Module 11: Adjusting Enterprise Operations Patrick Noonan

1. Module 11: Adjusting Enterprise Operations Patrick Noonan

2. About Green Mountain Coffee Roasters • Started as a small café in Waitsfield, VT in 1981 • Grew into the public company that it is today • Operates two business units: • Specialty Coffee Business • Keurig Business Source: Green Mountain Annual Report

3. Why the name change? • Keurig Green Mountain is so much more than just a coffee company. • Roughly 25% of their 6,500 employees are engineers. • This is a technology company with a focus on beverages.

4. A Powerful Brand Portfolio

5. Room for Substantial Growth

6. Adjusting Enterprise Operations Keurig Green Mountain

7. Effect of Accounting Method Choices on Valuation Models • Concern by users – accounting methods can be manipulative • Most choices between methods shift income between periods • Reduction in comparability or appearance of comparability • Four adjustment considerations: • Inventory Method • Operating Leases • Special-purpose Entities • Share-based Compensation

8. Inventory Method Keurig Green Mountain

9. Inventory Method • LIFO causes financial statements to lack comparability • Need to adjust LIFO amount to the FIFO equivalent • GAAP – Requires LIFO adjustment (makes this adjustment easy)

10. Inventory Method – Effects on Key Measures • If one company uses FIFO (F) and one company uses LIFO (L), assuming increasing inventory prices, we yield the following: • If both companies use LIFO but one company is Old (O) and one company is New (N), we yield the following:

11. Inventory Method – Keurig Green Mountain Obtained from Note 2 – Significant Accounting Policies (GMCR 10-K)

12. Operating Leases Keurig Green Mountain

13. Operating Leases • Most common form of off-balance sheet financing • Lease transactions effect both sides of the balance sheet and the income statement • Typically Long-Term Assets and Long-Term Liabilities • Leasing expenses (SG&A)

14. Operating Leases • Four financial reporting consequences to the lessee: • Leased asset is not on Balance Sheet (EATO is higher because NEA is lower) • Leased liability is not on Balance Sheet (Some ratios, such as total liabilities-to-equity, are improved) • Without adjustment (capitalization of operating leases) the return on NEA (RNEA) is higher (Improves perceived quality of company’s ROE) • Early years of lease – Rent expense on operating lease is less than depreciation and interest expense on capitalized lease (EPAT is lower for operating)

15. Operating Leases • Disclosures required by GAAP allow us to capitalize operating leases • Determine the discount rate • Compute the present value of future lease payments • Adjust the balance sheet to include the present value from step 2 as both a lease asset and lease liability • Adjust the income statement to include depreciation and interest in lieu of rent expense

16. Lease Commitments Obtained from Note 19 – Commitments and Contingencies (GMCR 10-K)

17. Capitalize Operating Leases: Step 1

18. Capitalize Operating Leases: Step 2 Estimate of omitted assets and liabilities related to recording leases as operating rather than capital.

19. Capitalize Operating Leases: Step 3 Additional enterprise asset (part of PP&E) Financing liability = $16,602 - $62,800 * 6.23% = $62,800 - $12,690

20. Capitalize Operating Leases: Step 4 • Addition of depreciation and removal of operating lease payments effect EPAT Rental Expense for 2013: $23.1 million

21. Capitalize Operating Leases: Summary • NEA increased by $62,800 • NFL increased by $62,800 • EPAT increased by $27,614 • 2013 Sales = $4,358,100 • Can alter understanding of a company’s enterprise operating activities

22. Accounting for the Adjustments: Operating Leases

23. Share Based Compensation Keurig Green Mountain

24. Share Based Compensation • Notion: Employees will work harder to increase the share price when they benefit directly from future price increases • SFAS 123R – Expense the fair value at the grant date, recognize an equivalent increase in equity • Problem – This omits any changes in the value of the stock between the grant date and the exercise date • Microsoft example

25. Share Based Compensation Adjustments • Compute the value of the options exercisable at BOY using BOY share price • Compute the value of the options exercisable at BOY using EOY share price • Estimate value of ESOs exercised during the current year • Estimate value of ESOs cancelled during the current year • Compute the value of options exercisable at EOY using EOY share price • Compute an estimate of additional share-based compensation from information computed above • Adjust NFL, CSE, EPAT and FEAT using information computed above

26. Stock Based Compensation Footnote 15: Obtained from Note 15 – Employee Compensation Plans (GMCR 10-K)

27. Stock Based Compensation $74.88 $23.24

28. Stock Based Compensation: Step 1 • Compute the value of the options exercisable at BOY using BOY share price

29. Stock Based Compensation: Step 2 • Compute the value of the options exercisable at BOY using EOY share price

30. Stock Based Compensation: Step 3 • Estimate value of ESOs exercised during the current year

31. Stock Based Compensation: Step 4 • Estimate value of ESOs cancelled during the current year

32. Stock Based Compensation: Step 5 • Compute the value of options exercisable at EOY using EOY share price

33. Stock Based Compensation: Step 6 • Compute an estimate of additional share-based compensation from information computed above Effect of change in exercisable options Effect of exercising and cancellation

34. Stock Based Compensation: Adjustments Expense due to change in market price Expense due to exercise and cancellation

35. Summary Keurig Green Mountain

36. Summary • Inventory Method Adjustments • Operating Lease Adjustments • Stock Based Compensation Adjustments

37. Questions? 37