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The Effect of Associate & Joint Venture Accounting
The Leverage of Low Margin
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The Effect of Associate & Joint Venture Accounting
Let us go back to the Batu Kawan example. Table 5 shows selected financial data taken from Batu Kawan’s 2013 and 2014 annual report.
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Table 5: Extracted Financial Data from Batu Kawan’s Statement of Comprehensive Income for Financial Year 2013 (in RM ‘000) |
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KLK as Associate |
KLK as Subsidiary |
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Revenue |
362,025 |
9,466,245 |
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Gross Profit |
93,859 |
2,047,721 |
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Operating profit |
94,152 |
1,361,389 |
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Share of profits of equity accounted investees, net of tax |
427,594 |
13,668 |
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Profit before taxation |
513,383 |
1,285,791 |
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Profit attributable to equity holders of the Company |
483,709 |
483,709 |
Table 6 shows the resulting margins derived from Table 5.
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Table 6: Profit Margins for Batu Kawan (in %) |
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KLK as Associate |
KLK as Subsidiary |
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Gross profit |
25.93 |
21.63 |
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Operating profit |
26.01 |
14.38 |
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Pretax profit |
141.81 |
13.58 |
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Net profit |
133.61 |
5.11 |
The conclusion is that associate and joint venture accounting can have a significant impact on the pre-tax and net profit margins, as the accounting treatment adds to the profit base (the numerator of profit margin formula) but not the sales (the denominator). Gross profit and operating profit margins are not affected by either inclusion or exclusion of associate profits as recognition of associate profits comes after the calculation of operating profit.
The Leverage of Low Margin
Businesses with low margin are able to show a strong increase in profit when the margin improves. Let’s take the example of Thong Guan Industries Bhd (“TGI”). Table 7 shows the TGI’s financials extracted from TGI’s 2016 annual report and corresponding margin and growth calculated from the data.
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Table 7: TGI’s Financials, Growth and Ratio |
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(in RM million) |
2012 |
2013 |
2014 |
2015 |
2016 |
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Revenue |
631.2 |
720.3 |
740.2 |
711.0 |
742.9 |
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Net profit |
27.2 |
28.2 |
17.5 |
38.5 |
55.9 |
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Net profit margin |
4.31% |
3.91% |
2.36% |
5.42% |
7.52% |
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Revenue growth (yoy) |
– |
14.11% |
2.77% |
-3.95% |
4.48% |
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Net profit growth (yoy) |
– |
3.54% |
-37.96% |
120.27% |
45.04% |
Note: yoy represents year-on-year
From the financial year 2014 to 2015, although the group’s revenue declined 3.95%, the increase in profit margin from 2.36% in 2014 to 5.42% in 2015 (which more than doubled) resulted in TGI’s profit surging 120.27%. Similarly, from 2015 to 2016, although TGI only reported a revenue growth of 4.48%, profits increased by 45.04%, thanks to a 39% increase in net profit margin, from 5.42% in 2015 to 7.52% in 2016.
Likewise, the opposite is also true. From 2013 to 2014, although revenue grew 2.77%, a 1.55 percentage point decrease in margin (from 3.91% to 2.36%) resulted in a 37.96% drop in profit.
Note:
There is a common confusion between “percent” and “percentage point”. Percentage point is the difference between percentages. In the above case, a fall in percent from 3.91% to 2.36% indicates a 1.55 percentage point decrease, and not a 1.55% decrease.
This concludes Chapter 11. Next week, we will explore Chapter 12: Operating Ratios.