Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Four – Key issues in accounting and their treatment under IFRS
companies with large operating leases as if these were debt, whether accounted
for as such or not, and they will often look as if they are being rather undervalued
if their market enterprise value is taken to be merely the sum of the market
capitalisation of their equity and of their stated debt.
Finally, do not forget the importance of clean value accounting to intrinsic
valuation models. If it is assumed that the figure represented by the capitalised
operating leases will grow, then this adds to the capital charges in an economic
profit model, and should be treated as a cash outflow (acquisition of fixed assets)
in a DCF model, as if the capital investments had in fact been made.
7. Derivatives
7.1 Why is it important?
Derivatives have become an integral tool used by almost all companies of
reasonable size. Their use varies but typically the vast majority of corporates use
derivatives to hedge exposures. The exposures might be:
• Future price of raw materials (e.g. aviation kerosene for an airline, cocoa
beans for a manufacturer)
• Foreign currency (e.g. customer balances in a foreign currency)
• Interest rates (e.g. protect against rising interest rates where the company
has predominantly variable rate debt)
Analysts need to understand how these instruments are reflected in the financials.
This is especially the case as the accounting issues are not straightforward. The
investor needs to be in a position to appreciate the entries that are made for these
items prior to considering a logical approach for analysis.
7.2 What is current GAAP under IFRS for derivatives?
7.2.1 Derivative refresher
Technically, a derivative is simply an asset whose value is dependent on the value
of something else, an underlying asset. A forward contract to buy Euros to fund
a summer holiday will, by the time the holiday arrives, have been either a
winning or a losing bet. The value of the derivative, in that instance, is the gain
or loss versus just buying the money when you needed it.
All derivatives are ultimately made up of four types of entity, or a combination
of more than one of them.
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