Module 5: Case study – the Consolidated Balance Sheet
Watch the Consolidated Balance Sheet video >
The primary source of information referenced will be the annual report and accounts that were
issued for the reporting period – 52 weeks ended 29th August 2015.1
The Consolidated Balance Sheet shows the financial position of the Debenhams group at two
moments in time; at the end of the year being reported and the comparative data for the
1
Debenhams’ Annual reports - http://phx.corporate-ir.net/phoenix.zhtml?c=196805&p=irol-reportsannual
previous year. As with the Consolidated Income Statement, all the headings on the balance
sheet and the individual descriptions are mandatory.
Historically, reporting businesses could adopt a variety of approaches. However, the 1980
Companies Act adopted the European 5th Directive on company reporting, restricting the format
to a choice between this vertical approach and a horizontal approach showing assets on the left
and liabilities on the right-hand side.
The advantage of the vertical approach is that both Net assets and Shareholders’ equity are
easily identifiable, whereas with the horizontal format it can be tricky to isolate these two
important values. Conversely, if you feel the need to identify gross (total) assets and gross
liabilities whilst looking at a vertical style balance sheet, then you need a calculator.
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The Consolidated Balance Sheet shows a group of companies that seem well capitalised
and not over-indebted. Shareholders’ funds (or equity) of over £850 million show an
increase of over 11% compared with the previous year.
Within Current Liabilities, Trade and other payables of £524 million far exceed
Inventories and Trade and other receivables of £78 million suggesting effective control
over working capital. This means trade suppliers probably only get paid when their
goods have been sold or, in other words, trade suppliers are financing a good portion of
Debenhams’ business.
Looking at the Consolidated Balance Sheet in a little more detail raises various questions.

Non-current assets
The value of non-current assets is £1.7 billion. Within this, there are tangible assets and
intangible assets.
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Tangible assets are comparatively easy to understand because you can visualise them –
department store fit-out, furniture and other movable equipment, systems etc. Tangible
assets are also depreciated, which means that a portion of their original cost is offset
against profits, recognising that they have a finite life, after which they will need to be
replaced. Therefore, depreciation is a measure of value used up and also a means of storing
up some cash profit to help pay for the replacement or, more likely, improvement, as
replacement on a like-for-like basis is uncommon.
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Intangible assets account for more than half the value of Non-current assets. It is important
to understand what these assets actually comprise of and exactly how they are valued,
because a radical reassessment of that value might have rather a serious impact on the
Consolidated Balance Sheet.
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Note 13 to the financial statements clarifies the composition of the £931.5 million
Intangible assets figure. It is primarily Goodwill - in this case it represents the difference
between the amount paid for a property portfolio compared with the “fair value” of the
assets actually acquired. As explained previously, this means that there is extra value which
the business buying these assets believes it can extract – part of which will be the extra
amount they are prepared to pay to secure them.
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Accounting rules require management to either “amortise” goodwill over a period of time
to try and match the extra value that is realised from these assets or undertake impairment
tests on a regular basis to confirm that these values have substance. Impairment tests
answer the question “have these values been impaired by any event or series of events
when compared with the last time we did this exercise (usually last year)?”
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Goodwill
What does Note 13 to the financial statements tell us:
“Goodwill is not amortised but is reviewed on an annual basis or more frequently if there are
indications that goodwill may be impaired. Goodwill represents the goodwill for a portfolio of
sites, which has been allocated to cash-generating units (“CGUs”) according to the level at which
management monitors that goodwill.
For the purpose of this impairment review, the recoverable amounts of the CGUs are determined
based on value-in-use calculations. These cash flow projections are based on financial budgets
approved by management covering a five year period. The five year plan is built up using
management’s previous experience and incorporates management’s view of current economic
conditions and trading expectations. Management determined sales growth in the five year
period to be a key assumption. The annual sales growth ranges from 0.0% to 4.0% during the
five year period. Cash flows beyond five years are extrapolated based on the assumption of 2.0%
growth after year five........
Based on the value in use calculations, there is substantial headroom against each of the
operating segments and a reasonable change in the key assumption used would not cause an
impairment to goodwill.
As a result of the impairment review, as at 29 August 2015, no impairment of goodwill has been
required."
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Debenhams’ management looks at the trade from each department store. Having
calculated its profit contribution, they assess the present value of future cash flows from
each one using assumptions about the future course of inflation, wage growth and
consumer spending etc.
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To calculate what these future cash flows are worth in today’s values, they then discount
them using a discount rate cost based on the organisation’s cost of capital. The cost of
capital calculation is a weighted calculation based on the returns required by each provider
of capital.
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Having calculated a present value of these cash flows, they then compare that with the
goodwill allocated to each store. They do not clarify whether they aggregate the results but
they do say there is plenty of “headroom”. In other words, there is little risk of goodwill
being overvalued.
The only other comment to make about intangible assets concerns internally generated
software which is valued at £62 million and is amortised over a period of about ten years. It
may seem unusual to capitalise internal costs incurred in developing the group’s systems but it
is common when developing bespoke IT systems. And it’s clear that Debenhams is investing
quite heavily in its systems.
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Pensions
Other non-current items of interest are the Retirement Benefit Surplus which is surprising and
suggests that the Debenhams pension schemes are more than fully funded. This is after a
period when actuarial valuations have consistently increased the value of future pension
liabilities.
These liabilities are based on longer life expectancy and very low-interest rates which form the
basis of the discount applied to future expected pension payments. There has been a significant
shift in the calculations underpinning the pension surplus over the course of the year and the
notes do not fully explain why the Defined Benefit Schemes’ assets have increased in value so
significantly over the course of 2014/15 beyond additional contributions from the sponsoring
company.
Pensions are an important topic as pension liabilities under the group’s Defined Benefit
schemes amount to £770 million or so which is a big figure in the context of Debenhams’
balance sheet.
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Deferred tax assets and liabilities
Deferred tax represents tax on profits which has been “deferred” as a result of differences,
normally positive from the taxpayer’s point of view, between reported and taxable profits. They
are not payable immediately but at some stage in the not too distant future, the position will
reverse. This deferred tax will then become payable, so there is a need to recognise a liability
now.
Historically the most obvious example of this timing difference would have been the difference
between the depreciation charged against profits, which was not an allowable expense, and
capital allowances which originally were structured so as to encourage investment in capital
assets by businesses. This creates a deferred tax liability which is recognised upfront and then
gradually written back against future tax charges so as to equalise the overall charge over time.
A deferred tax asset is the reverse – income or costs that have been disallowed initially but
which will become allowable against future profits. Provided you can be confident that this will
actually happen there is a case for regarding it as an asset.
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Derivative financial instruments
These comprise interest rate swaps designed to help Debenhams manage their exposure to
changes in interest rates and forward foreign currency contracts.
Why does Debenhams use them? A proportion of the group’s debt has an interest cost that
fluctuates with changes in market interest rates. Interest rate swaps are a means of managing
the risk from sudden unexpected changes in rates by fixing the cost at a level where
management feels comfortable.
Similarly, with the vast majority of merchandise sourced from non-sterling areas, fluctuations in
foreign exchange rates can cause havoc with profit margins. One way to manage this risk is to fix
the rate at which currency will be bought in order to settle with foreign suppliers.
Historically all this activity would have been off a balance sheet and only recognised at
transaction date. However, these are future obligations and they must be valued and shown on
the face of the Consolidated Balance Sheet. Even if there is no intention to trade, they cannot
be held until the maturity of the underlying position that they are intended to hedge.
They are split between current and non-current assets and liabilities according to when they fall
due and whether they are “in the money” (i.e. they have a positive value in the market place
and are therefore an asset) or “out of the money” (i.e. they have a negative value in the market
place and are therefore a liability) and they are dis-aggregated. You cannot net off assets
against liabilities – these need to be disclosed separately which is why they appear in a number
of places on the balance sheet. As a measure of how seriously Derivative Financial Instruments
are taken there are seven pages of notes on financial risk management and financial
instruments in Notes 21 and 22 to the Financial Statements.
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Current assets and liabilities
As explained in the previous session, current assets and liabilities are the oil that lubricates the
engine within any business or organisation. They circulate regularly and by definition will be
sold and settled within a twelve month reporting period, hence “current”. In a trading company
like Debenhams, it is not difficult to work out what these are likely to be and the balance sheet
descriptions – again, prescribed wordings that cannot be changed – are reasonably clear
without being too specific to Debenhams. So:
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Current assets
- Inventories are stocks of merchandise that have been bought but are unsold
- Trade and other receivables are monies that are outstanding from those who have bought
merchandise (or inventories) together with a range of other debts to be collected such as
recoverable VAT and prepayments of bills for a future period (think, for example, insurance
or telephone line rental, as personal examples)
- Cash and cash equivalents are just that; primarily petty cash, bank account balances and
deposits
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Current liabilities
- Bank overdraft and borrowings (banks and other lenders) that are due for repayment within
the twelve month period following the balance sheet date
- Trade and other payables are creditors for e.g. merchandise and equipment purchased,
income tax and social security due for payment and accruals for expenses arising in the
course of the day–to-day business such as utility bills
- Current tax liabilities represent corporation tax payable within the next twelve months
- Provisions are a little different as they are usually quite general and involve judgement.
Typically for a company like Debenhams, they are mainly allowances for costs relating to
areas such as promotional activities, usually future claims by customers against costs they
have incurred in the past
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Non-current liabilities
Many of the headings in this section of the Balance Sheet are exactly the same as the
descriptions under the Current liabilities section that we’ve just covered. The principal
difference is that these liabilities, while very real, are not expected to crystallise, or become
actually payable with cash, over the course of the next twelve months.
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Debt – long and short term
More details appear about the debt portfolio which attracts the attention of analysts and
investors in particular when assessing the group’s ability to continue financing activity into the
medium term at least. The subject of Treasury financial management will be dealt with in the
cash flow session but quite simply there is a skill to managing that debt portfolio to avoid large
cash calls on a business that it struggles to meet.
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Long-term obligations
This heading would normally include an underfunded pension fund liability but in Debenhams’
case, as referred to above, there is actually an asset. The heading of Other non-current
liabilities contains £341 million of property lease incentives. These have been received from
landlords who have incentivised Debenhams to open a store and “anchor” a retail property
scheme and a magnet for other retailers who seek to cluster around a department store like
Debenhams.
They include both cash incentives – contributions to fit-out - and rent-free periods which they
have capitalised (i.e. put on the balance sheet) and will amortise over the length of the
leasehold agreement.
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Shareholders’ equity
The final section of the Balance Sheet is headed up Shareholders equity and gives an analysis of
reserves which is supplemented by further explanations in the notes to the Financial
Statements.
The share capital is valued at the “nominal value” (according to their denomination e.g. 1p, 10p,
£1) of the shares in issue while the difference between the nominal value and the actual
proceeds from issuing shares is trapped in the statutory reserve Share Premium account. This
reserve is not distributable other than in a wind up or with court approval and is designed to
protect creditors.
The Merger reserve and the Reverse acquisition reserve relate to the corporate restructuring
that took place in 2005 and they largely cancel each other out. The Hedging reserve holds the
revaluation movement on all the cash flow hedges arranged by the company. The Other
reserves comprise changes in value, for currency and market reasons, of investments held in
overseas assets and investments held for resale. In this case, it comprises a 10% investment in a
department store in Cyprus called Ermes.
Retained earnings is one of the more significant reserves as it is the pot of “realised”
accumulated earnings out of which the shareholders get a cash return on their investment. The
other way is to sell their investment but assuming they want to continue to invest in
Debenhams, dividends are their source of income and these cannot exceed the value of
Retained earnings.
 Consolidated Statement of Changes in Equity.
This statement gives a little more detail on the movements in the various reserves over the
years that are being reported. It also deals with the all-important issue of appropriations of
retained earnings. These comprise share based payments and dividends paid to shareholders.
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Contingent liabilities
On page 137, there is a brief statement about contingent liabilities and the approach to setting
up provisions to address “legal or constructive obligations as a result of past events and where it
is more likely than not an outflow of resources will be required to settle...”. Otherwise, the
subject is not considered to be an issue or to result in a material liability. This is certainly an area
where the external auditors, PriceWaterhouseCoopers, will have sought to reassure themselves
that nothing significant is missing from the Consolidated Balance Sheet.
Interestingly, Note 29 contains an analysis of the minimum value of contracted operating lease
payments payable in future years valued at £4.7 billion. Despite being contracted obligations,
they are not shown on the Consolidated Balance Sheet as liabilities. These are operating lease
commitments, which means the rights and rewards of ownership remain with the owners not
the occupier, but Debenhams does have pre-emption rights over certain of the stores should
the owners wish to sell. And in any case, some of the leases are for periods that exceed twenty
years which in the context of the present day, means they can perhaps behave as though they
are the beneficial owners.
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