Starbucks Scandal and Corporate Tax - Assignment Example

Question Elimination of investment in S Limited and recognition of goodwill on the acquisition     Pearson Bodey Bodes 100% Interest Fair value of consideration transferred   7,000,000 less Fair value of identifiable assets acquired and liabilities assumed   Contributed equity 3,500,000 3,500,000 Retained earnings 2,800,000 2,800,000   6,300,000 6,300,000 Goodwill on acquisition 700,000     Dr Contributed equity 3,500,000   Dr Retained earnings 2,800,000   Dr Goodwill 700,000   Cr Investment in Pearson 7,000,000           Elimination inter-company sale of inventory   Dr Revenue 1,400,000   Cr Cost of goods sold 1,400,000       Elimination unrealised profit at closing inventory   Unrealised profit (($1,400,000 - $840,000)/2) 280,000   Tax effect 84,000       Dr Cost of goods sold 280,000   Cr Inventory 280,000   Dr Deferred tax asset 84,000   Cr Income tax expense 84,000       Elimination of inter-company management fee   Dr Other income 50,000   Cr Other expenses 50,000       Elimination of inter-company dividends paid   Dr Other income 280,000   Cr Dividends paid 280,000     Bodey Bodes PLC (£) Pearson PLC (£)     Consolidated Statement of comprehensive income   Revenue 8,400,000 2,800,000 (8,400,000+2,800,000-1,400,000) 9,800,000 Cost of goods sold 3,500,000 980,000 (3,500,000+980,000-1,400,000+280,000) 3,360,000 Other expenses 420,000 210,000 (420,000+210,000-50,000) 580,000 Other income 490,000 175,000 (490,000+175,000-50,000-280,000) 335,000 Operating profit 4,970,000 1,785,000 6,195,000 Tax expense 1,400,000 700,000 (1,400,000+700,000-84,000) 2,016,000 Profit for the year 3,570,000 1,085,000 4,179,000 Retained earnings - 1 January 2012 7,000,000 2,800,000 (7,000,000+2,800,000-2,800,000) 7,000,000 Dividends paid 1,400,000 280,000 (1,400,000+280,000-280,000) 1,400,000 Retained earnings - 31 December 2012 9,170,000 3,605,000 9,779,000 Statement of financial position   Assets   Cash 1,750,000 175,000 (1,750,000+175,000) 1,925,000 Accounts receivable 1,050,000 1,225,000 (1,050,000+1,225,000) 2,275,000 Inventory 4,200,000 2,100,000 (4,200,000+2,100,000-280,000) 6,020,000 Land 10,080,000 2,800,000 (10,080,000+2,800,000) 12,880,000 Plant 17,290,000 2,800,000 (17,290,000+2,800,000) 20,090,000 Investment in Pearson PLC 7,000,000 - (7,000,000-7,000,000) - Goodwill 700,000 700,000 Deferred tax asset 700,000 350,000 (700,000+350,000+84,000) 1,134,000 Total assets 42,070,000 9,450,000 45,024,000 Equity   Contributed equity 28,000,000 3,500,000 (28,000,000+3,500,000-3,500,000) 28,000,000 Retained earnings 9,170,000 3,605,000 9,779,000 Total equity 37,170,000 7,105,000 37,779,000 Liabilities   Accounts payable 700,000 595,000 (700,000+595,000) 1,295,000 Loans 4,200,000 1,750,000 (4,200,000+1,750,000) 5,950,000 Total liabilities 4,900,000 2,345,000 7,245,000   45,024,000             (b) The consolidated financial statements of Bodey Bodes PLC provide a comprehensive insight to the financial matters of the company. Since the financial statements provide the consolidated view of the financial performance and position of the group as a whole, therefore, there are some areas in the consolidated financial statements which can pose some discretion. The equity position of the group can raise some questions in the minds of the investors regarding the higher portion of equity as a funding source of the total assets of the group. The total assets of the group include a heavy amount of goodwill which is around £700,000. Because of this goodwill, the equity portion in the consolidated financial statement is overstated. This point can mislead the investors because goodwill is not that asset which can provide some economic benefits to the company rather it is the excess amount paid by the company in exchange for the fair value of the assets of the other company acquired. In this way, the consolidated financial statements should be taken into consideration by setting aside the impact of goodwill on the equity portion of the group. Another important consideration can also be made regarding the equity component of the group is that the retained earnings of the subsidiary company are not taken in the consolidated financial statements. However, the profit for the year figure is taken in the mainstream calculations to reach at the closing retained earnings figure. Question 2 Present value of Notes at the market rate of debt Present value of principal discounted at 10%: £4 000 000 × 0.7513 = £3 005 200 Present value of interest stream (£4 million @ 7% = £280 000) discounted at 10%: £280 000 × 2.4869 = £ 696 332 Total present value (= Liability component) £3 701 532 Equity component £ 298 468 Total face value of convertible notes £4 000 000 The accounting entries would therefore be: (a) Recording the initial issue of convertible notes. i) 1 January 2012 Dr Cash at Bank 4,000,0000 Cr Convertible Notes – Liability 3,701,532 Cr Option to convert notes – equity 298,468 (To record the issue of the convertible notes and the recognition of the Liability and Equity components.) ii) Date Payment Interest Expense Increase in Notes Liability Notes Liability at Date 1 January 2012 3,701,532 31 December 2012 280,000 370,153 90,153 3,791,685 31 December 2013 280,000 379,168 99,168 3,890,853 31 December 2014 280,000 389,085 109,085 3,999,938 31 December 2012 Dr Interest Expense 370,153 Cr Cash 280,000 Cr Convertible Notes – Liability 90,153 31 December 2013 Dr Interest Expense 198,979 Cr Cash 280,000 Cr Convertible Notes – Liability 99,168 31 December 2014 Dr Interest Expense 202,407 Cr Cash 280,000 Cr Convertible Notes – Liability 109,085 (b) 31 December 2014 Conversion Entry. Dr Convertible Notes – Liability 298,468 Dr Option to convert notes – Equity 4,000,000 Cr Share Capital 4,298,468 (To recognise the conversion of the convertible notes into shares at 31 December 2014) (c) The rate of return on convertible bonds is generally less than the rate of return on non-convertible bonds. This happens because the convertible bond has the feature of equity option as well. The investors forego some part of return in exchange for a higher likely gain in share price of the company at the time of conversion of debt into equity. However, the investors carry the downside risk of the share prices because of the likelihood of decrease in the share price. Question 3 Starbucks Scandal and Corporate Tax The coffee menu of Starbucks famously mystifies some people. In U.K, the accounts of Starbucks are very confusing. The company had been notifying its investors that it has been making profit though it constantly reported losses. This evident contradiction arises mainly from tax avoidance. It also sheds light on the flawlessly legal tactics, which multinationals all over the world use. Starbucks can be distinguished from other because it told the taxman one thing and investors the other (Bergin, 2010). The Seattle based company, having market capitalization of $40 billion is the world’s second largest food retailing businesses after McDonalds. Financial statements by its UK subsidiary reveal that since its commencement in UK in 1998 the company accumulated 3 million pounds in sales of coffee and opened 735 new outlets. Despite of it, the company paid income taxes of just £8.6 million (Bergin, 2010). In the past three years, the company reported no profit and therefore paid no taxes despite of having its sales of £1.2 billion in UK. In contrast to this, McDonalds paid taxes over £80 million on its sales of £ 3.6 billion in UK. Kentucky Fried Chicken, famously known as KFC, bore £36 million of taxes on its UK sales of £1.1 billion (Bergin, 2010). Analysts and investors categorized the UK business of Starbucks as ‘profitable’ and were very pleased with its performance in UK. They even cited the UK business of Starbucks as an example that must be followed back home in US. i. A loss maker with thick margin The way Starbucks UK deals with its differing versions can be categorized as if selling two different coffee. It sells espresso to investors, which is vibrant and strong and the taxman gets Americano. Like other large corporations, the company’s financial statements do not break down the amount of tax payments and profits by country. But in UK, companies are obliged to lodge accounts at the register of the company in order to give the true picture of the financial performance of the company (Bergin, 2010). In the fiscal year 2007, the company showed 10th consecutive loss. Yet, the COO Martin Coles said that the earnings of the fourth quarter of the company funded in expansion in overseas markets. Peter Bocian, the CFO told that the company enjoyed operating profit margins of nearly 15%, which is equal to the profit of approximately £50 million (Bergin, 2010). When Reuters interviewed the CFO Alstead of Starbucks regarding the UK taxman, he told, “The UK is very troubled, unfortunately. Historically it has performed a little bit better than it does now.” ii. Bean Counter Starbucks purchases coffee beans through a Switzerland based firm. Alstead told that tax authorities in Switzerland and Netherlands allow the company to allocate some amount of profits of its UK sales to Swiss and Dutch trading units. It is a prevalent requirement, which corporations meet by price setting, which is called as ‘transfer prices’. Transfer pricing is done by setting prices between different group entities. Professionals say that transfer pricing is a means of minimizing tax bills for a company. The company refused to provide details or comment on what its Swiss unit pays it for coffee beans. It further declined to provide details of the profit, which its Swiss unit makes, however Alstead told that it is moderately ‘profitable’. According to Pollsters, Amazon, Google and Starbucks are the three most damaged brands in terms of tax avoidance. All these three brands have failed to recover and have attempted for accusations, which term them as unsuccessful brands (Neville, 2010) Corporate profits are usually bear the tax of 25% in Netherlands and 24% in UK, whereas in Switzerland, international commodities are imposed taxes as low as 5%. Starbucks has also been the subject if customs inquiry in UK in 2009 and 2010 due to the practices of transfer pricing. A Starbucks spokesman said that, “This was resolved without recourse to any further action or penalty.” (Bergin, 2010) iii. Arm’s Length The tax authority of UK, Her Majesty Revenue and Customs (HMRC) allows the company to reduce the fees of intellectual property if the firms reveal that they were at ‘arm’s length’, which means that they can show they have agreed on the terms and conditions even if they were not linked. Starbucks states that it abides with the principle of arm’s length, even if the company has been reporting losses in UK. The accounts of McDonalds reveal that it pays the fees of trademark to associated companies. A spokesperson of another food retailer, KFC said that it does not pay such fees. Deloitte, an audit firm, which performs audit for Starbucks’ account refused to comment (Bergin, 2010). Question 4 (a) 31 December 2012     Dr. Cr.     Bonus Expense 175,000     Bonus Payable 175,000 (To recognize Bonus expense)       31 December 2013   Bonus Payable 15,000     Bonus Expense 15,000 (To recognize decrease in Bonus expense)       31 December 2014   Bonus Expense 40,000     Bonus Payable 40,000 (To recognize increase in Bonus expense)       31 December 2014   Bonus Payable 200,000     Equity 200,000 (To recognize bonus payment through equity issuance)     (b) (i) Goods acquired from a supplier by incurring a liability based on the market price of the goods. The above transaction is not a share based payment because no shares are to be issued rather a liability is created which will be settled through cash. (ii) Services provided by an employee to be settled in equity instruments of the entity. The above transaction is a share based payment because the services rendered by the employees will be paid out in the form of issuance of shares. (iii) Supply of goods in return for cash or equity instruments at the discretion of the supplier. The above transaction is a share based payment because the supplier is likely to charge either in the form of cash or equity or cash based payment linked with market value of equity. (iv) Dividend payment to employees who are holders of an entity’s shares. This is not a share based payment because dividend payments are likely to be made through cash. In case if they are made through bonus shares, then they would be considered as merely the appropriation of retained earnings to equity account. Works Cited Bergin, Tom., 2010. Special Report: How Starbucks avoids UK taxes. Reuters, [online] 15 October Available at: http://www.reuters.com/article/2012/10/15/us-britain-starbucks-tax-idUSBRE89E0EX20121015 [Accessed 15 February 2013]. Kvaal, Erlend and Nobes, Christopher., 2010. International differences in IFRS policy choice: a research note. 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