Coca Cola's Financial Position and Performance - Example

Analysis of Financial Report Student Name: University: Business: Instructor: September 10, 2013 TABLE OF CONTENTS Content………………………………………………………………………………………Page 1. Executive Summary…………………………………………………………………3 2. Introduction………………………………………………………………………...4 3. Description of Lease Contracts…………………………………………………….5 3.1 Type A leases………………………………………………………….5 3.2 Type B leases…………………………………………………….……5 4. Possible Impacts of ED on the performance and Financial Position ..........…………...6 4.1 Short Term Leases………………………………………....……….....6 4.2 Dual Cost Recognition Model….……………………………………..7 4.3 Lease Term………………………………………………………...…..8 4.4 Financial Report Presentation…………………………………………9 5. Conclusion……………………………………………………………………………..10 6. References…………………………………………………………………………..…11 1. Executive Summary Leases are significant transaction which transcend a number of industries and influence the financial reporting of the involved parties. The FASB (Financial Accounting Standards Board), and IASD proposed lease accounting changes on May 16th 2013, commonly referred to as Exposure Draft ED/2013/6. Since Coca Cola (our company) deploys leasing majorly for tax purposes, mainly as finance means, the Chief Finance Officer of the company is concerned about the possible effects of the proposed lease accounting standards on the financial position and performance of the company. It is on that basis that this report explores the existing lease contracts of Coca Cola and how they are recognized, classified, initially and afterward determined and presented by the company according to IAS 17 or AASB 117. The report also outlines the proposed guidelines for recognition, classification, initial and afterward assessment and presentation of leases from the lessee’s perspective. Finally, the report provides analysis of the possible effects on the financial performance and position of the company from the exposition implementation of the proposed guidelines to the existing lease contracts based on the last financial report. The report finds that since the company handles most of the operating leases it would be mostly affected by the proposed ED because they will be required to recognize the ROU asset on their financial statement position. In overall, the proposed ED will offer better information regarding the financial position and performance of the company for the users of the financial statement. 2. Introduction Leasing is a critical activity for a company, whether a private or public. It is a process of obtaining financing, acquiring access to assets and minimizing exposure to asset ownership risks to an organization. A number of companies lease assets such as manufacturing and construction equipment, trucks, and real estate. Due to leasing prevalence, it is critical for financial statement users to have a thorough and comprehensive insight of the company’s leasing activities. The current accounting methods for leases require lessors and lessees to categorize their leases as either operating leases or capital leases and to differently account for them. Those methods have been disparaged for their failure to meet the needs of financial report users since they do not give a truthful representation of leasing activities. Consequently, there has been an extensive request by financial report users as well as other stakeholders to adjust the accounting policy to compel lessees to recognize liabilities and assets originating from leases (AIS 117 p, 16). It is on that background that this report first explores the existing lease contracts of Coca Cola and how they are recognized, classified, initially and afterward determined and presented by the company according to IAS 17 or AASB 117. Second, the report outlines the proposed guidelines for recognition, classification, initial and afterward assessment and presentation of leases from the lessee’s perspective. Third, the report provides analysis of the possible effects on the financial performance and position of the company from the exposition implementation of the proposed guidelines to the existing lease contracts based on the last financial report. 3. Description of Lease Contracts of Coca Cola Leases of equipment, plant and property, where the company substantially has the rewards and risks of ownership have been categorized as finance leases. The other leases have been categorized as operating leases. Paid rentals with the operating leases were subjected to the income statement over the lease term on a straight-line approach. The finance leases were capitalized on the lease inception at the fair value lower of the assets leased and current value of the lease minimum payment. Every lease payment was allocated between the finance and liability charges to obtain a stable rate for the finance outstanding balance. The resultant fiancé charges net, lease obligations were incorporated within the long-term borrowing. The financial cost interest element is charged on the income statement for the lease duration, in order to generate a constant duration interest rate on the liability remaining balance for every period (Coca Cola Annual Report, 2012 p, 56). Equipment, plant and property obtained from finance lease were depreciated under the shorter of assets’ lease term and useful life. The leased assets useful life matches up with company regulation for the depreciable life of equipment, plant and property. The provisions were recognized when the company had presented constructive or legal obligation based on the past event; if it was possible that resource outflows representing economic benefits would be needed to settle the obligation and if a consistent estimate could be made of the obligation amount. When the company expected a reimbursement of a provision for instance within the an-insurance contract, the reimbursement was recognized as a different asset only when that form of reimbursement was virtually positive. When the time value effect of the money was material, the provisions were established by discounting the projected cash flows under the pre-tax rate which reflects the assessment of the current market of the risks explicit to the liability and the time value of the money. Where discounting was applied, the rise in the provision as a result of time passage was identified as an interest expense. 3.1 Type A leases Under type A leases, the charge finance for discount unwinding over the lease liability would be separately recognized from ROU asset amortization charge. The lease liability unwinding would be measured by the use of the effective interest model. The amortization of the ROU asset would be conducted a straight line expect there is a more representative model whereby the lessee projects to consume the future economic benefits of the ROU asset (Exposure Draft, 2013). 3.2 Type B leases The type B leases would originate from the total lease straight-line cost for every 12 months of the lease. The sum of the lease cost would include both the lease liability unwinding discount and the ROU asset amortization. The lease liability unwinding discount would be worked out by the use of the effective interest model. The ROU asset amortization would be balancing figure to make sure that the total lease cost is recognized over the lease on a straight line. 4. The possible Impacts of ED on the Performance and Financial Position of the Company The lease definition is consistent to the one presently applied in (AASB 17) or AASB 117, though the proposed ED gives additional examples and guidance for appraising whether a contract contains a service and or lease and for distinguishing these elements. The changes were effected as a resulted of the issues that a rose that the 2010 ED guidance could result in service contracts to be recognized as leases. The proposed ED centers on the lessee’s right to control the utilization of the recognized asset in the duration of the lease term and could result in different result s on the ones presently recognized based on the Interpretation 4 (Establishing whether or not an arrangement has a lease). Some types of leases are expunged from the scale of the proposed ED, such as leases of biological assets and intangible assets, concession service arrangements and lease designed to use or explore for natural resources (Exposure Draft, 2013). 4.1 Short term leases The proposed ED offers a simplified model for lease accounting for lessors and lessees where there is a maximum possible lease term, consisting of extension options and does not have any option for purchase. The simplified model would enable the lessor or lessee to decide to recognize payment of lease in profit or loss on straight line basis over the lease term. 4.2 The Dual cost recognition model The proposed ED categorizes leases as Type A and Type B based on whether the lessee is projected to utilize more than the substantial share of the economic benefit of the underlying asset over the duration of the lease. Asset leases apart from property would be Type A expect for when the lease term captures insubstantial share of the asset’s whole economic life or the lease payment present value is relatively insignificant to the underlying asset fair value. Leases of vehicles and most equipment would be categorized as Type A leases. Property leases such as buildings and land would be categorized as Type B leases expect if the lease term would be for the greater portion of the rest of the asset’s economic life or lease payment present value accounts for significantly underlying asset’s fair value. 4.3 Lease Term The lease term under the current provisions of the AASB 117, is the non-revocable lease period including other terms upon which the lessee has option for renewal and it is realistically positive at the lease inception that the option would be applied. Within the proposed ED, lease term extension option would be only included when the lessee has substantial economic benefit to apply the option (AASB 177 p, 17). 4.4 Financial Report Presentation The lease liabilities and ROU assets would be separately presented, either on the notes or financial position statements. There will be a distinction between the Type A and B liabilities and assets. Under the comprehensive income statement, the lease liability unwinding discount would be separately presented from the amortization of the ROU for both types of the leases. Cash payment classification in the cash flow statements would rely on the categorization of the lease as either type A or B. Regarding Type A leases, the repayment of the significant share of the lease liability will be categorized as a financing activity, whereas the lease liability unwinding discount will be presented in compliance with the AASB 117 provisions for the paid interest in the cash flow statements. Under Type B leases, the payments would be categorized as operating activity. Other variable and short-term lease payments that are not included in the lease liability measurement will be categorized as operating activities (Whitehouse 2009 p, 15). The described changes under the ED would significantly affect Coca Cola because it majorly utilizes operating leases to keep their balance sheet off debt. Due to the fact that operating leases affects only the income statement, proposed ROU approach would compel these leases to identify the liability and lease payment obligation for the leased asset ROU on the balance sheet. Then, the lessee would recognize amortization cost on the liability interest and ROU asset to make these payments under the income statement. One can argue that the costs of the approach prevail over the benefits due to the time spent working out the calculations, but the ROU method would enable consistent treatment of most leases, hence improving financial statements comparability among corporations. On my assessment, the financial statement comparability is a greater benefit for all the preparers and users of financial statement than less calculation. IASB, 2010 require lessees to present lease cash payments recognized as financing activities within the cash flow statements and should separately present them from the rest of the financing cash flows. This is a sensible provision because Coca Cola uses lease liability to finance its asset. When the lessor is either using the de-recognition model or performance obligation method, the income obtained from the lease would be categorized as cash flows originating from operating activities since the lease will be component of the lessors activities or operations. The lease income cash flows would hence be separately listed from the rest of the operating cash flows (Whitehouse 2009 p, 21). Lessors and lessees need to disclose qualitative and quantitative financial information, which explains and identifies the recognized amounts within the financial reports originating from leases and illustrate how they might affect the timing, amount as well as their future cash flows uncertainties. In principle, the disclosures proposed in the ED, conforms to the disclosures outlined under the IAS 17.1-56. 5. Conclusion The proposed ED will assist users of the financial information to understand leases’ financial performance. When the proposed ED comes to effect, the company will apply a simplified retrospective model on all the current leases, and not just to the new leases. The company will have to identify a liability in order to make lease payment at the current value and ROU asset for each of its outstanding leases. Leases are critical component of conducting business, be it international or national. The existing provisions differentiate leases as financing/capital leases and operating leases that differently shape the financial statement. The proposed ED would regulate how leases would be recognized and handled in order for the users of financial statements to get rid of uncertainties, for instance off balance sheet financing that the company is currently facing under the current standards. Companies which handle most of the operating leases would be mostly affected by the proposed ED because they will be required to recognize the ROU asset on their financial statement position. In overall, the proposed ED will offer better information regarding the financial position and performance of the company for the users of the financial statement. 6. References Financial Accounting Standards Board, 2010 16-October. 840 Leases. Retrieved 2010 16 October from FASB Accounting Standards Codification: http://asc.fasb.org/home Miller, P., & Bahnson, P. 2010. Off-balance-sheet financing: Holy Grail or holey Pail? Accounting Today , 24 (13), 16-17. Whitehouse, T. 2009. Hints That Lease Accounting Reform Will Hurt. Compliance Week , 6 (68), 30-31. Coca Cola, 2013 Annual Financial Report. Exposure Draft ED 2013. Read More