RFCOLP 1

RAISING FUNDS FOR CORPORATE OPERATIONS AND LIABILITIES, PROVISIONS, CONTINGENT

LIABILITIES AND CONTINGENT ASSETS. MEASUREMENT BASIS FOR ASSETS

By: Name

Course Name

Professor’s Name

University name

Department

City, State

14th Jan 2020

RAISING FUNDS FOR CORPORATE OPERATIONS, LIABILITIES, PROVISIONS, CONTINGENT

LIABILITIES AND CONTINGENT ASSETS. MEASUREMENT BASIS FOR ASSETS
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Abstract
Over a period of time, the way businesses have operated has changed a lot in a global scenario. With the advent
of technological advancement in the last decade, the operational efficiencies, and competition has also risen. In
the years, earlier to the IT boom, many companies in the Australian space used to run businesses on the
internally generated funds with considerably less support of external funding’s, but after in last two decade it has
picked up. After the debacle of 2008, and a short-run of recession, the corporations have changed its earlier
stance of going debt-heavy and came back in the support of Retained Earnings. As noticed in the report drafted
below, states that still companies have little percentage involved in the internal sources, and the external sources
such as Share Capital, Borrowing, Commercial Paper, are quite prominent. The companies also recognize the
assets and liabilities as per the standards issued by the AASB, and the peculiarity is sorted out by the internal
management practices, and customs followed by the corporations in general.
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List of Content

Abstract ....................................................................................................................................................................2
Introduction ..............................................................................................................................................................4
Different Sources of Funds Used by Selected Companies ...................................................................................4
Evolution and Changes of Different Sources of Funds ........................................................................................5
Percentage of Internally, and Externally Generated Funds ..................................................................................5
Relative Merits and Shortcomings of Different Sources of Funds .......................................................................5
Merits and Shortcomings of Internal Source of Funding .................................................................................5
Merits and Shortcomings of External Source of Funding ................................................................................6
Types of Interest and Non-Interest-Bearing Liabilities ........................................................................................6
Key Provisions of AASB 137, Provisions, Contingent Liabilities, and Contingent Assets .................................6
Provisions .........................................................................................................................................................6
Contingent Liabilities .......................................................................................................................................6
Contingent Assets .............................................................................................................................................6
Onerous Contracts: ..........................................................................................................................................7
Reference of AASB 137 in the Company’s Annual Reports ...............................................................................7
Different Category of Assets Recorded by The Company ...................................................................................7
Basis of Measurements Used by the Company for Each Class of Recorded Assets ............................................8
Summary...................................................................................................................................................................8
List of References .....................................................................................................................................................8
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Introduction
There are two types of funding used by the entities; External, and Internal Funding. Depending upon the
countries, financial environment, policies of the governments, the sources of finance are being used by the
organizations. Internal sources are considered traditional, most used, and favorable options in Australia whereas
external funding is mostly used for aggressive expansion, mergers, and acquisition, funding large projects. Both
options have their own pros and cons. This report discusses in detail the sources of funds, the evolution over
three years, with merits, and shortcomings, of funds. It also discusses in detail the provisions of AASB 137 with
the details imbibed from the selected company’s financials, and the asset classes and measurements used by
them.

For meeting and describing the above-mentioned criteria, two companies have been selected; Woolworths
Group, and Fonterra Co-operative Group. Both companies are listed in the Australian Stock Exchange focused
on the food segment.

For comparison purposes, two companies: Woolworths Group and Fonterra are chosen.
The Woolworths Group has more than 70 brands, 3292 stores including 328 hotels, and 183 BIG W. The group
employs more than 2,00,000 people. The group. On the economic front, it has earned a free cash flow of $941
million on revenue of $59,984 million, and the Return on Funds Employed comes at 24.2%. (Woolworth Group,
2019).

The Fonterra, the largest exporter of dairy products with 140 countries as an export market, is in the business of
milk and milk products. Some of its popular brands are Anchor, Anmum, Anlene, Farm Source, etc. (Fonterra,
2019)

Different Sources of Funds Used by Selected Companies

There are two major sources of funds used by corporations in the Australian businesses; Internal funding, and
External Funding. A detailed discussion regarding the same is hereunder:

Internal Funding
The main source of internal funding comes from the cash profits generated by the company. The cash profits are
transferred to the Retained Earnings after deducting expenses such as payment to suppliers, taxable amounts,
salaries, etc. The dividend is also a popular source of internal funding.

For Internal Funding sources, the Woolworths Group depends upon cash generated from operations reduced by
the cash expenses. This is reflected in the Retained Earnings and The Cashflow Statement in the financial
Statement.

External funding
It consists of sources such as borrowings, supplier credits, advances, term loans, debentures, commercial paper,
bonds, and so on. In Australia, big organizations are major players in the borrowing domain due to increased
competition, and favourable terms of financing. Mostly the borrowed funds are used to facilitate mergers and
Acquisitions. (Kent, 2017)

The Woolworths Group’s External funding sources are Short-term Money Market Loans, Bank Loans,
Securities, etc., and Bank Loans, Borrowings, and Finance Leases are in the Non-Current segments. Also, it has
an equity holding valuing $6033 million.
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Evolution and Changes of Different Sources of Funds

As we have already discussed the various sources of Funds, Internal and External, the evolution of the different
sources of funds are mentioned hereunder.

The Woolworths Group has proceeded with the buyback of 58,733,844 shares in 2009 for an amount of $28.94
per share and cancelled it. In the past year since 2017, the company has not done any activity in the issuance and
cancellation of Shareholding. Reserves are the most important sources of internal funding; the overall reserves
have grown from $353 million to $490 million in 2019. Also, in the reserves, the most important part is
contributed by the operating cash flows of the company and in comparison, to 2017 to 2019, the revenue has
grown from $3122 to $2948 million.
For External source of Funding, the Woolworth Group depends upon the debt instruments, bank loans, Short-
term market loans, and flexible loans.

For Fonterra Group, External Funding mainly consists Share Capital, Borrowings and Bank Overdrafts. The
borrowing has increased over a period of time from 5151 levels to the 5361 levels in last three years. But, on the
equity front, there is no noticeable changes. The Retained Earnings have reduced from a level of 1637 to 360
levels due loss booking due to impairment of China Farms, New Zealand consumer and Food Service business
etc.

Percentage of Internally, and Externally Generated Funds

As we have already discussed above, the internal and externally generated funds are the prime sources of the
company’s financial resources. And considering the primary source of funds for internal generation is Retained
earnings and remaining all the funds fall in the broad category of External Borrowing. So, considering the same,
any company would have a very lower ration of internally generated funds in comparison to the funds from other
sources.

For the Woolsworth Group, the funding is bifurcated as 68% in the External Borrowing and remaining 32% as
the internal borrowing consisting of Internal Equity. Over the last three year, this ratio has remained in the
similar range.

For Fonterra group, the percentage of Internally generated funds is around 3%, and remaining 97% comes from
the External borrowing which includes long term loans and other borrowings from outside sources For Fonterra
Group, the total

Relative Merits and Shortcomings of Different Sources of Funds

Both the funding options; Internal and External has its own merits and demerits. Internal sources of funds are
quite popular in Australian businesses, even though there is no scarcity of debts from External Sources. A few of
the important and noticeable advantages and disadvantages are mentioned hereunder.

Merits and Shortcomings of Internal Source of Funding

Due to the slowdown, and lesser availability of the funds from external sources, the favourite source has funding
has shifted to internal sources. For large corporations with a steady flow of resources, the internal source has
become the prime contender for fuelling expansions and debt repayments. In the last two years, the majority of
the corporates have availed the fund requirements via internal route, rather than depending on the external ones.
(Kent, 2017). The revenues generated from business sources or internal funding helps in two major ways; putting
a curb on the excessive and unnecessary expansions, and providing a safer route in comparison to borrowings.

The major demerits for the Internal Source of finance are the unavailability of the resources and the feasibility of
funding only expansions small requirements. Moreover, the repayment from internal funding does not qualify for
tax benefits as in case of interest repayments which is eligible for tax deductions. (O'Farrell, 2019)
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Merits and Shortcomings of External Source of Funding
Before 2007, when the financial debacle of 2008, has not hit the world, most of the companies used to raise
funds through External Sources, and primarily via debentures and loans. But, with the onset of economic
recession, the listed corporates have rolled back the debt-funded investments. The biggest demerit of the external
borrowing and mainly financial loans turns out to be the consistent payments and fear of liquidation or
restructuring in case of default. The economic slowdown bottlenecks the revenues, and it becomes very difficult
to even cope-up with the regular interest payments. Another major drawback is the unavailability of funds as
financial institution tightens the rope after the financial defaults and economic slowdown.

Contrary to the demerits, external borrowing is a very efficient source of finance, if the company is not in a
position to fund crucial or strategic investments in a dearth of internal funding. This case is quite visible in
economic slowdowns or for companies that are quite young in the market.

Types of Interest and Non-Interest-Bearing Liabilities

A business could have multiple liabilities, and some include Corporate bonds, accounts payable, etc. The
external borrowings are mostly interest paying liabilities and current liabilities except Short-term loans are
generally non interest-bearing liabilities.

Fonterra group has two categories of assets, one interest-bearing, and non-interest-bearing liability. Interest-
bearing liabilities include Commercial Paper, Bank Loans, Finance Lease, Capital Notes, etc. These represent
the interest-bearing debt net of the hedging. Remaining Liabilities such as Trade and Other Payables, debt owed
to suppliers, provisions, and other current liabilities falls under the head of Non-Interest paying liability.

For Woolsworth Group too

Key Provisions of AASB 137, Provisions, Contingent Liabilities, and Contingent Assets
The accounting standard AASB 137, discusses three main terms; provisions, contingent liabilities, and
contingent assets. Also, it discusses onerous contracts. For better understanding the key terminologies used
under this standard are as follows:

Provisions
A liability is defined as an obligation that occurred in the past and requires to be settled in the future with the
resources of the company. And, if the liability could not be determined with certainty in terms of time, and the
amount required, it is known as a provision. A company is obliged to set aside an amount as a cautionary
measure to clear the liability if it arises in the future. Thus, if a contingent liability is accepted by the company
and the probability is more than 50%, a provision is required to be made for the respective amount.

Contingent Liabilities
If liability has arisen due to a past event and requires the outflow of resources, but the occurrence of the liability
depends upon the events beyond the control of the entity. Also, if the liability could not be measured totally or
with complete reliability, it is considered as contingent liabilities. An example of Contingent Liability could be
providing a guarantee on behalf of a company or person, and in case of failure from the person or entity, the
guarantor needs to fulfill the obligation.

Contingent Assets
The contingent asset could be defined as an asset whose possibility would only be confirmed by events or events
that are uncertain and not fully within the control of the entity. For instance, if a company has filed a lawsuit on
the company for using the propriety technology of the company, the entity has a very high chance of success
ratio, then the gain arising from the lawsuit would be termed as a Contingent Asset. But, the company would not
record it until the receipt of money becomes certain.
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Onerous Contracts:
If a company has undertaken a contract whose mandatory obligations exceeds the future economic benefits
derived from it. In simple words, a loss-making contract with net unavoidable obligations is considered as
Onerous Contracts. To illustrate, a company has entered a contract with an obligation of completing it within 6
months otherwise a heavy penalty would be levied. And, if the company is sure that it won’t be able to meet the
deadline, and the penalty would be much higher than the profits it would earn.

The company needs to create an obligation for contingent liabilities and onerous contracts by measuring the
amount, and the probability of the occurrence, and record it as provisions. As per paragraph 66 of AASB 137, if
the stated conditions for contingent liabilities and onerous contracts meet, the provision is required to be made
by the entity.

Reference of AASB 137 in the Company’s Annual Reports

AASB – 137 covers Provisions, Contingent Assets, Contingent Liabilities, and Onerous Contracts. Though there
is no specific mention of the AASB 137 in the Annual Reports of the Woolworth Group, the company has
adequately followed the regulations mentioned in the AASB 137. The company has assumed the onerous
contracts for one of its networks, Big W, as it has gone through severe impairments due to a reduction in the 50
basis points in the profit margins, and it may become an Onerous Contract over some time. Total Current and
Non-Current Provisions (including Onerous Contracts) stood at $2514 million for the year 2019, and $2393
million for the year 2018. (Woolsworth Group, 2019)

Similarly, even in Fonterra Group, there is no specific mention of AASB 137, but as a consumer staple company,
it is also exposed to the contingent liabilities, hence needs to create provisions for various claims and cases filed
against it. As of 31st July 2019, the company has not recognized any contingent liability because a case filed by
Danone in 2014, has been paid off to the tune of $183 million, along with interest. The case has been stayed by
the Singapore Arbitration and due to the uncertainty of a further proceeding from the Danone, no amount has
been taken to the provisions or considered as a provision.

Different Category of Assets Recorded by The Company

The assets are mainly of two types; Non-Current Assets, and Current Assets. Other types could be Tangible
assets, Intangible Assets, etc.

Non-Current Assets
Non-Current Assets consist of development properties, freehold land, warehouses, retail and other properties,
along with leasehold improvements and plant and equipment. The Intangible Current Asset recorded by the
company is Goodwill, Brand Names, Licenses, etc.

Fonterra Group has non-current assets in the heads of; Property, Plant, and Equipment, Equity Accounted
Investment, etc.

Current Assets

The Woolworths Group has

The Fonterra group has financial assets such as Derivatives Financial Instruments, Tax Receivable, apart from
Trade and Other Receivable, inventory, etc. It also has a criterion mentioned for Asset held for sale too, there are
three investments where the company is partaking its stake and listed them under this category.

Others:
Other categories include Intangible and Tangible assets. Fonterra has Livestock, and intangible assets, along
with the financial assets such as Derivative Financial instruments, and Equity accounted investments.
 RFCOLP 8

Basis of Measurements Used by the Company for Each Class of Recorded Assets
Non-Current Assets such as property, plant, and equipment are calculated at the cost less accumulated
depreciation, impairments, and amortization if applicable. If the asset is self-constructed then the cost would
include materials, wages & salaries, interest costs, and other overheads on a proportion basis.

For Woolworths Group, the depreciation is charged at a straight-line method reduced by the salvage value over
the useful life of the asset. Leasehold products are amortized and the impairment or revaluation also takes place,
if necessary. The amount arrived from the sale of an asset is only accepted if the contract is unconditional, or the
title has been passed to the party. Goodwill, an intangible asset, is calculated at the net acquisition value after the
payment of purchase consideration and measured at a cost reduced by impairments. Other intangible assets are
amortized over the life of the assets on a straight-line basis. Two assets, Brand Names, and Liquor and Gaming
Licenses have an indefinite useful life.
Other land and other assets which could be assessed with the fair value using the market rates in force, is derived
and considerable changes are made in the value based on the revaluation of the asset.
(Woolworth Group, 2019)

For Fonterra Group, Cash is recorded as per the value it represents on the counting date, Accounts Receivable is
and Inventories are recorded at the amount due from the customer and value of goods and material purchased
along with fair value or net realizable value whichever lower is recorded.

In the Case of Non-Current Assets, the group follows cost less accumulated depreciation method or amortization
and impairment losses. If an asset is constructed in-house the book value would include the raw material,
overheads, and borrowing costs, if incurred while the preparation stage. The depreciation is charged on a
straight-line method and leasehold assets are amortized over the useful life of the assets. The assets are also
subject to the impairments, and revaluation if the indicators whether internal or external information are present.

The main criteria for calculating depreciation are deriving the life of the asset is derived by the management on
an annual basis and accordingly, the changes in the depreciation are made. The depreciation of the previous year
is not changed as a policy. In the case of Freehold properties, the value of the property is assessed as per the
current market valuation. Accordingly, if the difference is substantial, the changes are made to the respective
assets.

Summary
As we have seen in the main report, the companies have relied heavily on the external capital for their
operations, but the external borrowings have not increased over the years, and remain steady in a closed range.
Companies do follow classification rules and classified their assets as per the regulations laid down by the
relevant accounting standards. Also, as both the companies are involved in the food sector, litigation, and claims
are quite visible in the business environment and mainly, it happens due to the quality issues, or infringement of
Patent, or Trademarks. So, the respective criteria mentioned by the AASB 137 is followed by the companies for
calculation, presentation, and disclosure of provisions, Contingent Liability, and Contingent Assets. As there is
not standard format for all the cases, the recognition of cases, and the estimation rests with the judgement of
management.

List of References
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