Wholesale Dividends: Good or Just Special?

NewImageA number of US companies (including Costco, for example) are rushing to pay out massive dividends before December 31, 2012 to beat the dividend tax hike that is pending. A quick refresher on dividend taxes in the US: Under George W., long-term capital gains and dividends were subject to a temporary tax break resulting in a maximum tax rate of 15% (compared to normal business and employment income subject to a maximum tax rate of 35%). This tax holiday was supposed to have expired December 31, 2010 but was extended for two years by President Obama. Politically, dividend and capital gains tax rates are important. Those with less-than-average wealth generally don’t care about these rates since that set of the population doesn’t usually own investment portfolios that generate capital gains and dividends. However, the wealthy really do care, and they’re the ones who contribute to political coffers. But let’s leave the political aspects aside since they can be all-consuming on their own.

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If you are a US company and you know the dividend tax holiday is about to expire, you would prefer to give your shareholders cash before December 31, 2012 so they would only pay the 15% tax rate. If you paid the dividend the next day, January 1, 2013, your shareholders would be subject to a maximum 40% tax rate (39.6% to be exact). That’s a big difference. Especially when your dividend payment is $675 million. What? Who gets dividends like that?? Well, the Walton family does. Yes—the founding family and controlling shareholders of Walmart. They own and control 51% of the shares of Walmart and have decided to trigger a one-time, special dividend of roughly $1.3 billion, of which their portion is roughly $675 million. Issuing the dividend by December 31, 2012 results in tax savings of about $166 million for the Walton family alone. That’s a big deal and smart tax planning.

In Costco’s case, the special dividend works out to about $7 per share. This is well above the normal dividend rate of about $0.14 per share and works out to a total of $3 billion. Interestingly enough, the very same day that Costco announced its special dividend, it also announced new debt offerings (meaning it will be borrowing from investors) of $3.5 billion. Do you see any connection between the two? Paying the dividend requires $3 billion in cash, but Costco needs that cash for day-to-day operations, so it borrows more cash.

Should we care? I think so. This is a clear case of tax policy driving economic decisions—maybe even bad economic decisions. In Costco’s case, the US Treasury will collect substantially less tax than if the dividend was paid a month later, and the interest cost on the new debt is tax deductible for Costco, which will decrease its taxable income for years to come. In my opinion, this is a clear case of a wealth transfer to the rich at the expense of the general US tax payer, or at least the expense of the US government. There are some potential arguments to justify such behaviour but I don’t find them compelling. I will chalk this up to a capitalism #fail.

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Fracking government

The Quebec government’s decision to extend the moratorium on natural gas hydraulic fracturing (commonly referred to as “fracking”) has certainly raised some eyebrows within Canada and internationally.  Fracking has been used to access natural gas reserves that were previously thought to be inaccessible or at least not economically feasible to access.  The science is pretty simple: pump water at great pressure into rock with cracks and natural gas and viola, the water pressure opens the cracks up letting the natural gas be captured.  I’m not convinced that this does not carry substantial health risks but I will admit that the research is not conclusive.

 

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As a result of some mixed results, the Quebec government introduced a temporary moratorium on all natural gas fracking in the province.  In the middle of September, there was some indication that the government was considering a permanent ban.  While this has clear political repercussions, and potentially some health benefits, it also has some substantial accounting implications.  There are a number of companies that had started natural gas fracking operations or exploration within Quebec prior to the moratorium, most notably Talisman Energy and Lone Pine Resources.

Talisman just reported their third quarter results and included a substantial impairment charge related to their Quebec fracking operations.  An impairment charge is a non-cash write down of an asset.  Over the past two or three years, Talisman had purchased exploration rights (an asset), done some successful drilling and exploration (an asset), and started to building capital infrastructure to support fracking (an asset).  Now that Quebec is considering a permanent ban, those assets are virtually worthless.  Under generally accepted accounting principles (IAS 36, IAS 16), that decline in value is referred to as an “impairment”.  The asset must be written down to its value-in-use (pretty much zero if you can’t pull natural gas out of the ground) or its recoverable amount if you can sell it (pretty much zero since no one will buy those assets with a government strongly considering a permanent ban).  The asset write down creates an expense for the same amount – a non-cash expense but an expense nonetheless.  This expense is typically large and commonly results in a loss for the period.  Check out Talisman’s third-quarter financial statements, particularly the income statement (page 2) and note 9 (page 9) for more information on this impairment.  For another example of an impairment charge see the post about Microsoft.

This is another great example of how accounting is a pretty good reflection of real life or at least economic reality.

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Welcome back Alberta!

While I doubt that my recent post shaming the Alberta CAs had any influence, it is great to see them come to their senses and rejoin the national CPA unification initiatives.  This is better for students and for the public, no question about it.  For those remaining curmudgeons, I toss you this encouraging message from Gloria Gaynor:

For the complete formal announcement, click on the image below.

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Is Teavana the Next Nirvana? Starbucks Thinks So.

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.

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Balance Sheet (Equity Portion)

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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/)

Queens Report on Student Mental Health

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Queens University has, in my opinion, really been the leader of higher education institutions trying to get a grasp on students’ mental health.  Their push was the result of a very unfortunate string of tragic events a few years ago.  I’ve blogged about that leadership before here.  Queens released a monumental report outlining a number of strategies to help increase student mental wellness.

 

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A few key snipers from the report.  Students’ self-reported strategies for dealing with stress:

• Talking to friends/family (74%);
• Distractions (64%);
• Getting enough sleep (57%);
• Regular physical activity (57%);
• Setting priorities (56%);
• Eating a healthy diet (51%); and
• Using time management (43%).

The key suggestions in the report:

  1. Faculty should be willing to accommodate alternative exam needs. I’ve read the report and I’m not totally clear what that means.  Clearly we have a legal obligation to accommodate students registered with the Disability office.  Beyond that, it gets really tricky.  I see the benefit of accommodation, but flexibility comes with huge costs around exam integrity and fairness.
  2. Classes offered all 12 months of the year.  This is meant to allow students to spread the work load across the full year as opposed to the usual 2 semesters (8 months).  It also helps students who fail a course  – they can redo it during the summer and get back on track.  My Faculty is notoriously bad around this and I will continue to push for improvements.
  3. Make student mental health a part of regular courses.  This could include student research around mental health, perhaps best suited for courses in psychology but definitely not excluded form other areas.  A few years ago a group of my students authored a managerial accounting case around the costs of institutionalizing mentally ill patients inside prisons.  It made for very interesting group discussions.
  4. Linking faith-based support and mental health support.  This one surprises me.  I know that many students are spiritual if not necessarily religious (a very important distinction).  Apparently there is research to suggest that students that feel supported in their spirituality are mentally healthier.  Very interesting and something I will definitely follow up with.
  5. Reducing or removing stigma.  No surprise here – students feel awkward or conscious about approaching someone for mental health help.  We need to … we must … make mental health a normal part of conversations on every campus so that students feel equally comfortable talking about broken legs, STDs, or mental illness.
I encourage you to read the full report, it is a terrific document and a great resource for all people involved in higher education.  Thank you Queens!

A quick note to my CA colleagues in Alberta

The rest of the country has been patient but the time has come.  Get your shit together.  Two pictures that may make your future a bit more clear.

 

1. This is the rest of the country with ~80% of Canadian accountants on board.  You are left behind … in the dust.

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2.  This is you.  No bus in sight.  You now realize that you’re miles from anywhere, isolated and left with not a hell of a lot.  Good luck.

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If you are an Alberta CA on council, make the right decision.  If you’re an Alberta CA not on council, we’ll welcome you with open arms in BC … in our new CPA body.

Lighting Up: The Cash Flow Machine

Recently, many Canadian provinces have initiated lawsuits against the large tobacco companies, apparently to recover healthcare costs that the provinces must pay to treat individuals with smoking-related illnesses at hospitals. There is little scientific doubt that smoking is not good for our health, yet many people still choose to smoke (or are addicted to smoking). This is relevant to accounting in two ways. First, since smoking is a tough habit to break, once the tobacco companies get you hooked they have a solid source of cash. Second, those tobacco/health lawsuits should have an impact on tobacco companies’ financial statements.

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Whether you choose to smoke is not the point of this blog post. Rather, we should consider the business model behind tobacco companies. Take Phillip Morris International (PMI) as an example. From 2009 to 2011, PMI generated over $22B of net income and almost $28B of cash flow from operations. PMI has a gross profit ratio of over 25%, meaning that for every $1 of sales, the cigarettes cost PMI less than 75 cents. In fact, its overall profit margin is 11%. This means that every time someone pays $10 for a package of cigarettes (excluding taxes), $1.10 is pure profit for PMI.

What does PMI do with all this excess cash and net income that it generates? A quick look at its statement of cash flows suggests that virtually all of it gets returned to shareholders as dividends or share repurchases. In the past three years, nearly $30B has been returned to shareholders. No wonder some analysts are so keen on tobacco companies! Most mature, stable companies have similar cash flow patterns—positive cash flow from operations, negative cash flow for investing activities (as the company reinvests in its capital assets, etc.), and negative cash flow for financing (as it repays loans and pays dividends). The unusual thing about PMI is the scale of the cash flow and the fact that there is very little capital project investment, so the cash flow can all be returned to shareholders.

As Alberta, Quebec, and others have jumped on the litigation bandwagon to sue tobacco companies, I would have expected the financial statements of PMI to show substantial liabilities and provisions for potential payouts in case they lose the lawsuits. Given that many of the lawsuits are over $50 billion each, they are not immaterial. Surprisingly, virtually no lawsuit provision is shown on PMI’s balance sheet. There is plenty of disclosure in Note 21, but no actual liability has been recognized. Remembering that Note 21 is drafted by management and may be slightly biased, it explains clearly that PMI is confident that it will win virtually all the lawsuits out there based on its past performance. For the few it may lose, management claims that it is unable to estimate the amount of potential payment and therefore has not recorded anything. This article provides a quick summary of recent tobacco-related settlements. As you can see, some of the past settlements have been very significant—upwards of $100 billion. PMI did not have much equity at the end of 2011: merely $551 million. It wouldn’t take many unsuccessful (from PMI’s perspective) settlements to chip away at that equity very quickly.

Conclusion? While the machine is up and running, tobacco companies will likely generate a ton of cash and return it to their shareholders. When the gig is up and they start to lose their lawsuits, they won’t have any cash on hand anyway since they handed it all back to their shareholders. If you think that they’ve got a while before the gig is up and you can stomach owning tobacco stock, then you may do very well. I suspect that a tidal wave of unsuccessful settlements (from PMI’s perspective) is around the corner. Once it settles one suit, the tidal wave will break and the cash machine will collapse. It will be interesting to see if and when tobacco companies begin to record these likely settlements and how they disclose them in their financial statement notes. Let’s revisit this a year from now.

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Note: this blog was originally posted on my site hosted by Pearson Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Is our vocabulary really that limited?

In the last two weeks I have heard the following words be used in a derogatory fashion: “Jew”, “gay”, and “retard”.   Worse, all three were being applied to a specific person in response to specific behaviour.  Even worse, all three words were uttered by people who have higher education.  Perhaps we need to offer a special course to all first year students?  We could title it, “Expanding your vocabulary beyond four letter and other inappropriate words”.  The “Jew” and “gay” comments were in relatively private settings (less than 100 people), the “retard” comment was on the twitter sphere by the queen of shallowness, Ann Coulter.  If you have missed the news around this, she is referring to Obama.

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I’ve never understood how she gets the airtime that she does or why anyone would waste $10 on one of her books.  If you want to see her “wisdom” up against Bill Maher, watch this.

While many tweeters put her in her place very quickly, the best response was made by John Franklin Stephens.  Kudos to him for taking the high road rather than stooping to her level.  His letter to Coulter is definitely worth reading and should provide a ray of hope that there are still kind and generous people in this world.  Its unfortunate that they don’t get the same airtime as the loud bullies like Coulter.  (Click the image below for the full letter).

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Life gets crazy

I write this as students are busy studying and stressing over exams.  Stress is a common thing on a university campus.  Learning should not be easy.  Good learning should be challenging; requiring students to dig deep, reflect on positions they may never have considered before, adjust their outlook on the world.  We commonly get into discussions that require students to move from position A to position B or at least deeply contemplate such a move.  No question, that is stressful.

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Professors are not immune although I don’t expect students to feel any sympathy since in their eyes we are usually the reason for their stress.  Fair enough.  Professors’ lives include a job that can be all consuming, especially if you love your research and enjoy working with students.  Add in a dearth of strong leadership, a shortage of people to spread the work, plenty of opportunities to try new things – and the academic life can quickly become a rat race.  Without a doubt that is why I started yoga, golf, and classical music.  The decisions to start those (all independent) were not driven consciously by stress but I now see in hindsight that the outcome from all three is VERY positive.  I have to give a huge shout out to the instructors and yogis at Kelowna Moksha – since March 2011 I’ve been a devotee and seriously notice a mental difference when I get to yoga and when I don’t.  Thank you Kylie et al!!

Today I was reading a post from Inside Higher Ed, a great source of everything academic, when I came across the following piece of advice:

If you give your life to the institution, don’t expect the institution to reward you with a life. Fight hard for what really matters to your happiness. Sleep, eat well, and exercise. Consider not eating at your desk at least once a week; schedule in exercise. If you’re depleted or ill, you will not teach well or write well.

That is SO true.  I’ve been an professor for over ten years and especially since coming to UBC Okanagan in 2007, I have given much to the institution.  I’ve enjoyed it for sure.  Lots of challenges and opportunities but really it is not worth burying myself for this institution.  Literally and figuratively.  I don’t blame UBC, UBC Okanagan, or my Faculty – I suspect that every large institution and corporation out there can find itself encouraging people to devote themselves to the organization without truly appreciating what that means from the individual perspective.  The institution is like a large black hole of energy sucking in small stars.  It may feel good to be a part of something but rarely does that black hole spit you out with more energy than you began.  (That’s probably a really bad analogy and I suspect my physics and astronomy colleagues will correct me!)

The Inside Higher Ed post finished with a quick reminder of Mary Oliver’s poem, The Summer Day.  I first ran into that at an excellent Parker Palmer retreat back in the spring – it truly is a wonderful poem but particularly the last portion,

Tell me, what else should I have done?
Doesn’t everything die at last, and too soon?
Tell me, what is it you plan to do
with your one wild and precious life?

That’s an excellent wake up call.  Each of us only has one life, one body, one mind.  We’d better take care of it and do the best we can.  This is a one shot deal.

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