Part 2

You have been retained by your client Global Holdings to advise them on how to respond to two letters received from two activist investors on their register of shareholders. Your client wishes to ensure that when presenting financial information to the external stakeholders, they comply with the best practice in financial and stakeholder reporting.

Detailed below are relevant extracts of the two letters.

You are required to:

1. Comment on and corroborate, using published research, the user expectations from a good quality Annual Financial Report (AFR).

2. Advise on the validity, or otherwise, of the 3 deficiencies highlighted in the letter and your prescribed recommendations for improvement.

3. Exemplify to your client the contents of a set of integrated financial reports and substantiate how that will better meet the requirements of the external stakeholders when compared to the traditional financial report.

Letter 1

One of the main shareholders of Global Holdings Limited is the Capital Growth Hedge Fund, an investment company based in Texas in the USA. Capital Growth Hedge Fund (CGHF) is an activist investor who invests in poorly managed businesses and actively engages with the management of the investee company, with the intent of improving the performance of that company which results in the share price going up and CGHF making large profits on their investments.

CGHF has written to the Directors of Global Holdings. The contents of the letter include the following:

A) Return of surplus cash to shareholders

You have $300 million in your bank account. This cash is idling in your bank account. Your performance on prior investments made in the last 10 years has been dismal. The return on equity for the last financial year ended December 2019 is only 4%. The historical average return on equity for the last 10 years has been 6%. We therefore write to request that the directors declare a special dividend of $300 million and return the surplus cash to the shareholders rather than waste these funds on another non-performing investment.

B) Error in accounting for Revenue from the Media Division

The Media Division of Global Holdings contributes 12% of the total turnover of Global Holdings. We would like to bring to the notice of the Board of Directors that the manner in which revenue is recognised for this division is not compliant with IFRS 15 – Accounting for Revenue.

IFRS 15 requires the organisation to recognise revenue only after the work is done.

However, you are counting 20% of the advertising revenue immediately when the advertising contract is signed with the customer.

This contravenes the requirements of IFRS 15 and is resulting in your business overstating revenue reported. As a result, the annual profits are overstated.

C) Inappropriate performance indicators being used to manage the business

The disclosed long-term plan for your company is to grow sales by 8% to 10% a year over the next 5-year period. We would like to bring to your notice that your gross profit margin percentages have been falling each year over the last 5 years. Gross margin percentage for the year ended December 2019 is only 12%, the lowest it has been for the last 10 years. As a result, your earnings per share are also more or less unchanged for the last 5 years. 

This is not acceptable to us as investors in your company. Hence, we would suggest you consider changing your long-term plan objective from an 8% to 10% sales growth to a new target of 18% to 20% gross margin achievement.

Letter 2

The Canterbury Pension Fund is also a very large shareholder in Global Holdings Ltd. Canterbury Pension Fund (CPF) has also written a letter to the Directors of Global Holdings criticising the quality of the Financial Report for the year ended December 2019. Relevant extracts of that second letter are detailed below.

Environmental Impact Reporting

Given that information on how businesses address and disclose information on Environmental, Social and Governance issues are managed is becoming increasingly desired by external stakeholders, we were disappointed to note that there was no information in your latest Financial Report on the carbon footprint generated by your business in the year 2019. 

We would like to see this information published when you report your half yearly results in June.

Further we would suggest that, as done by many other entities similar to yours, you present a set of integrated reports that addresses the information needs of your various stakeholders when you next report in December 2020.