Audit Project- A514

Provided By
Sankalp Bhatnaga

Md Moniruzzaman

Saleh Al Ghareeb

Sheryll Espinas

Wangming Guan

05/06/2014
 Coca-Cola 1

Industry Report:

I. Introduction………………………………………………………………… page

II. Industry Trends………………………………………………………….. Page

III. Key Business Process of Beverage Industry………………... Page

IV. Industry Specific Audit Risk………………………………………... Page

V. Major risks………………………………………………………………….. Page

VI. Implications of above risks for conducting audit…………. Page

VII. Audit testing procedures…………………………………………... Page

VIII. General Economic Risk…………………………………………….. Page

IX. Regulatory Risk…………………………………………………………. Page

X. Industry Competition………………………………………………….. Page

XI. Financial Structure…………………………………………………….. Page

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Company Report:

I. General Background …………………………………………………… Page

II. Vertical Analysis………………………………………………………… Page

A. Balance Sheet………………………………………………………….. Page

B. Income Statement…………………………………………………… Page

III. Horizontal Analysis…………………………………………………… Page

A. Balance Sheet………………………………………………………… Page

B. Income Statement………………………………………………….. Page

IV. Ratio Analysis……………………………………………………….. Page

V. Financial Strength Measurement………………………………… Page

VI. Management efficiency and effectiveness…………………… Page

VII. Risk Assessment………………………………………………………. Page

VIII. Recommendation……………………………………………………. Page

 Coca-Cola 3

The beverage industry is a vast and growing industry with 7 billion potential consumers

around the world. The demand on beverage production is increasing daily. In the United States

of America the beverage industry accounts for an estimated one- third of the global spending.

Consequently, the beverage marketing is one of the most profitable businesses in the United

States of America. The most successful soft drinks in the world are Coca-Cola and Pepsi-Cola

which originated here. Any business in the beverage industry in order to be successful should

begin with good beverage formulation, the right beverage label design, correct beverage

packaging and advice from America's best beverage consulting companies and beverage

marketing companies.

The Coca-Cola Company is the world’s largest beverage company and it owns more than

500 nonalcoholic beverage brands. The Coca-Cola Company provides variety of beverages such

as water, enhanced water, juices and juice drinks, ready-to- drink teas and coffees, and energy

and sport drinks. Moreover, Coca-Cola Company owns and markets four of the world’s top five

nonalcoholic sparkling beverage brands; Coca-Cola, Diet Coke, Fanta, and Sprite.

Throughout the years, Coca-Cola Company has used many slogans in the company

advertising, which started in 1906 and is continuing till today. The reason for mass advertising is

to create direct communication with its customers worldwide which makes the Coca-Cola

Company beverage distribution, the largest beverage distribution system in the world with

serving approximately 57 billion of all types of company’s beverages around the world every

day.
 Coca-Cola 4

The vision of Coca Cola Company is to create a long-term destination for business and it

creates a "Roadmap" for winning.

Industry Trends

Beverage industry is still working with both new and continued trends. The first trend is

that the beverage industry will continue to rise throughout 2014 to reach $667.5 billion which is

a 4.5% increase over 2013’s sales of $638.8 billion, and the beverage industry will continue to

grow to reaching an expected $796 billion by 2018. The second trend of beverage industry is

sales of private label products which will continue to grow to reach $133 billion by 2016 (Market

Research.com). When the recession hit in 2008 to 2012 the sale of private label product began

growing slowly, now the sale of private label products in beverage industry is building again and

continuing to grow due to improved quality and increased marketing. The final trend is emphasis

on healthy beverages. It will continue to focus on health- conscious offering and the beverage

industry will experience some changes during 2014.As per reports in the start of 2014 school

year, sugary drink will be replaced by healthier offering such as fruit cups and fat-free milk.

The Coca- Cola Company gets feedback every year from the consumers which make the

company adopt new trends every year. After, the company receives the feedback; it consults its

experts in the company to place the new trends each year. Coca-Cola Company has new trends in

2014, some of the trends related to beverages and the other related to food. The beverages trends

in 2014 which Coca Cola Company is focusing are; Green tea, and Juices. First trend, green tea

has high demand from restaurants because lately people have started preferring to drink tea over

coffee with snack. Second, the company is trying to make a mark in fruits and vegetable juices

because millions of people prefer healthy juice. (Coca- Cola.com)

 Coca-Cola 5

Key Business Process of Beverage Industry

The beverage industry is a complex industry. Key business processes of Beverage

Company are the real value creating processes in the organization that ensures that organization

remains competitive over time. The value chain or key business process of beverage industry is

almost same in all the companies. The value chain of Coca Cola is as follows that demonstrates

the value chain of beverage industry.

Figure: Coca Cola Value Chain

Source: The Coca-Cola Company’s 5by20 Initiative

Coca-Cola has more than 500 beverage brands are manufactured, marketed, and

consumed in more than 200 countries at a rate of more than 1.8 billion servings per day through

a complex and decentralized global value chain that spans producers of raw materials; suppliers

of ingredients, packaging, equipment, and other goods and services; bottlers who manufacture,

package, and distribute (or contract third parties to distribute) beverages; retailers who purchase
 Coca-Cola 6

those beverages for resale to end consumers; and recyclers and artisans who reuse product

packaging.

Industry Specific Audit Risk

One of the biggest assets of a company is inventory and the controls for inventory should

make sure all inventory on the balance sheet actually exists. A business must have in place a

proper segregation of duties so that no single individual handles all or most aspects of the

inventory, such as transaction, authorization, preparation, and payment. For example, the

physical custodians of any types of inventory should have no access to accounting records,

including the inventory records, cost accounting records, or the general ledger. In addition,

company should plan for safeguarding inventory, which means that the company sets in place

procedures to prevent and detect misuse of inventory so that the financial statements are adjusted

and fairly stated.

Major Risks

The operating environment for the beverage industry continues to be characterized by

intense price competition, aggressive marketing, entry of non-traditional competitors and market

consolidation. Uncertainties related to raw material prices, availability of credit, difficulties in

financial services sectors have created volatility in global economy and financial markets,

making consumers cautious on spending. This has led to shift from previous spending pattern to

inexpensive and cost saving options which has affected growth and earnings in beverage

industry. Any macroeconomic factor (such as increased fuel prices) that has effect on consumer

spending or that has capacity to put pressure on input cost would ultimately affect beverage

industry’s financial condition. Health Risk and general awareness in consumers about their

health has created low demand, which is the major risk for the industry.
 Coca-Cola 7

Regulatory barriers including Restrictions on sale of sweetened drinks in certain markets,

especially as imposed by local government is another concern. In case of Coke, Inventory plays a

very important role and so does its disclosure. Valuing inventory in one way or the other can

make huge impact on cost of goods sold and hence on profits.

Inventory management is a key risk or success factor since efficient inventory

management directly affects profitability. Recalls of inventory in certain markets due to poor

quality controls damages the companies brand and profitability, which is one of the major risks.

Implications of Above Risks for Conducting Audit

Our audit team would need to build expertise in those areas in beverage industry that may

cause chances of material misstatement and increase our overall audit risk. To comply with the

professional standards our team would deploy trained staff to gain thorough knowledge about

regulatory environment in beverage industry. Industry risks would impact audit procedures in

following manner.

o Since competition in beverage industry is always rising, our team would evaluate whether

there is substantial doubt about the client’s ability to continue as a going concern for one

year. We would be strictly observing if there are events such as negative cash flows from

operations, defaults on loan agreements, adverse financial ratios, work stoppages etc.

o Inventory will be critical account which warrants for additional audit procedures.

o We would focus on audit of cash and financial investments. Positive cash flow from

operations is important parameter for industry that can be used as indicator of efficiency

in operations. Also liabilities, expenses, revenue and most other items flow through the

cash account thus examination of cash transactions would be helpful for us in the

substantiation of many other items in financial statements.

 Coca-Cola 8

o Coca-Cola employs reasonable number of workers in manufacturing, supply chain operations &

bottling plants. Unsatisfactory pays and other economic conditions can play a big role in

employee turnover. Also payroll is one of the largest operating costs in the company. Thus we

intent to focus on payroll.

Audit Testing Procedures

Risk in Accounts Financial statement Assertion type Audit test procedure

Assertions
Evaluate consistency in method of

Inventory Valuation Account Balance accounting used to value yearend

inventory.

Examine sample of recorded

Inventory Rights and obligation Account balance inventory items with supporting

documents and contracts.

To ensure all payroll costs are

Transaction and recorded pertain to entity and no

Payroll Validity/occurrence
events ghost employee accounts exist.

Trace sample of inventory and

ensure that the inventory is

Revenue Completeness & Transaction and
recorded.
recognition Cutoff events
Compared sales invoice date with

shipment date to sales journal.

 Coca-Cola 9

General Economic Risk

Coca-Cola Company is an international company that operates in a global market. The

entity faces numerous economic risks such as fluctuation in commodity prices, foreign exchange

rate, interest rate, political stability and recession. These economic risks posed a huge hurdle in

the continuity of the operation of the business. Erratic commodity prices directly affect sales

revenue; business can only temporarily absorb changes in raw material prices and passing on the

additional cost of raw materials to consumers which will result in a decrease in sales. Earnings

and expenses incurred by the company are recorded in the currency where it operates other than

the U.S. dollar. The appreciations of currency in one market counterbalance the devaluations of

the other. However, fluctuation in U.S. dollar affects the company’s value of balance sheet and

net operating income since all of its operations must be consolidated and reported to U.S. dollar.

Political environment has an immense impact on how business operates. Instability requires the

company to be flexible in their operations to be able to adapt to new political landscape.

The Food and Beverage Industry faced regulatory risk from the United States

Environmental Protection Agency, Food and Drug Administration, Internal Revenue Service,

Individual State Regulatory bodies and Foreign Regulatory bodies.The company/Industry is

concerned about the possible implementation of Eco-tax and Product Stewardship Program that

will results in increase in operational cost and reduced earnings. Environmental consciousness,

resulted in legislation enacted in ten States (California, Connecticut, Hawaii, Iowa, Maine,

Massachusetts, Michigan, New York, Oregon and Vermont) and some parts of the world, the so

called “Bottle Bill” which requires the purchaser of the item to deposit a refundable fee for a

certain beverage container. The customer claimed their deposit by returning the container to the

place where they purchased the product. This law is adopted in few geographic markets. Coca-
 Coca-Cola 10

colas’ concern is the possibility of adoption of this law to the rest of the markets where it

operates that will result in less demand for Coca-Cola product due to unpopularity of the law.

Industry Competition

The Coca Cola Company has high risk of competition not only inside the United States of

America but also around the world. There are many reasons which make the company under high

risk of competition; easy entry in beverage industry, health concern, and economic crisis.

First reason of high risk of competition, it is easy for any companies to enter the beverage

industry because the new company can start with one product and small marketing tactic that

attempts to set the company apart. Moreover, there is no market limitations because the new

customers have options to select what they need based on two factors, price and the quality of

product. Also, there is no consumer switching and zero capital requirement.

Second reason of the high risk of competition is health. The public health officials and

government officials are becoming increasingly concerned about the public health consequences

associated with obesity, particularly among young people. In addition, the researchers, health

advocates and dietary guidelines are encouraging consumers to reduce consumption of sugar

sweetened in beverages. Consequently, the Coca-Cola Co tries to change in their recipe to reduce

the sugar without affecting its quality.

The last reason of high risk of competition the economic crisis, The Coca- Cola Co is a

global company and it enters in many economies around the world. That means the company has

competitors in each country and when any country has economic crisis immediately will effect to

the Coca- Cola Company. There are increasing beverage companies operating in multiple

geographic areas, and new brands in the market with similar prices. Also, Coca-Cola does not

really have an entirely unique flavor compared to other kinds of beverage products, such as
 Coca-Cola 11

PepsiCo’s. There are some soda brands, like Dr. Pepper, becoming popular because of their

unique flavors.

One key industry trend that will lead to increased competition is possible new taxes on

sugar-sweetened beverages and additional governmental regulations that restrict them for young

children, which would reduce demand for a large and potential consumer segment consisting of

school children that will affect its profitability. More companies will invest in water products and

certain still beverages that can be allowed to sell in schools. Coca-Cola has to compete with

those companies with healthy beverage brand images.

Financial Structure

For several beverage companies that have negative operating income, they should not use

debt as the financing tools, which can make the financial condition of the company become

worse. Also, most of the beverage companies have high inventory turnover, such as 5.90 of

industry average in 2013, so the total cash inflow received also tends to be high. In this

condition, these companies should not use debt as the financing tools, as it can fund their

business activities with their cash inflow and operating income. In addition, the companies with

high cost of equity should not use debt, since adding debt to their capital structure will lead to

higher weighted average cost of capital. Coca-Cola has investments in bottling partners, which it

accounts for under the equity method, and its operating results include its proportionate share of

such bottling partners’ income or loss.

 Coca-Cola 12

General Background

The Coca-Cola Company is the world’s largest beverage company. Beverage products

were sold in the United States since 1886. The company operates in more than 200 countries. It

is headquartered in Atlanta, Georgia and employed 130,600 people as of December 31,

2013. Coca-Cola is a manufacturer, distributor and marketer of non-alcoholic beverage. The

company owns or licenses and markets more than 500 brands, including diet and light beverages,

waters, juices and juice drinks, teas, coffees, and energy and sports drinks. The company has a

dominant market position, driven by strong billion dollar brands in its portfolio (Coca Cola 2013

10-K).

Vertical Analysis

Balance Sheet:

The enterprise long term liability in 2013 is 21.27% of its total liabilities and equity and

its major competitor PepsiCo is 31.41%. Coca Cola has a much narrower margin compared to its

major competitor in the market. The data indicates that long term liability has inclined from

17.10% in 2012 to 21.27% in 2013. The 4.17% difference has direct correlation to the

composition of other forms of liabilities. The current liabilities such as accounts payable has

increased by 0.56% while loans and notes payable decrease by -0.14%, current maturities of long

term debt by -0.69% and accrued income taxes by -0.20%. The company has a history of using

long term debt to retire its maturing liabilities (Coca Cola 2013 10K Report).

Income Statement:

In comparing the company’s performance to its major competitor, Coca Cola has a better

command in gross profit than PepsiCo, 60.68% compared to 52.96% of PepsiCo. In 2013 Coca
 Coca-Cola 13

Cola’s gross margin slightly improved by 0.36%, this is attributable to cost of sales. Despite the

decrease in sales the company‘s gross margin is slightly higher than in year 2012. The other

operating expense of 1.91% is due to the company’s productivity and reinvestment program

(legal, outplacement and consulting fees). The company’s reported earnings is impacted by

revaluation and devaluation of currency since all earnings of each individual subsidiary has to be

translated to U.S. currency. Sales are also affected by consumer health awareness (Coca Cola

2013 10K Report).

Horizontal Analysis

Balance Sheet:

Certain items in the balance sheet reflect upward trends while other items indicated the

opposite. These are the result of the management strategic planning to effectively and efficiently

manage limited resources, however some factors not under the control of management can

directly and indirectly affect the business. The company Cash and cash equivalents increased by

23.36% and Short term investments increased by 33.69%. The company credited its favorable

results due to its overall cash management strategy. Other assets increased by 30.01% and other

liabilities decreased by 36.03%, this is due to the company’s reclassification of certain pension

plans and moving it from other liabilities to other assets which was the result of actuarial gains,

higher returns and incremental funding in 2013. Coca Cola has issued a long term debt in 2013

which causes this line item in the balance sheet to increase by 29.98%. The funds procured was

used to extinguished some of the company’s maturing debts which resulted in declined in current

maturities of long-term debt by -35.07% (Coca Cola 2013 10K Report).

 Coca-Cola 14

Income Statement:

The company’s operating income was affected by sales, structural changes, currency

fluctuation and price in each geographic segment of operation. Coca Cola’s operating income

decline by -4.56% while its competitor’s major competitor PepsiCo experienced an incline by

6.51%. This was due to PepsiCo’s soaring sales of its snack products like Lays potato chips and

Quaker oatmeal (Bloomeberg.com) (Coca Cola 2013 10K Report).

Ratio Analysis:

Valuation Ratios

Dec 31, Dec 31, Dec 31, Dec 31, Dec 31,
Years
2013 2012 2011 2010 2009

Price to earnings (P/E) 19.54 19.00 18.27 12.42 17.81

Price to operating profit (P/OP) 16.40 15.90 15.42 17.36 14.76

Price to sales (P/S) 3.58 3.57 3.36 4.18 3.92

Figure: Coca-Cola Co., historical price multiples

Source: http://www.stock-analysis-on.net/NYSE/Company/Coca-Cola-Co/Valuation/Ratios

Coca-Cola Co.'s P/E ratio increased from 2011 to 2012 and from 2012 to 2013. The P/E

ratio tells analyst how much an investor in common stock pays per dollar of current earnings.

P/OP ratio increased from 2011 to 2012 and from 2012 to 2013. Because P/E ratio is calculated

using net income, the ratio can be sensitive to nonrecurring earnings and capital structure that is

why price to operating profit is calculated and used here. The P/E ratio looks better than P/OP

ratio for Coca Cola.

 Coca-Cola 15

P/S ratio increased from 2011 to 2012 and from 2012 to 2013. A rationale for the P/S ratio is that

sales, as the top line in an income statement, are generally less subject to distortion or

manipulation than other fundamentals such as EPS or book value. Sales are also more stable than

earnings and never negative.

Valuation
60

50 52.4
46.7
40

30

20
20.97
18.13 18.4
16.52
10
3.84 1.56 1.5 1.85
0
Price to Earnings Price to Sales Price to next year Price-earnings-growth Price to Free Cash Flow
expected earnings (PEG) (PFCF)

Coca Cola Industry

Figure: Valuation ratio of Coca Cola and the industry (2013)

Source: http://www.stock-analysis-on.net/NYSE/Company/Coca-Cola-Co/Valuation/Ratios

Coca Cola all valuation ratios are impressive in comparison to industry ratio, even though

its growth is not in pace with the industry. We do not take this as a red signal because the

company is in its maturity. And the good thing is, the Coca Cola has lots of free cash flow that

shows that the company has less risk in terms of going concern.
 Coca-Cola 16

Financial Strength Measurement

Dec 31, Dec 31, Dec 31, Dec 31, Dec 31,
Years
2013 2012 2011 2010 2009

Current ratio 1.13 1.09 1.05 1.17 1.28

Quick ratio 0.90 0.77 0.78 0.85 0.95

Cash ratio 0.73 0.59 0.58 0.61 0.67

Debt to equity 1.12 0.99 0.90 0.76 0.48

Coca-Cola Co.'s current ratio improved from 2011 to 2012 and from 2012 to 2013. A

liquidity ratio calculated as current assets divided by current liabilities.

Coca-Cola Co.'s quick ratio deteriorated from 2011 to 2012 but then improved from 2012

to 2013 exceeding 2011 level. A liquidity ratio is calculated as (cash plus short-term marketable

investments plus receivables) divided by current liabilities.

Cash ratio improved from 2011 to 2012 and from 2012 to 2013. A liquidity ratio

calculated as (cash plus short-term marketable investments) divided by current liabilities.

Coca-Cola Co.'s debt-to-equity ratio deteriorated from 2011 to 2012 and from 2012 to

2013. A solvency ratio calculated as total debt divided by total shareholders' equity. This ratio

poses a threat because it is getting worse each year.

Overall Coca Cola’s financial strength is impressive. However, the deterioration of quick ratio

and debt equity should be taken into consideration. We will measure those in comparison to the

industry
 Coca-Cola 17

Financial Strength
Coca Cola Industry

1.1
1
0.9
0.8
0.7
0.57

QUICK RATIO CURRENT RATIO LONG TERM DEBT TO EQUITY

(Figure: Financial strength of Coca Cola and the industry (2013))

Therefore, in comparison to the whole industry, the financial position of Coca Cola is not

impressive in terms of ratio even though the amount in the balance sheet and income statement

are huge.

Growth Rates

Growth rate for sales of Coca Cola for last 5 years is 9.94% whereas the industry growth

rate is 7.21%. The interesting thing about Coca Cola is its EPS is growing at 6.90% rate where

the industry EPS is reducing at 2.18% rate

Management efficiency and effectiveness

Coca Cola is doing great in return of assets and investments. It has better bargaining

power with its debtors, but the management of Coca Cola is not performing the way the

management of the industry is performing in terms of inventory and asset turnover.

 Coca-Cola 18

Management Efficiency and

Effectiveness
10
9.3 8.6 9.1 9
5 6.8
4.7 0.5 0.7
0
Return on Assets Receivable Turnover Inventory Turnover Asset Turnover
(TTM) (TTM) (TTM) (TTM)
Coca Cola Industry

Source: http://www.fool.com/quote/nyse/coca-cola/ko/financial-ratios

Risk Assessment

Coca-Cola Company has operationally positioned itself as a leader in the industry. The

company’s comparative advantages as strong brand portfolio and market leadership continues to

be impacted by the position of its competitors. Risk remains high for the industry that water

scarcity and poor quality impact production costs and capacity, regulations affect sales at certain

points of sale, and rising labor wages and healthcare costs in the US further weigh down on its

profit margins. Water shortages have been created because of rapid population growth and

continued pollution of existing freshwater sources. Increasing production costs or face capacity

constraints may affect Coca-Cola’s profitability in the long run. Possible new taxes on sugar-

sweetened beverages and additional governmental regulations may reduce demand that affect its

profitability. In a result of tight labor markets, increased overtime, government mandated

increases in minimum wages and a higher proportion of full-time employees, labor costs for the

company have been rising. Coca-Cola relies on bottling partners’ financial that a deterioration of

the financial condition or results of operations of major bottling partners could adversely affect
 Coca-Cola 19

net operating revenue; could result in a decrease in equity income; and could negatively affect

the carrying values of investments resulting in asset write-offs. Increase in the cost, disruption of

supply or shortage of energy or fuels or ingredients, other raw materials or packaging materials

could affect its profitability. The growth of current ratio was due to increase in current assets and

decrease in current liabilities from 2012 to 2013, which could suggest that Coca-Cola has

inferior payment conditions for accounts payable compared to payment conditions for accounts

receivable, so that auditors should focus on more accounts payable (Coca Cola 2013 10K

Report).

Recommendation

After conducting ratio analysis, horizontal and vertical analysis and other analytical

procedures, our findings are:

a) Company is going concern

b) There are no other significant risks.

c) There are no material misstatements in past.

d) The company’s financial performance is consistent with regards to industry over the

years. On the basis of our observations above we can accept the audit engagement of The Coca

Cola Company.
 Coca-Cola 20

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 Coca-Cola 21

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