Creative Accounting - Football's Dark Secret

The increased prioritisation of profit-making in the football industry has been widely reported over the last decade; with this development into more of a business than a sport leading to greater financial regulations being imposed by the governing bodies. Abiding by these rules requires constant re-evaluation from an accounting perspective, with financial reporting boards such as the IASB and IFRS implementing the standards necessary in order to keep up with the number of financial transactions in the sport. In this article I will be exploring a selection of these financial transactions as well as the controversies surrounding how they can be “creatively” accounted for in the football industry.

Football’s accounting standards

Given the complexity and number of transfer types that can occur in the sport, there are a wide range of different accounting standards that need to be followed.

Perhaps the most important is the treatment of players in the balance sheet under International Accounting Standard 38. Not only are footballers traded by their registration right rather than their name, but the clubs who own them are able to recognise them as intangible assets on the balance sheet – as long as they meet the following criteria (IASB, 2019):

It is probable that the future economic benefits that are attributable to the asset will flow to the entity.

- Which they of course will, as their performances on the pitch help determine the clubs final league position and progress in cup competitions (leading to greater prize money).

The cost of the asset can be measured reliably.

- i.e.: the transfer fee it took to bring the player to the club.

Given that the basic transaction of a player transfer from one club to another meets both of these criteria, the purchasing club will first capitalise the cost of the incoming player’s registration (the transfer fee).

IAS 10 is then applied, with this standard mandating that the purchasing club amortise the value of the player’s registration right on a straight-line basis over the length of the contract (Kulikova and Goshunova, 2014). This has two effects on the club’s financial statements:

1. The amount amortised each year is taken to the Statement of Profit and Loss and treated as an expense.

2. The value of the intangible asset in the balance sheet is reduced by this amount which is amortised each year.

To understand what this means, let’s apply this principle to one of the biggest transfers that’s taken place this summer: Jack Grealish to Manchester City.

The Aston Villa graduate joined the blue side of Manchester for a fee of £100 million this summer, on a six-year contract. As of the date he signed for the club, his value on the balance sheet will therefore be his transfer fee of £100m. An amortisation charge is then incurred in each of his six years contracted to the club, with his value in the balance sheet thus decreasing in equal instalments as time passes (think of a car depreciating by the same value each year you own it). This is a simple calculation to make, with City’s amortisation charge relating to the acquisition of Jack Grealish being worked out as £100m / 6 years = £16.6 million.

In addition to the value of their asset reducing by £16.6m in the balance sheet, Manchester City will also recognise £16.6 million in their income statement as an amortisation expense each year. This is an important point to consider especially when football fans question “how can FFP allow clubs like Manchester City to keep spending like this?”. The £100 million transfer fee is spread over the life of the contract and never included as a whole in the income statement at any one time, thus aiding clubs in abiding by Financial Fair Play regulations – a rule set based on each club’s reported profit or loss for the season.

In terms of the procedure for the selling club, it follows the typical process undertaken when disposing of an intangible asset. The asset is derecognised from the balance sheet, with the difference between the transfer fee agreed and the carrying value of the player’s registration rights at the date of the sale posted to the Income Statement as a profit or a loss (PWC, 2018). Of course, as an academy product this isn’t applicable in the case for Aston Villa with regards to their sale of Jack Grealish – which is an area we will touch on a little later on.

This use of human resource accounting in football is highly controversial and has been the subject of debates for several decades. Whilst it is common in US sports such as basketball and American football to recognise player registrations as intangible assets, this method was only first adopted by football clubs in 1989 by Tottenham Hotspur (Rowbottom, 1998).

Before being universally regarded as the correct accounting method, it was previously argued that the purchase of the registration right should instead be treated as an expense as soon as the agreement is made – therefore taking the entire transfer to the Statement of Profit or Loss instantly (rather than over the course of the contract) (Oprean and Oprisor, 2014). It was only as recent as a study conducted in 1998 that it was published that 89% of English clubs treated a transfer as expenditure (Rowbottom, 1998) - thus showing that no definitive method had been accepted by all.

Balance Sheet misstatements?

When potential investors of a company complete their due diligence before finally plunging the cash, they will - or at least they should - take a look at the financial statements of that company, in particular their balance sheet. With football clubs regarded as companies now more than ever, this is where the issue comes in, as the use of the aforementioned accounting standards can lead to a false position being presented to anyone curious about the club’s financial health.

Three potential causes of this are the:

• Purchase of young players with high potential, for a low fee

• Promotion of players from the youth academy

• Poor form of certain players and any potential injuries

In the first instance, when these young players do end up fulfilling their high potential, they will remain in their club’s books as these low value commodities – not accurately representing their true market value (Pavlović, Milačić, & Ljumović, 2014) given their contribution to the team.

The same occurs with players developed from a club’s youth academy – with each of these players having an asset value of 0 in the club’s balance sheet as no transfer fee was required to bring them to the club. For clubs such as Barcelona and Ajax, who are globally renowned for their development of academy players, this will lead to a significantly large difference between their book and market value.

Barcelona’s Champions League winning squad of 2011 included 9 players who had an accounting value of 0 (including Lionel Messi, Xavi, Andres Iniesta and Sergio Busquets).

Another potential area which could lead to a false financial position being portrayed by the club concerns their players who are in poor form, have suffered serious injuries, or are at the end of their careers. These are examples where the most recent transfer fee is valued significantly greater than their current market value. A yearly impairment test (where the club assess the carrying value of the registration rights against the best estimate of fair value less disposal costs) would solve this issue of a club potentially overvaluing their assets, but this is only ever required when injured players are deemed unable to contribute to their team again – not when they are in poor form or near the end of their careers.

With this the thought that the current accounting standards do not accommodate for the requirements in football will remain, as it can be argued that footballers who are in poor form or near the end of the career also no longer provide the same economic benefits that was initially associated with them under IAS 38.

Creative accounting

Whilst accounting standards are there to be followed, they can also be worked around – and the football industry do just that. Twisting the transactions in an attempt to reduce the overall impact on losses for the season is common across clubs of all sizes, and here’s how they do it:

The Derby County way:

As mentioned above, the value of a newly-purchased player on the balance sheet will be the transfer fee that was incurred in bringing them to the club. This will reduce in value by the amortisation charge incurred each year – until, by the end of the contract, the player has a net value of 0 in the club’s books. In other words, the club will reduce the player’s value on a straight-line basis until their value is listed as nil – a fairly simple accounting method that is widely adopted by the footballing world.

Derby County however, chose not to follow this standard business practice. Instead of adopting a straight line basis, the Rams chose to amortise their player’s value over the life of a contract using a residual value – in other words, they assigned an expected value they believed each player would be worth at the end of their contract. .

Derby County owner Mel Morris (pictured left)

In practice then, let’s say the club signed Player X for £10m on a 5-year contract. In normal circumstances, the club will amortise Player X’s value in the balance sheet by £2m each season until, by the end of the 5 years, the player has a value of nil in the balance sheet. Derby County logic however prescribes that a value is allocated to each player - so let’s say in this instance they decided that Player X had a value of £2m at the end of their contract. The amortisation charge that follows will therefore by (10m – 2m)/5 years = £1.6m, saving the club £0.4m each year in amortisation expense.

You may now be thinking:

“But if they are at the end of the contract, doesn’t that mean the club can no longer receive a transfer fee for that player?”

Correct – and yet the owners of Derby County were so desperate in reducing their costs that they foolishly thought they could get away with it. Whilst the club’s auditors may have, luckily the EFL and its arbitrators did not overlook this accounting policy – with the club being severely punished by way of hefty fines and a transfer embargo. With this, the club can now no longer field a full XI of senior players, have an irritated manager who has publicly displayed his discontent, as well as an owner desperate to give up the keys to the football club. Moral of the story? Follow the rules.

The FC Barcelona way:

Barcelona are in trouble. Years of financial mismanagement has left the Spanish giants over €1 billion in debt, with the departure of their most prized asset leaving a colossal hole in the club. Failing to abide by La Liga’s financial fair play rules has meant that many at the club have reduced their salaries but in truth, this situation could have happened a lot sooner had it not been for their creative accounting.

In the summer of 2020, Barcelona completed the signing of Miralem Pjanic from Juventus, with Arthur Melo travelling in the opposite direction (both pictured below). However, this was not a regular player + cash deal. Officially, Pjanic was signed for €60 million by Barcelona, whilst Arthur was sold for €72 million. What using these balances did, rather than a simple €12 million cash transfer, was the following:

• Selling Arthur for €72 million increased the club’s total asset balance significantly, split across both the cash balance as well as the accounts receivable (dependent on how much of the fee was paid up-front by Juventus). In a league where one of the financial metrics used to determine the total expenditure cap for a club is net assets, this could have been crucial in securing a slightly higher balance than previously expected.

• The €72 million received will be treated as immediate income in Barcelona’s financial statements. Meanwhile, the €60 million spent on Miralem Pjanic will be incurred over the course of the contract as an amortisation expense (as mentioned earlier). As he signed a 4-year contract, this works out to be €15 million hitting the income statement each year.

The net result is therefore a positive net impact of (€72m - €15m) €57 million in Barcelona’s income statement. Given the net losses that Barcelona have reported in recent years, this form of creative accounting was certainly helpful for the club to remain in line with both UEFA’s and La Liga’s financial fair play rules.

Extension of contracts

Another way a club can reduce their expenses during a financial year is by extending the contract of a player they have purchased. By doing this, the remaining transfer fee that is left to be amortised is now spread over a longer period of time.

For example, let’s say that in 3 years’ time Jack Grealish signs a contract extension for an additional two years at Manchester City. By that time, his book value would have decreased in the balance sheet to (£100m x 3/6 years) £50 million. With a two-year contract extension (on top of the 3 years already remaining on his original contract), Grealish would be contracted to Manchester City for another 5 years. Therefore, by amortising the book value of £50 million over the new contract length, Manchester City will incur an amortisation expense of £10 million per year. As discussed earlier, based on the original contract length that was signed this summer, Manchester City will need to amortise £16.6 million per year – and therefore the extension of his contract in would have saved the club £6.6 million in expenses over the next couple of years.

(Ruben Dias has recently signed a contract extension with Manchester City, thus allowing the club to spread the amortisation charge from his £62 million transfer fee)

Timing differences

Often a club will push certain expenses from one season to another in order to reduce the potential chance of being non-compliant with either European or domestic financial fair play rules. This can be seen in a club’s intention of pushing for sales (or signings) early or late in the transfer window depending on which financial year will need the least financial hit - given that most football clubs have year-ends that correspond with the end of the football season, this is a relatively straightforward task to complete by the club’s executives.

Another example is the impairment of a player’s contract (due to performances or league position), and when this impairment expense is incurred. A club relegated from the Premier League for example, will far prefer the idea of impairing their player’s contracts at the end of the financial year that they were in the Premier League – as the league’s Profitability and Sustainability rules allow a club to lose up to £105 million over a three-year period. The other alternative would be to incur this expense at the beginning of the club’s season in the Championship – which would leave the club in a far more perilous position as they would be incurring additional expenses in a league where the maximum loss outlined by its financial guidelines is just £13 million. Clearly the timing of the transaction can be just as impactful as the transaction itself.

The accounting methods implemented by football clubs have changed several times since the conception of the sport with a now-compulsory procedure, starting from the introduction of IAS 38, being established globally. However, the application of intangible assets in football accounting will remain a topic of discussion for several years to come - and will only be fuelled further by these football clubs who insist on rules being there to be manipulated, rather than followed.

Bibliography:

IASB. (2019). IAS 38 — Intangible Assets. [online] Available at: https://www.iasplus.com/en/standards/ias/ias38 [Accessed 19 Apr. 2019].

Kulikova, L. and Goshunova, A. (2014). Human Capital Accounting in Professional Sport: Evidence from Youth Professional Football. Mediterranean Journal of Social Sciences, 5(24), pp.44-48.

Oprean, V. and Oprisor, T. (2014). Accounting for Soccer Players: Capitalization Paradigm vs. Expenditure. Procedia Economics and Finance, 15, pp.1647-1654.

Pavlovic, V., Milacic, S. and Ljumovic, I. (2014). Controversies about the Accounting Treatment of Transfer Fee in the Football Industry. Management - Journal for theory and practice of management, 19(70), pp.17-24.

PWC (2018). Accounting for typical transactions in the football industry. [online] Available at: https://www.pwc.com/gx/en/audit-services/ifrs/publications/ifrs-9/accounting-for-typical-transactions-in-the-football-industry.pdf [Accessed 15 Apr. 2019].

Rowbottom, N. (1998) Intangible Asset Accounting And Accounting Policy Selection in the Football Industry – PHD thesis, Department of Accounting and Finance, School of Business, University of Birmingham