IB233 Financial Reporting 1

Seminar 1 – Solutions

Sainsbury Annual Report and Financial Statements Familiarisation Exercise

One of the aims of this module is to enable you to prepare, read, critically evaluate and
interpret published financial statements.

This exercise has the following objectives:

 To increase your familiarity with the contents of annual reports and financial statements
 To improve your understanding of the basis on which they are prepared
 To enhance your ability to locate pertinent data for financial analysis purposes
 To introduce topics covered later in the module (and in FR2)

The questions are based on Sainsbury’s annual report and financial statements 2019 available
from my.wbs or from Sainsbury’s website:
https://www.about.sainsburys.co.uk/~/media/Files/S/Sainsburys/documents/reports-and-
presentations/annual-reports/sainsburys-ar2019.pdf

1. What are the major sections in the annual report and financial statements?

There are broadly two sections in a company’s published annual report – the first
contains narrative reports, and the second contains the financial statements and related
notes.
The narrative reports can be broken down into those reviewing and explaining
Sainsbury’s business and financial results (the “Strategic Report”) and those discussing
issues to do with governance, for example, how the company is run, who the directors
are, their responsibilities and other corporate governance matters (the “Governance
Report”).

What is the purpose of the different sections?

Essentially it is all there because it is considered useful to the users (the IASB defines the
principle users as investors, lenders and other creditors). Regulation of differing types
has been required over the years to ensure that companies do provide information that is
considered useful, and also as a result of a history of companies not adhering to
underlying principles of good practice.

Companies legislation requires all UK companies to publish their annual financial

statements and related notes and a strategic report (i.e. statutory requirements).
Companies Act 2006 specifies what a company should discuss in its strategic report and
there is other guidance on this published by the FRC (Financial Reporting Council). The
format and content of the financial statements and related notes is laid down by
international financial reporting standards.

Listing requirements set out by the FCA (Financial Conduct Authority) specify the details

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 of corporate governance that companies are obliged to provide, and guidance on this is
provided by the UK Corporate Governance Code, which is produced by the FRC.

Strategic Report and other narrative reports (pages 1-88)

2. What is Sainsbury’s business strategy?

The headline on page 9 states that Sainsbury’s vision is to be the most trusted retailer
where people love to work and shop. Its goal is to make our customers’ lives easier every
day by offering great quality and service at fair prices. Its business strategy is based on
the following:
 We know our customers better than anyone else
 Great products and services at fair prices
 There for our customers
 Colleagues making the difference

These aspects are underpinned by five key values, which are discussed further on pages
18-27:
 Living healthier lives
 Making a positive difference to our community
 Sourcing with integrity
 Respect for our environment
 A great place to work

There are various diagrams on a number of pages with strategies, models, values,
priorities, all mentioned. Is it clear how all these fit together?

What are Sainsbury’s KPIs? (pages 28-29)

The Strategic Report is required to contain an analysis of the company’s financial key
performance indicators. KPIs are determined by the company and should include a mix
of financial and non-financial measures that the directors judge are most effective in
assessing progress against objectives or strategy, monitoring principal risks, or are
utilised to measure the development, performance or position of the entity or the impact
of its activity. There should be alignment between the KPIs presented in the strategic
report and the key sources of value and risks identified in the business model.
Sainsbury’s KPIs are:

Financial Non-financial
Underlying PBT Colleague engagement
Underlying basic EPS Community investment
Retail operating cash flow Greenhouse gas emissions reduction
Retail free cash flow
Retail underlying EBITDAR margin
Retail underlying operating margin

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 Dividend per share
Core retail capital expenditure
Pre-tax ROCE
Gearing
Lease adjusted net debt/underlying EBITDAR
Like-for-like sales
Retail sales growth
Like-for-like transactions growth
Cost savings

3. What is the key measure of profit that Sainsbury uses to evaluate its performance, and
why is this measure used? What issues does the use of this measure profit raise?

The performance highlights shown on page 1 of the annual report include “underlying
profit before tax”.

All profit measures included in Sainsbury’s KPIs (pages 28-29) use “underlying profit”.
Underlying profit is an alternative performance measure (APM). APMs are detailed on
page 185 and explained here as measures the directors believe provide additional useful
information for understanding the financial performance and financial health of the
Group. One issue with APMs is that they are not defined by IFRS, so they may not be
directly comparable with other companies who use similar measures. Note page 185
does state that the APMs should be considered in addition to and are not intended to be
a substitute for IFRS measurements.

Underlying profit before tax is defined as profit before tax adjusted for certain items
which, by virtue of their size and/or nature, do not reflect the Group’s underlying
performance. Note 3 Non-GAAP performance measures (page 106) shows the items
Sainsbury’s considers are non-underlying. These are:
 Property-related – profit/loss on disposal of properties, investment property fair
value movements, impairment and onerous contract charges
 Argos – costs related to its integration
 Sainsbury’s Bank transition – costs relating to the transition to a different IT platform
 Asda transaction costs – Costs relating to the proposed merger with Asda (which
wasn’t permitted by the CMA)
 Restructuring costs – resulting from various changes to operating models
 Other – perpetual securities coupons, non-underlying finance movements,
unwinding of fair value adjustments arising from previous acquisitions, defined
benefit pension scheme financing charges

In other words, Sainsbury is stripping out of its key profit measure all items which do not
relate to its core (underlying) supermarket activities.

Note – EBITDAR (also included in Sainsbury’s KPIs) is a common measure of profit used by
analysts, and Sainsbury defines this as underlying earnings (profit) before tax before
underlying net finance costs, underlying share of post-tax results from joint ventures,
depreciation, amortisation and rent. Depreciation and amortisation are excluded for this

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 measure of profit because these depend on a business’s chosen accounting policies,
which can vary from company to company, and also because they are non-cash expenses,
and so the resulting “profit” is closer to a “real” profit figure based on cash flows. Rent is
excluded because how much a company is property owning versus renting varies.

What do you observe about this measure of profit compared to other measures?

The consolidated income statement (page 96) shows operating profit decreased from
£518 million in 2018 to £312 million in 2019, a decrease of 40%, and profit before tax
decreased by 18.7% from £409 million to £239 million. This decrease can be explained by
the analysis of operating profit on the face of the income statement. It can be seen that
underlying profit before tax actually increased by 8% - from £589 million to £635 million.
However, Sainsbury’s has excluded net expenses of £396 million (2018: £180 million) from
this profit which it has defined as not part of its core business activities. Further details of
this is given in note 3 (page 106).

4. Who runs the company (i.e. who are the executive directors of Sainsbury)? (page 44)
What are the key elements of the Sainsbury directors’ remuneration package? (page
72)
What is the total directors’ remuneration for 2019? (pages 72 and 83)

Executive directors:
Mike Coupe – CEO
Kevin O’Byrne – CFO
John Rogers – CEO of Sainsbury’s Argos

The non-executive directors are an essential part of corporate governance mechanisms

but are not directors running the company day-to-day.

Key elements:
Executive: Fixed – base salary, pension contribution, benefits
Variable (performance related) – annual bonus, deferred share award,
long-term incentive plan
Non-executive: Fixed fees and benefits

Total directors’ remuneration 2019:

Executive directors: £8.6 million (2018: £7.4 million)
Non-executive directors: £1.1 million (2018: £946K)

Auditor’s Report and Financial Statements (pages 91-171)

5. What accounting framework has been used by Sainsbury’s in the preparation of its
financial statements? (Accounting policies page 101)

The accounting policies state that the group financial statements have been prepared in
accordance with IFRSs as adopted by the European Union and IFRIC (International

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 Financial Reporting Interpretations Committee) and with those parts of Companies Act
2006 applicable to companies reporting under IFRSs.

6. Who is Sainsbury’s auditor? (pages 91-95)

Ernst and Young LLP

What is the auditor’s opinion on Sainsbury’s 2019 financial statements? (page 91)

“Clean” (unqualified) opinion on financial statements, i.e. that the financial statements
give a “true and fair” view. Also that they have been properly prepared in accordance
with IFRSs as adopted by the EU, Companies Act 2006 and Article 4 of the IAS Regulation.
This opinion applies only to the group and company financial statements and related
notes on pages 96-180, and not to the preceding narrative reports. The auditors do give
an opinion (page 94) that the Strategic Report and Directors’ Report is consistent with the
financial statements and that these statements have been prepared in accordance with
applicable legal requirements.

International auditing standards also require the auditors to report, as appropriate, on

other issues such as disclosures relating to principal risks and going concern.

How much did Sainsbury pay its auditors in 2019? (Note 6 page 113)

Audit and related services £3.8 million

7. Particularly in what areas have judgements and estimates been used in the preparation
of the financial statements? (pages 104-105)

Included in the accounting policies are details of where judgements, estimates and
assumptions have been used which affect the application of accounting policies and
reported amounts. These areas are:
 Identification of assets and liabilities to be classified as held for sale
 Operating lease commitments
 Consolidation of structured entities
 Aggregation of operating segments
 Impairment of non-financial assets and loans and advances
 Post-employment benefits
 Provisions
 Determination of fair values
 Revenue recognition – fair value of Nectar points
 Supplier arrangements (including supplier rebates – cf. Tesco scandal.)

8. What does Sainsbury’s revenue comprise and when is it recognised? (Note 4 page 108)

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 Revenue consists of sales through retail outlets and online, and, in the case of Financial
Services, interest receivable, fees and commissions.

Sales through retail outlets are shown net of returns, the cost of Nectar reward points
issued and redeemed, colleague discounts, vouchers and sales made on an agency basis.
Commission income is recognised in revenue based on the terms of the contract.

IFRS 15 Revenue from Contracts with Customers was applicable for the first time for the
2019 financial statements. Following the model set out in IFRS 15, revenue is recognised
when the Group has a contract with a customer and a performance obligation has been
satisfied, at the transaction price allocated to that performance obligation. Details of the
effect of the adoption of IFRS 15 are given on page 103, and for Sainsbury have been
minimal. (Note – more about IFRS 15 in lectures 11 and 12.)

9. What are Sainsbury’s largest assets and liabilities at 9 March 2019? (SoFP page 98)

Of total assets of £23,541 million, property, plant and equipment total £9,708 million –
by far the largest class of asset. Amounts due from Financial Services customers (i.e.
loans and advances) are the next largest at £3,349 + £3,638 million = £6,987 (total of non-
current plus current).

The largest liability is amounts due to Financial Services customers and other deposits (in
other words the customers’ deposits) of £7,601 million (total of non-current plus
current). Unsurprisingly for a supermarket, trade and other payables is a significant
current liability at £4,444 million.

10. What are the depreciation methods and rates applied by Sainsbury for different classes
of property, plant and equipment? (Accounting policies in note 11 page 118)

Freehold buildings and leasehold properties – 50 years or the lease term, if shorter
Fixtures, equipment and vehicles – 3 to 15 years
Both on the straight-line basis

11. What is the basis of measurement of Sainsbury’s land and buildings and what is their
carrying amount? (Note 11 page 118)
What is the market value? (page 21)
Comment on this difference.

Land and buildings are measured (valued) at historical cost less accumulated depreciation
and any recognised provision for impairment.
Net book value of land and buildings per statement of financial position (including
freehold and leasehold) £7,753 million.
Estimated market value of properties: £10.4 billion (In Strategic Report page 43)

Sainsbury’s accounting policy of historical cost (verifiable, reliable) does not reflect

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 current market values (more subjective, but possibly more relevant). This emphasises
the importance of knowing what the accounting policy is for different items in the
financial statements. In the case of property, plant and equipment, a company may
choose historic cost or fair value (more of this in FR2).

12. What categories of intangible assets does the Sainsbury group have? (Note 12 page
121)
What is meant by “goodwill”? (Accounting policies in note 12 page 120)

Intangible assets comprise computer software, acquired brands, customer relationships

and goodwill.
Goodwill recognised in the financial statements is only from the acquisition by Sainsbury
of a subsidiary company. It is the excess of the fair value of the consideration over the
fair value of the group’s share of the net identifiable assets of the acquired subsidiary at
the date of acquisition. (More in FR2.)

13. How much debt does Sainsbury have on its group balance sheet at 9 March 2019?

How do you define debt?

Current and non-current liabilities per the statement of financial position (balance sheet)
(page 98) total £11,417m + £3,668m = £15,085 million
Borrowings (current and non-current) included in this total £1,782 million
Retail net debt (which incorporates the group’s borrowings, bank overdrafts, financial
assets classified as at fair value through other comprehensive income, derivative financial
liabilities, and obligations under finance leases, net of cash and cash equivalents and
derivative financial assets, excluding Financial Services’ own net debt) (note 27 page 150)
totals £1,142 million. This definition of net debt plus the perpetual securities is referred
to in the CFO’s financial review (page 42).

What is the total of shareholders’ funds on the consolidated balance sheet? (page 98)

Total equity £7,960 million

What does this tell you about how Sainsbury is financed?

This will depend on which definition of debt is used, but a gearing ratio (debt to equity)
should be calculated. The KPI gearing ratio (page 29) is defined as net debt divided by
net assets and is 13.5% at 9 March 2019. This is also referred to in the CFO’s financial
review (page 43). Sainsbury is a relatively low-geared company, and gearing has fallen
for the past few years from a high point of 42.3% in 2014-15.

14. How many shares has Sainsbury in issue at 9 March 2019? (Note 20 page 127)
What is Sainsbury’s market capitalisation?

2,206 million ordinary shares of 284/7 pence each. Share capital per balance sheet = £630

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 million (remember this is the nominal value of shares issued).
Market capitalisation needs the market price per share which is not disclosed in the
financial statements.

What dividend did Sainsbury pay to its shareholders in 2019? (Note 10 page 118)

10.2p per share totalling £224 million. This comprises £156m final dividend for 2018 and
£68m interim dividend for 2019.
The group has proposed a final 2019 dividend of 7.9p per share totalling £174m, resulting
in total dividends for the 2019 financial year of £242 million. This is similar to the 2018
total dividend of £224 million but follows a few years of dividend decline.

Sainsbury’s has committed to paying an affordable dividend and fixed dividend cover at
2x cover (Chairman’s letter page 3).

15. What is your overall impression of the information contained in the annual report and
financial statements?

Answers will be varied, and may include issues to do with:

 Length (188 pages)
 Mass of detailed information – particularly financial figures
 Who reads it all?
 Are there better ways of providing this information?
 Are narrative reports in first half company spin or gloss – since not audited
 Understandable? Comparable to other companies, particularly in same sector?
 Clarity of presentation
 Use of alternative performance measures – underlying profit, KPIs
 Confidence in information through financial reporting processes and final external
audit