Here is a lesson in foresight. I wrote an article on this company many years before. I'll post up my analysis when I get the chance. The editor softened the article as he felt it was too strong in its original form. But here is what happened to them: -
http://www.managementtoday.co.uk/news/1 ... -break-up/
Chorion
While researching the discussion of cash and accrual accounting I decided to try and find a good example of how different accounting conventions can show up radically different operating results depending upon how you use and interpret accounting rules. During a recent SIGNET meeting I spotted an annual report for Chorion and realised that my example was in front of me.
If you want to be an ace accounting sleuth your starting point should be the annual report. Rather than read it from front to back make sure you read the annual report back to front. At the front of an annual report you will always see the glossy cover at the rear of the annual report you find all the real detail about a company, the notes to accounts. This is where you can find really interesting detail.
Recognition of expenses
Intangible assets and investment in film and TV productions make up the vast bulk of Chorion’s assets. These assets are capitalised costs meaning that most of the balance sheets assets are not physical entities more approximations of value and future charges to the profit and loss account.
Film and TV production is written off over the period in which it is expected to generate revenues. In other words, when a new production of Noddy or the Mister Men is filmed the costs don’t hit the profit and loss account immediately but over the time. In the 2003 report there is a discussion on this but this is lacking in the 2004 report.
Goodwill and intangible assets are written of in equal amounts over their estimate useful lives. This is 8 years for goodwill, 10 years for trademarks and for copyrights the remaining copyright period. Copyright periods can be any up to 70 years in length after the author’s death. The copyrights Chorion own relate principally to Agatha Christie, Georges Simenon and Mister Men, These are being written off in equal instalments due to expire in 2046, 2059 and 2058. My investing career will probably be over by 2058 so I hope my children’s, children’s are still into Mister Men then. If Chorion were to adopt say a 10 year maximum then the annual write off would wipe out their current reported profit. Chorion were easy to contact to clarify their position and should be commended on providing a quick and clear response. Chorion carry out an impairment test each year, which is audited, to ensure that the value of the unamortised copyright is supportable by future revenues. Their view is that it would not be correct to amortise this investment over a shorter period as I suggested. Although the amortisation period exceeds 20 years, the policy was considered entirely appropriate.
It is interesting to note that the presumption of a 20-year maximum life for goodwill and other intangibles under current UK GAAP disappears under International Financial Reporting Standards, replaced with the value of the asset being tested annually for impairment. This could have a significant effect on Chorion and other similar companies with the adoption of IFRS. Being an AIM listed company though Chorion is not required to comply with IFRS until 2007.
Revenue
We have seen that expenses are recognised over long periods of time. The consequence of expensing over long periods is possible understatement of those expenses; therefore how is revenue derived?
According to the annual report the turnover is recognised in accordance to the type of revenue. Licensing agreements are recorded by spreading income over the term of the contract. Film and TV income royalties are recognised as turnover when the programme is delivered to the broadcaster subject to; the licence agreement being sign by both parties, the licence term commencing and the collection of the licence fee is reasonably assured. In other words, revenue appears to be applicable over varying terms.
Some supportive arguments here are that you could easily be adding value to a brand by effective marketing of that brand. Therefore perhaps the annual impairment in that value is false? Also it should not be forgotten that a lot of TV revenue nowadays is poor in relation to the revenue from spin of products and merchandise, the value of which is difficult to quantify.
Chorion is a good example of how accounting rules can significantly affect the interpretation of how a business is operating. Overall it does appear that Chorion has adopted an accounting policy that while consistent with underlying logic isn’t fantastically prudent. It should be noted however that other similar companies follow similar policies. Certainly policies that could be substantial in relation to their profits are ones that should be carefully assessed and monitored by investors.
If you want to be an ace accounting sleuth your starting point should be the annual report. Rather than read it from front to back make sure you read the annual report back to front. At the front of an annual report you will always see the glossy cover at the rear of the annual report you find all the real detail about a company, the notes to accounts. This is where you can find really interesting detail.
Recognition of expenses
Intangible assets and investment in film and TV productions make up the vast bulk of Chorion’s assets. These assets are capitalised costs meaning that most of the balance sheets assets are not physical entities more approximations of value and future charges to the profit and loss account.
Film and TV production is written off over the period in which it is expected to generate revenues. In other words, when a new production of Noddy or the Mister Men is filmed the costs don’t hit the profit and loss account immediately but over the time. In the 2003 report there is a discussion on this but this is lacking in the 2004 report.
Goodwill and intangible assets are written of in equal amounts over their estimate useful lives. This is 8 years for goodwill, 10 years for trademarks and for copyrights the remaining copyright period. Copyright periods can be any up to 70 years in length after the author’s death. The copyrights Chorion own relate principally to Agatha Christie, Georges Simenon and Mister Men, These are being written off in equal instalments due to expire in 2046, 2059 and 2058. My investing career will probably be over by 2058 so I hope my children’s, children’s are still into Mister Men then. If Chorion were to adopt say a 10 year maximum then the annual write off would wipe out their current reported profit. Chorion were easy to contact to clarify their position and should be commended on providing a quick and clear response. Chorion carry out an impairment test each year, which is audited, to ensure that the value of the unamortised copyright is supportable by future revenues. Their view is that it would not be correct to amortise this investment over a shorter period as I suggested. Although the amortisation period exceeds 20 years, the policy was considered entirely appropriate.
It is interesting to note that the presumption of a 20-year maximum life for goodwill and other intangibles under current UK GAAP disappears under International Financial Reporting Standards, replaced with the value of the asset being tested annually for impairment. This could have a significant effect on Chorion and other similar companies with the adoption of IFRS. Being an AIM listed company though Chorion is not required to comply with IFRS until 2007.
Revenue
We have seen that expenses are recognised over long periods of time. The consequence of expensing over long periods is possible understatement of those expenses; therefore how is revenue derived?
According to the annual report the turnover is recognised in accordance to the type of revenue. Licensing agreements are recorded by spreading income over the term of the contract. Film and TV income royalties are recognised as turnover when the programme is delivered to the broadcaster subject to; the licence agreement being sign by both parties, the licence term commencing and the collection of the licence fee is reasonably assured. In other words, revenue appears to be applicable over varying terms.
Some supportive arguments here are that you could easily be adding value to a brand by effective marketing of that brand. Therefore perhaps the annual impairment in that value is false? Also it should not be forgotten that a lot of TV revenue nowadays is poor in relation to the revenue from spin of products and merchandise, the value of which is difficult to quantify.
Chorion is a good example of how accounting rules can significantly affect the interpretation of how a business is operating. Overall it does appear that Chorion has adopted an accounting policy that while consistent with underlying logic isn’t fantastically prudent. It should be noted however that other similar companies follow similar policies. Certainly policies that could be substantial in relation to their profits are ones that should be carefully assessed and monitored by investors.