ratio in the year 2008 and 2009 was 1.75 and 2.349 respectively. In the year 2008 the company spent 1.75 part of the net marking capital on the inventory and in year 2009 it was 2.349. The incensement show that the company now become very conscious about the inventory
In the year 2008 the company has quick ratio equal to 0.921:1 while the ideal ratio is 0.5:1 which shows that the company is more efficient in conversion the liquid assets. But in year 2009 the quick ratio falls to 0.814 but this is also not at all a bad condition.
The current ratio in the 2008 and 2009 was 1.104 and 1.137 respectively. The reason for its growing was just because of the increment in the inventory level which was shows in the inventory to net working ratio.
It indicates the relationship between the debt and internal debt. We have calculated the following ratio:
Debt equity ratio:
The shell's company debt to equity ratio in the year 2008 (0.108:1) shows that the company has less external debt which give benefit in reduction of interest and in the year 2009 (0.226:1) shows that the company is more dependable on the internal debt. The debt ratio should be ideal.
Capital gearing ratio
By this ratio we know about the relation between the equity shares and fixed bearing debt like debentures of the company. The company's position in the year 2008 and 2009 was 12.65 and 4.42 that mean the company reduced the part of equity share from the debentures or other fixed bearing debts.
The company's position was 0.45 and 0.111 in the year 2008 and 2009 respectively. This is not a high value for this ratio so we can say that investing in this company is not harmful.
Profitability ratios reflect a company's general efficiency and performance. One can split profitability ratios into 2 kinds: returns and margins. Ratios that reflect margins represent the company's ability to interpret sales dollars into earnings at various stages of evaluation.
Gross profit ratio
The gross profit margin gazes at cost of goods traded as a proportion of sales. This ratio check at how well a business controls the manufacturing of its products, the cost of its inventory and next passes on the expenses to its customers.
The calculated measure of TAQA Company's gross profit ratio for the year 2008 was 39.71 % and in the year 2009 was 24.81 %. It shows that the company is not in the condition for controlling its cost on the sales. The company has decreased its efficiency in controlling the cost of sales.
Operating profit ratio
Operating profit is furthermore recognized as EBIT and is present on the firm's income statement. EBIT stands for earnings before interest and taxes. In this, the operating profit margin reflects at EBIT as a proportion of sales. This ratio (or operating profit margin ratio) is in general, a gauge of general operating efficiency, including all of the expenses of normal, daily business action.
The operating ratio of TAQA Company for the year 2008 was 18.49 % and for the year 2009, it was 2.84%. It shows that the company is presently not in the position to efficiently manage its daily activity. as it has decreased the operating ratio more than three times.
Net profit ratio
When perusing a simple profitability ratio analysis of a firm, net profit margin is the most frequent margin ratio employed. The net profit margin evaluates profitability after considering of all expenses including interest, depreciation and taxes. The company's net profit margin decreases from 13.06 % to 4.58 %. However this can be due to many reasons for example changes in external environment, complaint policies etc. but this decrement shows that the company fails in controlling the expenses.
Investor generally considers liquidity ratios to decide the ability of commerce to pay off its small term obligations from hard cash or near cash assets to appraise the risk connected if were to spend in this corporation. Breakdown to pay off small term obligation may produce in financial difficulty or insolvency in near prospect. Liquidity ratios assist investors to reduce the risk in stock market outlay to monitor out financial sound corporations on stock pick to construct up their "buy and hold" portfolio.
Cash ratio calculates the ability of commerce to meet small term obligations. It measures to the degree which present obligations can be remunerated from cash or fast cash assets. The company's cash ratio decreases form the 0.63 to 0.49, which is clearly indicating that the company has decreased its ability for paying the requirement of cash. By this the company's image falls in front of the investors. So the company should try to make this figure better.
Quick ratio is also known as Liquidity Ratio or Acid Test; it evaluates the ability of a corporation to pay off its instant obligations from present assets, excluding inventories. The cause of excluding inventories is owing to its little liquidity and consequently quick ratio offer better measurement of business ability to paid off its present obligations in contrast to current ratio. Generally, quick ratio does not relate to firms with inventory that is easily converted into cash, they use current ratio in its place. The company quick ratio in the year 2008 was 1.197 and in the year 2009 was 0.968. So it clearly indicates the deep fall in the company's paying to its short term debt in comparison to current liability.
Current ratio evaluates the firm's capacity to pay its short-range liabilities from temporary assets. If the current ratio is <=1 than this can be considered as a dangerous condition for the firm. The best ideal ratio is 2:1 but the company's current ratio in the year 2008 was 1.46: 1 and in the year 2009, it was 1.169. So the company should try for improve it.
Normally the solvency ratio is designed for the interpretation that how the corporation is able to accomplish its debts in admiration of its interior debt which is also called as equity of the company. We have calculated following solvency ratios:-
Debt equity ratio
Debt to equity ratio reflects the association between shareholders funds and long-term debts. It is also recognized as 'External-Internal' share ratio. This ratio is a gauge of owner's reserve in the commerce. Proprietors are generally always eager to have more money from borrowings since:
- Their risk in the business is condensed and subsequently their stake too.
- Interest on borrowings or loans is a deductible expense while computing chargeable profits whereas dividend payments on shares are not so permissible by Income Tax Authorities.
The usually satisfactory debt-equity ratio is 2:1.
In the year 2008 the company was in very bad condition for paying its debts which resulted in the increase of un-satisfaction among the investors. But in the year 2009, the company improved its D: E ratio but this does not mean that the company is now in better condition. The ratio is still not above the desired mark of 2:1.
This ratio provides the same sign as the debt-equity ratio as this ratio is a disparity of debt-equity ratio. Equity ratio is also recognized as solvency ratio. This is a relation among long-term debt and whole long-term funds of a company. Debt to Total Funds relations shows the percentage of long-standing funds, which have been raised by the company through the way of loans. This ratio (equity ratio) evaluates the long-term fiscal position and accuracy of long-standing financial policies. In UAE debt to entire funds ratio of around 2:3 or 0.67 is considered acceptable. A higher amount is not measured good and treated a pointer of dangerous long-term financial spot of the commerce. It shows that the commerce depends too greatly upon outsiders' loans. There is a clear indication that the company is in a good condition having an equity ratio .084 and .111 for the year 2008 and 2009 respectively.
Capital gearing ratio:
The term "leverage" or "capital gearing" usually refers to the percentage of relationship among equity share capital counting reserves and surpluses to any preference share capital and supplementary fixed interest behavior funds or loans. In additional words it is the fraction between the fixed dividend and fixed interest bearing funds with non dividend or fixed interest bearing funds. Equity share capital generally includes equity share capital with all reserves and surpluses categories that is associated to shareholders. Fixed interest manner funds include debentures, other long-term loans and preference share capital. The company's position is looking improved with the CG ratio of 0.124 and 0.176 for the year 2008 and 2009 respectively. This is still not a sound condition but the company has improved itself for the previous year. (2010)
Comparison between Shell and TAQA
After getting all kind of ratio now we can easily compare both companies.
By profitability ratio we can say that in the 2008 the TAQA is more efficient in controlling the direct expenses because its gross profit ratio is higher from the shell company. But in the 2009 both company approximately have the same position. The TAQA is more capable in operating the daily and business activity but it get a fall in the year 2009 while the position of Shell was average in both year. If we talk about the net profit ratio then we can say that in the year 2008 the TAQA has earn more profit then the shell company but in the year 2009 both company have approximately same position. There is little different between both of them
By liquid ratio, TAQA is more powerful in fulfilling the current liabilities where the shell company is more conscious in keeping the proper inventory. TAQA also have more liquid resource than the shell company.
By solvency ratio it can be seen that the TAQA believe in keeping more external debt from the internal debt. Sometimes this can be risky because the external debt has to paid regular interest and also has to pay the redemption value while the shell company believes in minting both levels equal.
- Abu dhabi national energy. (2010). Retrieved on April 9th 2010 from http://investing.businessweek.com/businessweek/research/stocks/financials/financials.asp?ticker=TAQA:UH&dataset=balanceSheet&period=A¤cy=native
- Royal Dutch Shell plc (ADR) financials. (2010). Retrieved on April 10th, 2010 from http://www.google.com/finance?fstype=ii&q=NYSE:RDS.B
- Welcome to TAQA. (2010). Retrieved on April 10th, 2010 from http://www.taqa.ae/en/index.html
- People & Organisation. Retrieved on April 10th 2010 from http://www.shell.com/home/content/are/innovation/about_us/