Coca-Cola Company Practical Problems of Applying Fair Value Measurement - Coursework Example

Finance and Accounting Affiliation: Lecturer: Coca-Cola Company Practical Problems of Applying Fair Value Measurement 1. Introduction Recent considerations by the IFRS have aimed at the measurement of liabilities and assets. However, the question on the problem of when instead of where the measurement of value needs to be applied is still unanswered (Nissim 2010). The practical application problems have become dominant in a lot of companies; Coca-Cola included. According to the IASB standards and guidelines, fair values have been authorised for use, in particular, liabilities and assets, for instance, the fixed assets (FASB 2009). However, the principles that are intended to govern the measurement of fair value application are not expressed well. The issues include the appropriateness of its use and the situations where fair value measurement is beneficial or detrimental, hence creating practicality problems in their application. The paper is on a survey on the practicality problems in the fair value measurement application at Coca-Cola Enterprises, a beverage manufacturing company. The company has its equity share capital listed on the New York and London. It also has its financial statements and annual reports accessible at their website (Norwalk 2010). The reports reveal the yearly financial performance of the company. 2. The fair value concept Fair value is preferred measurement basis for the IASB for financial reporting. IASB’s definition of fair value is “the sum for which assets may be exchanged between well informed, ready parties in an independent transaction.” The term “fair value” differs from the values in use (FASB 2009). It shows estimations of a firm, entailing the influence of the factors that are particular to a firm and are not appropriate for all firms. A firm establishes its fair value in the absence of any exchange costs that are involved in the disposal or sale of its assets (Enria 2012). An investment asset’s fair value must always incorporate the market circumstances at the conclusion of the reporting period unlike other assets at any previous period. The fair value is based on a particular date since the market circumstances may undergo alterations from the time (Plantin & H Shin 2008). The changing market circumstances lead to differences in the asset reported a fair value that may be wrong; hence it is essential for the fair value to represent the real market situation. The particular date, well-informed and independent parties are vital conditions that contribute to the reporting of a correct fair value. The fair value of an asset must be based on the current prices. IASB advocates and advice firms to measure the fair value of their investment assets based on the estimation of a valuer that is independent. The valuer must have reputable credentials, qualifications and latest experience in the setting and class of the investment asset whose value is to be measured. IFRS 13 Fair Value Measurement IFRS 13 Fair Value Measurement is a standard that relates to the IFRSs and necessitates or authorizes fair value measurements or estimation. It sets out guidelines for measuring fair value in practice. It offers a particular IFRS structure for the determining of the fair value and outlines the requirements for the reporting of fair value measurements. It described fair value regarding the “exit price” concept and utilised the “fair value hierarchy”. The measurement of fair value is market-centred instead of entity-specific (Burkhardt & Strausz 2009) The objectives of IFRS 13 is to describe what fair value means, outlines a solitary IFRS structure used in the estimation of the fair value and needs reporting of measurements of fair value. IFRS 13 aims to improve comparability and reliability in the measurement of fair value using the “fair value hierarchy”. The hierarchy rates the input that is utilised in the monitoring techniques and methods into three different levels. The hierarchy offers the top priority to the fixed stated priced in the active markets for the similar liabilities or assets and the last priority to the inputs that are unobservable. IFRS 13 necessitates an entity applying the fair value measurement to maintain stability with the unit of account and the highest and best use of the non-financial property or asset. The market needs to be the most advantageous and the valuation methods must consider information availability in the inputs development by the “fair price hierarchy” It guides on disclosure of information on the fair value that is utilised by the users to evaluate the financial statements. The standard also stipulates an effective date and transition. Specifically, IFRS 13 applies to yearly financial reporting times normally on January 1st or after that (Ohlson & Penman 2009). 3. The non-current asset types owned by Coca-Cola The three most three most significant types of non-current asset owned by Coca-Cola Enterprises and Company include: i. Equipment and plant ii. Buildings and Land and iii. The Coke intangible assets (Brand and Goodwill) In Coca Cola’s financial reporting, Machinery, Equipment and plant are often stated at cost. The costs of repair and maintenance on the plant that does not enhance the service perspective or lengthen the economic life are stated as expenditure incurred. Depreciation is determined and captured in the financial books primarily using the straight-line technique instead of the estimated usefulness of the assets of the company (CFA Institute 2007). The value of the Machinery, Equipment and plant are reassessed from time to time so as to ensure their value is up to date. The depreciation on plant and machinery is undertaken periodically in the range of not more than 20 years while that of buildings is done within a range of not more than 40 years. Depreciation on land is not incorporated in the current value since it continually appreciates. Additionally the improvements and construction works on the buildings are not depreciated till they become available for use. Buildings and pieces of land under leaseholds are amortized utilizing the straight-line technique in the shorter of the outstanding lease period. It comprises of lease renewals that are estimated as being reasonably assured, or theyre projected economically useful lives are definite (PricewaterhouseCoopers 2014). During valuation of the assets, Coca-Cola does not record depreciation value for the duration where the long-lived or disposal asset is categorised to be sold even if it continues to produce income for the duration. Varied situations, change or market circumstances point toward the salvaging of the value of the Coca Cola’s fixed assets including machinery, land, equipment, buildings and plant. Hence, their value is often reassessed or measured again so as to incorporate either the decrease or the increase in their market value. The use of current market prices in the valuation enables the reflection of the changes in the business climate in the current operating duration using the past information (Benston & Vrana 2009). The comparison of the two values enables the company to predict future losses or gains in the value of its assets that are then incorporated in the estimation of the future cash flows anticipated due to the utilisation of the asset and its ultimate disposal or sale. The cash flow estimates are steady with Coca Cola’s plans and projections. In a situation where the predicted cash flows show that assets are less in comparison with the recorded values, then the company takes the difference as an impairment loss. The company also has a vital intangible asset, the Coke brand and goodwill that are valued to be worth more than $80 billion (Zhang 2012). Although the brand and goodwill intangible asset accounts to a significant part of the total business value, the Coke trademark according to business valuations claims that the company is not incorporating it in its financial disclosures. It is because of the existing secret formula that is considered extremely valuable to the company. Coca-Cola utilises many techniques in the measurement of the fair value of its fixed assets. Their methods include discounted cash flows and appraisals both of which are in line with coca cola’s assumptions that it sees as representing the true market value of the assets (Choy 2010). 4. Difficulties that Coca-Cola Company faces in the fair value measurement Coca-Cola Enterprises and company faces difficulties in the course of measuring the fair value of its non-current assets of Equipment and Plant, Buildings and Land and the Coke intangible (brand) asset. The fair valuing accounting has proved to be less dependable and consistent since it permits for significant financial results doctoring. The fair value measurement being an internal affair or activity at the company, the reliability problem of the method has a direct impact on the company (Klamer & McCloskey 2009). According to a report on the fair value use at Coca-Cola, the beverage giant, it was established that the absence of reliability was a more predominant problem. The assets disposal activities at the company, for instance, encountered valuation difficulties because the estimation of gains from the discount, prepayment and default rates was hard. With the case of the company’s brand and goodwill asset, their fair values are by the predicted cash flows and are regarding the “fair price hierarchy” falls under level 3. It creates concerns to do with debt agreements and compensation violations. Additionally, the reliability problem of fair value has created wrong price-to-book ratios especially to do with coca cola’s equipment and machinery. The interpretation of the value ratios require great care since the observable facts, information and data are usually minimal (Beaver 2005). The report also identified that the application of fair value measurement is that it is a source of volatility in the earnings from the sale of the assets. The volatility presented by the fair value measurement gives rise to a lack of transparency making investors shy away since they question the future prospects of the company. The volatility leads to fluctuations in the fair value of assets making the future cash flows to be unpredictable and risky (Samuelson, 2006). The managers become frustrated during the disclosing of the fair value frequent rise and fall since they cannot regulate the fluctuation. Fair value measurement of the non-current assets of Coca-Cola faces the problem of wide and comprehensive disclosure requirement. The problem creates the concern of information overload the whole length of Coca Cola’s financial statements spans to more than 50 sheets. The incorporation of the consolidated financial records occupies a huge portion of the financial statements hence become cumbersome to read through (Watts 2008). Additionally they are not often specific and are based on generalisations thus may offer a wrong interpretation. The fair value measurement model employed by Coca-Cola, like other models is faced with the problem concerning historical transactions. In the balance sheet of the company, many values are lacking. It has made its price to book ratio to be huge. The problem is attributed to the company’s central management not permitting its brand intangible asset to be incorporated into the balance sheet. It has led to the creation of imperfections in the company’s cost accounting and fair value measurement (Brooks & Buckmaster 2013). The forecasting of future cash flows also becomes hard because of property valuation errors. Another problem the company has faced it to do with the valuation of the long-term contracts, especially its land and building on leasehold. Fair value measures and estimate the assets only at the start of the end of the accounting period instead of focusing on the entire period. 5. The fair value measurement practicality for companies that are not actively traded In the case of the company, the practical application of the fair value offers an ideal accounting solution for the financial instruments used for trading functions. Conversely, the fair value measurement application tends to overvalue the financial instruments in the non-deep and liquid markets. Vital factors influence the methods relevance in the application in the markets. In an instance where the financial statements contain similar entities, the resultant fair value is likely to be altered. It is due to the assumption of the market that assumes that the presence of the appropriate or close to appropriate market situations, well-informed, independent and parties that are economically sensible. Regarding the reflection of IASB fair value measurement of the companies in the non-deep and liquid markets is not realistic. Fair value has little influence in the companies since they utilise business models that involve the addition of value by the production process for the supply to the consumers (Freeman & Penman 2009). However, exceptions exist with the practical use of the fair value measurement model regarding their fixed assets valuation. The measurement will have to take into account the equity investments instead of the operating investment as part of the portfolio operation. The other equity investments have to be stated as a historical asset. The costs of interest and service are stated as expenses used in the creation of income for the companies. Alternatively, in the income statement, the interests and non-current assets operation liabilities and debts can be recorded as a distinct component (Ohlson 2010). 6. Conclusion Recent considerations by the IFRS (International Financial Reporting Standards) and the IASB (International Accounting Standards Board) have aimed at the measurement of liabilities and assets. The practical application problems have become dominant in a lot of companies; Coca-Cola included. According to the IASB standards and guidelines, fair values have been authorised for use, in particular, liabilities and assets, for instance, the fixed assets. However, the principles that are intended to govern the measurement of fair value application need to be expressed well. The use of the fair value measurement needs to be appropriate to the company context and operational type so as to make the measurement beneficial, hence creating practicality solutions to the problems in the companies. The fair value needs to be time conscious since its reports need to reveal the yearly financial performance of the company. The company has faced practical problems regarding the application of the fair value measurement. The value of the Machinery, Equipment and plant need to be continually devalued from time to time so as to ensure their value is up to date. The company also needs to allow its brand asset to be included in the fair value measurement hence enabling the company to represent a true reflection of the financial position of the company. The real, accurate and up to date financial information will act as a guide to the prospective investors since they would make investment decisions based on the fair value of the company’s assets and liabilities. References Nissim, (2010). Fair Value Accounting in the U.S. Banking Industry, Occasional Paper Series, Center for Excellence in Accounting and Security Analysis, Columbia University, FASB Statement of Financial Accounting Concepts, (2009). Using Cash Flow Information and Present Value in Accounting Measurements Norwalk, Conn.( 2010) FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements FASB Statement of Financial Accounting Standards (2009). The Fair Value Option for Financial Assets and Liabilities. Enria (2012), Fair Value and Financial Stability Occasional Paper Series No. 13, European Central Bank, Plantin, H. Sapra, and H Shin,(2008). “Marking to Market, Liquidity, and Financial Stability”, Monetary and Economic Studies (Special Edition) Burkhardt and R. Strausz, “The Effect of Fair vs. Book Value Accounting on Banks”, unpublished paper, University of Berlin. “Fair Value Accounting for Financial Instruments: Some Implications for Bank Regulation”,(2014) BIS Working Paper No.209. Ohlson and S. Penman,(2009) “Accounting for Employee Stock Options and Other Contingent Equity Claims: Taking a Shareholders’ View,” Journal of Applied Corporate Finance, Spring, pp. CFA Institute (2007), Center for Financial Market Integrity, A Comprehensive Business Reporting Model: Financial Reporting for Investors. A recent PricewaterhouseCoopers (2014)’ survey found investors to be skeptical of fair value accounting for operational assets; Measuring Assets and Liabilities: Investment Professionals’ Views LLP. Benston, D., and Vrana,(2009) "Comments by the American Accounting Associations Financial Accounting Standards Committee on the FASBs Conceptual Framework for Financial Reporting, Call for Preliminary Views. Zhang. C, (2012) “On Accounting Valuation of Corporate Assets,” working paper, University of California, Berkeley Choy.A, (2010) “Fair Value as A Relevant Metric: A Theoretical Investigation,” working paper, University of Alberta. Klamer . A, and McCloskey. 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