Presented below are excerpts from Note 1 to Starbucks' September 30, 2012, consolidated financial statements in which Starbucks describes accounting policy for long-lived assets.
a. Leasehold improvements are substantial costs incurred by Starbucks to outfit, remodel, and improve leased retail outlets. Why does Starbucks capitalize and amortize leasehold improvements? Does its policy for determining useful lives in the presence of a lease renewal option yield high-quality accounting numbers? How would Starbucks account for the leasehold improvement costs remaining at the end of a lease it had expected to renew but did not?
b. Starbucks has an ARO related to the leasehold improvements. Describe how Starbucks recognizes the ARO initially in the balance sheet. Then describe how Starbucks recognizes changes in the ARO-related asset and ARO liability in the income statement over time. How is income affected when Starbucks actually spends cash to return a leased property to its original condition? If Starbucks spends more cash than reflected in the ARO liability, how will it account for the difference?
c. How would the first two sentences of the Long-lived Assets section of Note 1 appear if Starbucks followed IFRS? Which system do you believe provides the best quality accounting for long-lived asset impairment?
d. The second paragraph of the Long-Lived assets section of the note describes how Starbucks reflects impairment charges in the income statement. Which line item would you prefer that Starbucks use to report the charges? Why?
Property, plant and equipment are carried at cost less accumulated depreciation. Depreciation of property, plant and equipment, which includes assets under capital leases, is provided on the straight-line method over estimated useful lives, generally ranging from 2 to 15 years for equipment and 30 to 40 years for buildings. Leasehold improvements are amortized over the shorter of their estimated useful lives or the related lease life, generally 10 years. For leases with renewal periods at the Company's option, we generally use the original lease term, excluding renewal option periods, to determine estimated useful lives. If failure to exercise a renewal option imposes an economic penalty to us, we may determine at the inception of the lease that renewal is reasonably assured and include the renewal option period in the determination of appropriate estimated useful lives. The portion of depreciation expense related to production and distribution facilities is included in cost of sales including occupancy costs on the consolidated statements of earnings. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. When assets are retired or sold, the asset cost and related accumulated depreciation are eliminated with any remaining gain or loss reflected in net earnings.
We test goodwill for impairment on an annual basis during our third fiscal quarter, or more frequently if circumstances, such as material deterioration in performance or a significant number of store closures, indicate reporting unit carrying values may exceed their fair values. When evaluating goodwill for impairment, we first perform a qualitative assessment to determine if the fair value of the reporting unit is more likely than not greater than the carrying amount. If not, we calculate the implied estimated fair value of the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to the implied estimated fair value. As a part of our ongoing operations, we may close certain stores within a reporting unit containing goodwill due to underperformance of the store or inability to renew our lease, among other reasons. We abandon certain assets associated with a closed store including leasehold improvements and other nontransferable assets. Under GAAP, when a portion of a reporting unit that constitutes a business is to be disposed of, goodwill associated with the business is included in the carrying amount of the business in determining any loss on disposal. Our evaluation of whether the portion of a reporting unit being disposed of constitutes a business occurs on the date of abandonment. Although an operating store meets the accounting definition of a business prior to abandonment, it does not constitute a business on the closure date because the remaining assets on that date do not constitute an integrated set of assets that are capable of being conducted and managed for the purpose of providing a return to investors. As a result, when closing individual stores, we do not include goodwill in the calculation of any loss on disposal of the related assets. As noted above, if store closures are indicative of potential impairment of goodwill at the reporting unit level, we perform an evaluation of our reporting unit goodwill when such closures occur. During Fiscal 2012 and fiscal 2011 we recorded no impairment charges and recorded $1.6 million in fiscal 2010.
Part 2
a. How does the concept of fair value drive the accounting for acquisitions?
b. What method will Starbucks use to translate its foreign subsidiaries' financial statements so that they can be consolidated? Will Starbucks report gains and losses on the translation in net income?
c. At the date of acquisition, it is likely that the La Boulange trade name and proprietary recipes and processes had book values near $0. One year later, what amounts will be shown in Bay Bread's own financial statements for:
• Trade name
• Proprietary recipes and processes
• Goodwill
One year later, what amounts will be shown in Starbucks' consolidated financial statements for:
• Trade name
• Proprietary recipes and processes
• Goodwill
• Depreciation and amortization expense
The consolidated financial statements reflect the financial position and operating results of Starbucks, including wholly owned subsidiaries and investees that we control. Investments in entities that we do not control, but have the ability to exercise significant influence over operating and financial policies, are accounted for under the equity method. Investments in entities in which we do not have the ability to exercise significant influence are accounted for under the cost method. Intercompany transactions and balances have been eliminated.
Our international operations generally use their local currency as their functional currency. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Income and expense accounts are translated at the average monthly exchange rates during the year. Resulting translation adjustments are recorded as a component of accumulated other comprehensive income on the consolidated balance sheets.
On July 3, 2012, we acquired 100% ownership interest in Bay Bread, LLC and its La Boulange bakery brand (collectively ''La Boulange''), to elevate our core food offerings and build a premium, artisanal bakery brand. We acquired La Boulange for a purchase price of approximately $100 million in cash. The following table summarizes the allocation of the purchase price to the fair values of the assets acquired and liabilities assumed on the closing date (in millions):
Fair Value at July 3, 2012
Property, plant and equipment...................................................$18.1
Intangible assets.....................................................................24.3
Goodwill..............................................................................58.7
Other current and noncurrent assets.................................................5.1
Current liabilities.....................................................................(6.4)
Total cash paid ....................................................................$99.8
The assets acquired and liabilities assumed are included in our Americas operating segment. Other current assets acquired primarily include cash, trade receivables, and inventory. In addition, we assumed various current liabilities primarily consisting of accounts payable and accrued payroll related liabilities. The Intangible assets acquired as part of the transaction include the La Boulange trade name and proprietary recipes and processes. The La Boulange trade name was valued at $9.7 million and determined to have an indefinite life while the intangible asset relating to the proprietary recipes and processes was valued at $14.6 million and will be amortized over a period of 10 years. The $58.7 million of goodwill is deductible for income tax purposes and was allocated to our Americas operating segment.
Source: Starbucks Corporation, Form 10-K for the Fiscal Year ended September 30, 2012.
Part 3
a. Estimate the average total estimated useful life of depreciable property, plant, and equipment. Starbucks reports $580.6 million of depreciation and amortization in the statement of cash flows, of which $4.5 million relates to amortization of limited-life Intangible assets. Does the estimate reconcile with stated accounting policy on useful lives for property, plant, and equipment? Explain.
b. How should an analyst interpret fluctuations in this estimate for a given company over time? How should an analyst interpret differences in this estimate between a company and its competitors?
c. Estimate the average age of depreciable assets, the percentage of PP&E that has been used up, and the remaining useful life. How might an analyst use this information?
Presented below is a portion of Note 7 to Starbucks' 2012 consolidated financial statements.
Property, Plant and Equipment, net September 30, 2012 October 2, 2011
Land ...........................................................$ 46.2.............$ 44.8
Buildings.......................................................225.2..............218.5
Leasehold improvements..................................3,957.6............3,617.1
Store equipment.............................................1,251.0............1,101.8
Roasting equipment..........................................322.8...............295.1
Furniture, fixtures and other.................................836.2...............757.8
Work in progress..............................................264.1...............127.4
Property, plant and equipment, gross..................$ 6,903.1..........$ 6,163.1
Less accumulated depreciation and amortization.....(4,244.2)...........(3,808.1)
Property, plant and equipment, net ....................$ 2,658.9..........$ 2,355.0