For most corporations, intangibles have become increasingly essential to financial success and progress, as well as a significant part of their value. There is a wide spectrum of intangibles in corporations, one of which is brands and includes designs, symbols, tones, or words used to distinguish and identify a corporation’s products from those of a competitor (Harrison et al, 2014: p55). Brands, however, are not a mere sign or name but also give the branded service or product a unique image, especially in terms of their attributes and quality in the customer’s perception. Moreover, these brands are widely considered as a key competitive factor with significant influence on the preferences of the consumer. Due to the significance attached to brands by corporations, how they are treated in accounting terms has been highly controversial and a subject of intense debate. As a result, the International Accounting Standards Committee adopted the IAS 38 Intangible Assets guidelines, which proposed how intangible assets, including brands, should be measured, recognized, amortized, and disclosed (Harrison et al, 2014: p55). This paper will seek to suggest useful brand information about Nestlé that would be of interest to investors, the significance of brands to Nestlé’s financial position and performance, and appropriateness of accounting treatment of brands at Nestlé. The paper will also discuss IAS 38 Intangible Asset’s prohibition from recognizing internally generated brands.
Nestlé’s Brands and their Disclosure in the Financial Statement
Nestlé, overall, owns some 2000 brands across the world that manufacture, produce, and supply cooking aids and prepared dishes, pharmaceuticals, milk-based products, cereals, and baby foods. Some of these brands include Cerelac for baby foods, Perrier for bottled water, Nesquik Breakfast Cereal for cereals, Kit Kat for confectionaries, Nescafe Classic for coffee, Maggi for frozen foods, Nestlé Coffee-Mate for dairy, Nesquik for drinks, Dog Chow for pet foods, and PowerBar for sport nutrition among others (Nestlé S.A, 2013: p55). There are several aspects that an investor or lender should be interested in about brands to help them make an informed decision, which should be looked for in the financial statements. The first aspect is market segmentation, specifically because customer choice is influenced by brands depending on the market in which the particular brand is marketed in (Backhaus et al, 2011: p1085). In Nestlé’s financial statement, there is analysis of revenue and results by operating segment, which includes revenues and results for Nestlé Water and Nestlé Nutrition in Zone Europe, Zone Americas, and Zone Asia, Oceania, and Africa (Nestlé S.A, 2013: p94). As such, the investor should be interested in valuing the brand in each market segment, while also identifying the total brand value from the segment valuations sum. With regards to Nestlé’s financial statements, the brand’s markets are split into homogenous and non-overlapping groups of consumers using geographical segmentation.
Another aspect that investors would be interested in involves the financial analysis of the brands, in which they would want to identify and forecast earnings and revenues from brand-generated intangibles for each of the market segments already identified above (Backhaus et al, 2011: p1085). In the case of Nestlé, the intangible earnings are defined by subtracting the applicable taxes, charge on the employed capital, and operating costs from the brand revenue. As such, Nestlé’s financial statements do disclose this information in an understandable manner. Investors and lenders may also wish to know about demand analysis on brands, specifically in order to assess the role played by the brand in driving product demand in the market where these brands operate. In addition, they would wish to know the demand analysis so as to determine the proportion of intangible earnings that can be attributed to the measured brand. In Nestlé’s financial statements, this is done by identifying vital demand drivers for the branded business, as well as the degree to which the brand directly influences these drivers (Backhaus et al, 2011: p1085). However, the financial statements from Nestlé do not use the role of branding index, which would have represented the intangible earnings percentage generated by the brand.
Investors and lenders would also wish to know about competitive benchmarking in relation to the brand, which is important because it helps in determining the competitive weaknesses and strengths in relation to the brand (Backhaus et al, 2011: p1086). This, in turn, aids in deriving the specific rate of brand discount that is reflective of the profile of risk linked to expected earnings in the future, which is measured using the brand strength score. In the financial report from Nestlé, competitive benchmarking information is presented through a structured evaluation of the brands’ geographic footprint, market, and growth trend, although they should perhaps have also included information on the brands’ stability and legal protectability. Finally, investors may also wish to know about brand value calculation because the brand value provides the net present value of earnings for the brand at the brand discount rate (Backhaus et al, 2011: p1086). This calculation would reflect the brands’ ability to generate earnings in the future. While this information is presented in Nestlé’s financial report in terms of assessment of opportunities in underexploited or new markets, it is not done so clearly as it only reflects the forecast period and not beyond.
Significance of Brands to Nestlé’s Financial Performance and Position
The identification and measurement of brands as an intangible asset is problematic for Nestlé and other corporations, specifically because most of these brands are considered to have been internally generated with little recognizable historical cost under the IFRS. As a result, brands under Nestlé do not appear on their financial position statement. Whereas recognition of brands is an important element that allows Nestlé to succeed in a competitive market, the theoretical support underpinning their placement on financial position statements is still developing (Hightower, 2013: p62). However, in cases where the created brands can be identified, such as Nestlé Nutrition and Nestlé Waters, their development expenditure has been capitalized in the financial statements. Moreover, from the financial statement, Nestlé seeks to identify brands whose development costs can be reliably measured using the value of their property, plant, and equipment, as well as financial debt and other liabilities (Nestlé S.A, 2013: p91). On the other hand, where the brand is not recognizable as internally generated, its development expenditure is taken as an expense within the year in which it was incurred.
Strong brands are important for creating consumer emotional attachment and trust, fostering relationships between the products and consumers and lead to several financial benefits for the company (Bloomberg News, 2014: p1). In the case of Nestlé, their strong brands have enabled them to pursue premium pricing as consumers tend to pay more for brands they believe to be of lower risk and higher value than other alternatives. For example, the Nespresso capsules are significantly more expensive than other “loose” ground coffees and are only sold by Nestlé Nespresso. Despite being almost thrice as expensive as other alternative products, the fact consumers perceive it as being more valuable than its competitors and the coffee unit at Nestlé drove a 7.1% increase in Nestlé’s organic sales (Bloomberg News, 2014: p1).
Another benefit of brands to Nestlé is that they lower the cost of sales since consumers of a valued brand will normally make frequent and repeat purchases, which amortizes customer acquisition costs through a longer-term relationship with customers (Koltrowitz, 2013: p1). Products like Kit Kat from Nestlé are the first choice for most customers, while Nestlé owns various national and regional brands that consumers have a longstanding and close familiarity with. Because of this, Nestlé does not have to use significant funds for continuing promotion, which is reflected in their financial statement. Finally, Nestlé’s strong brand has also resulted in growing market share globally since their valued brands are able to acquire customers who are loyal to their products. Moreover, these customers also recruit more clients to use the brands, which, in turn, increase Nestlé brands’ market share and reduce the costs of customer development and provides an advantage against competitive attacks (Koltrowitz, 2013: p1).
Accounting Policy Applied to Nestlé’s Brands and their Appropriateness
From the Accounting Policies section of the financial statement, it is evident that Nestlé prepares its financial statement in accordance with the IFRS with the financial statements and the brands included in it being prepared under the historical cost policy (Nestlé S.A, 2013: p80). However, this is not the case throughout as there are exceptions, such as regarding financial liabilities related to mergers and acquisitions which are given at amortized costs. The historical cost accounting policy as applied to Nestlé’s brands requires that all brand items in the financial statement are based on their original costs, or what they cost Nestlé to create them. Thus, this means that the value of the brand is recorded at its historical cost on the balance sheet, rather than its fair market value that would account for amortization. As such, the value of the brand as identified in the financial statement is the sum of all costs involved in developing the brand to the state it is in when the financial statement is compiled (Hightower, 2013: p63). It is the actual cost that Nestlé incurred during the creation, as well as development, of their brands, which is calculated from the funds invested along with the time cost of the money used for the brand.
As already noted, this accounting principle does not consider the amortization, which involves the spreading out over a specific time period of the capital expenses related to the brands for tax and accounting purposes (Hightower, 2013: p64). Amortization, in this case, acts to match the expenses of the brand with its generated revenue. Failure to amortize the brand value in the financial statement has several disadvantages. To begin with, it does not evaluate the brand’s current market value but, rather, only considers the value of the brand at the time when it was created and developed. Therefore, the focus is mainly on the allocation of costs to the brand, rather than on the brand’s value, ignoring the possibility that the brand’s value may be lower or higher according to present value on the market and focusing on the cost of R&D and its depreciation. Moreover, it is difficult to establish a brand’s value with fluctuations in inflation since this policy assumes that currency utilized during R&D of the brand stays stable, indirectly assuming that there is no change in purchasing power during this period (Hightower, 2013: p64). Current revenue of the brand may also rise as a result of inflation, causing its value to rise in the future.
Despite these defects and restrictions in the historical cost accounting policy applied by Nestlé to its brands, this policy is still preferable for several reasons. To begin with, most accounting firms and accountants are hesitant to value brands at the present market value or price, specifically because there is a risk of creative accounting and malpractice where considering the amortized value of the brand has a direct effect on Nestlé’s share value price (Accounting Standards Board, 2010: p82). Using the historical cost policy, Nestlé’s accountants are able to safeguard their brands’ integrity, particularly against modifications where using amortized brand value would alter the figures and facts. As such, accountants may use alternative measures in the evaluation of brands in order to influence their value. Moreover, on top of being easier to produce, historical cost accounts do not record any gains by the brand until these gains are realized which gives a clearer picture of the brand’s value (Accounting Standards Board, 2010: p82). Perhaps more importantly, Nestlé can forecast the brands’ future costs of operation, specifically because historical cost accounting provides a choice to use alternate resources in measuring, reporting, and recognizing economic information on the basis of past data.
IAS 38 Intangible Asset’s Prohibition of Internally Generated Brand Recognition
With regards to internally generated intangible brands, there are various problems that arise with regards to the identification of whether there are identifiable brands that could generate economic benefits in the future, as well as in the reliable determination of the brand’s expenses and revenue (Grüber, 2014: p52). IAS 38prohibits internally generated intangible assets, of which brands are part, from being recognized as assets. The rationale underlying this thinking is that incurred expenditure does not lead to assets that can be considered as identifiable resources, specifically because they are not separable and do not come from legal and contractual rights. Moreover, incurred costs are not likely to be identified particularly as generating goodwill. If a corporation’s financial statement was to recognize internally generated brands as an asset, this would endanger the company’s quality of earnings, while also compromising the balance sheet’s reliability and representational faithfulness (Grüber, 2014: p52). This is due to the fact that management may have the opportunity to manipulate the brand’s earnings if internally generated brands were to be recognized.
Recognizing internally generated brands in the financial statements will make the latter unverifiable, particularly because it will be hard to agree on the brand’s exact value since it is based on the estimate of the management (Sinclair & Lane, 2014: p293). Moreover, the company’s management may be biased and could be tempted to value internally generated brands higher than others, which automatically sacrifices the value’s objectivity and neutrality. The brand’s value would also not be conservative, particularly since management would be including a brand without a reliable value on the balance sheet. In addition, including an internally generated brand in the financial statement would not be very relevant with the reduction of the financial statement’s predictive value and consistency. Indeed, the company could write off internally generated brands if they become impaired without a set pattern. As a result, it becomes difficult for creditors and investors to predict future earnings effectively since the company’s accountants may impair different amounts of internally generated brands every year (Sinclair & Lane, 2014: p293).
The internally generated brand would also provide a worthless feedback value. Because the company’s accountants estimate the internally generated brand’s original value, they may also have to make estimates of the impaired value, as well as the amount that will not be impaired (Elliot & Elliot, 2012: p41). As already noted, such estimates are not reliable and, because of the unreliability of the past value and impairment value of the internally generated brands in the financial statement, feedback value to creditors and investors will be worthless. An explanation for this is that the values cannot provide feedback regarding how these brands impact on the company’s operations and, instead, will be a reflection of the accounting estimates done by the company. From the reasons identified in this section, it is evident that internally generated brands should not be recognized in the balance sheet. Not only do they fail to meet the requirements that an asset should have, such brands are also not relevant or reliable. While some items included in the balance sheet are similarly either irrelevant or unreliable, internally generated brands are neither reliable nor relevant (Elliot & Elliot, 2012: p42). As a result, internally generated brands should not be recognized in the financial statements of a brand.
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