In recent news, coffee giant Starbucks decided to expand beyond its well-known Tazo tea line by purchasing Teavana Holdings Inc. This purchase raises a number of interesting strategic questions (e.g., has Starbucks saturated the coffee market and can only achieve growth through new markets?) and also has some interesting accounting aspects. Most notably, Starbucks is offering $15.50 per share, while Teavana shares were trading at approximately $10 per share prior to the announcement. What do these share prices represent? Or more importantly, how do these share prices tie into accounting information? Below are copies of Teavana’s Income Statement (Consolidated Statements of Operations) and the equity portion of its balance sheet.
Balance Sheet (Equity Portion)
At the bottom of the income statement, earnings per share (EPS) is calculated and disclosed as $0.47 per share for the year ended January 29, 2012. EPS is a “flow”—how much each share earned for the past year. Let’s look at another metric. At the bottom of the balance sheet, we find out that total equity (assets – liabilities) is $67 million. Divide that equity by the number of common shares outstanding, and we find that the accounting value is $1.75 per share ($67,002,000 / 38,281,836 shares). Why is there such a dramatic difference between the EPS and the accounting value per share?
This difference between the market value (or fair value) of the shares ($15.50 per share) and the book value (or accounting value) of the shares ($1.75 per share) is really the result of accounting using (primarily) historical cost (i.e., IAS 16) to measure assets and the refusal by standard setters to value internally generated intangible assets (IAS 38). What this means is that Teavana’s assets on the balance sheet are undoubtedly undervalued. If the assets are undervalued and the liabilities are correctly valued, then equity will also be undervalued—dramatically so in Teavana’s case.
I have two comments on this: 1) This is not a horrible thing. The other option is to try to fair value all assets, which would create measurement problems and introduce some big bias issues for management when valuing assets. 2) This is not a horrible thing. Wise financial statement users (like you) who are aware of this measurement issue can still use financial statements to make decisions. We’ve pointed this out before; financial statements are not designed to reflect market values, and we shouldn’t expect them to.
I look forward to seeing Starbucks integrate Teavana into its stores and I will also try to write a later post that shows how Starbucks accounts for Teavana post-acquisition. Now, go brew yourself a cup of tea!
Note: this blog was originally posted on my site hosted by Pearson Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)