Supplementary memorandum submitted by
Milk Link (DFoB 36a)
INQUIRY INTO THE FAILURE OF DAIRY FARMERS OF BRITAIN
RESPONSE TO
COMMENTS IN
IGNACITY PAPER
TO EFRA SELECT
COMMITTEE[7]
1. Introduction
1.1 Milk Link notes the memorandum submitted
by Ignacity and wishes to comment on two aspects of this paper.
1.2 The first is to respond to several criticisms
of Milk Link's accounts and business practices made in the paper.
There has been no correspondence between the parties and the writer
of the Ignacity paper has not sought to confirm the accuracy of
his assertions. The criticisms are:
— treatment of contributions to Member
Capital Accounts;
— treatment of intangibles;
— revaluation of fixed assets;
— the Profit & Loss account overstates
the actualite; and
— Milk Link has a generous bonus policy.
1.3 The second is in relation to the suggestion
that a new form of commercial paper would be necessary to allow
members of a co-operative to trade their asset. Milk Link believes
this is actually possible under present arrangements as it itself
has done and continues to do.
2. Contributions to MCA
2.1 Milk Link's policy, which has been applied
consistently, is clearly set out in its accounts under Accounting
Policies. On page 47 of the Report and Accounts 2009, note "s"
(Member Reserve Loans) states "Under the Society's rules,
the Member milk price consists of a "headline" price
and a distribution of profits, currently 0.5 pence per litre.
This amount is withheld from payments to Members to create a reserve
which is then distributed to Members, who have agreed to lend
the amount to the Society as a Member Reserve Loan. The amount
of each Member Reserve Loan is credited to the relevant Member's
Capital Account." The treatment has been thoroughly reviewed
and agreed both by Deloitte LLP (Milk Link's current auditor)
and by Grant Thornton LLP (the previous auditor).
2.2 The amount credited to Members Capital
Accounts is set out at the foot of the P&L account, which
also shows the cumulative profit and loss reserve carried forward.
2.3 It is clearly set out on Milk Link's
Balance Sheet that these contributions are separate from General
Reserves as they are shown as a separate caption under Funds provided
by Members whereas both the Revaluation reserve and Profit and
loss reserve appear in a different section of the Balance Sheet
headed Capital and reserves. It is thus perfectly clear that Milk
Link is treating Member Capital Accounts as a liability on the
Balance Sheet—not (as Ignacity asserts) "treating money
that belongs to individual members as part of its own assets".
3. Treatment of Intangibles
3.1 The Goodwill on Milk Link's balance
sheet arose in relation to the acquisition of its processing businesses
and represents the excess of consideration over the fair value
of the tangible assets acquired. This begs the question as to
why Milk Link should have paid greater than tangible asset value?
The reason is clear—Milk Link believed (and subsequent trading
has confirmed) that the income generated by the assets acquired
justified a higher value. UK accounting rules state that such
excess value must be treated as Goodwill and amortised over the
expected life of the business stream with a maximum of 20 years.
This is Milk Link's policy and is clearly set out on page 45 of
the Annual Report & Accounts 2009 as Accounting Policy "d".
3.2 Milk Link regularly reviews whether
any impairment is appropriate (as required by Accounting Standards)
on the basis of achieved profit from the businesses acquired compared
to that expected at the time of acquisition. To date no impairment
has been necessary (other than in respect of businesses which
have been sold).
4. Revaluation of Fixed Assets
4.1 Milk Link commissioned King Sturge,
a firm of Chartered Surveyors, to carry out a valuation of all
the Group's properties as at 4 April 2009, in accordance with
the principles adopted by the Royal Institute of Chartered Surveyors.
This revealed a surplus over book value of £11.3 million
and was recorded in the accounts as at 4 April 2009 in accordance
with accounting standard FRS15. For the record, the gain did not
arise through the Profit & Loss Account but in the Consolidated
Statement of Total Recognised Gains and Losses and it should be
stressed was not as suggested by Ignacity a factor in determining
any executive bonus. The surplus is recorded as a separate caption
on the balance sheet and not as part of the Profit & loss
reserve. FRS15 requires the gain to be amortised over the remaining
useful lives of the assets and this cost is charged to the Profit
& Loss Account.
4.2 The Milk Link Board took the view that,
following various acquisitions and disposals, the Group's asset
base was now stable and accordingly, it was appropriate to update
the value of its processing facilities to reflect more accurately
their value to the business.
5. The Profit and Loss Account overstates the
actualite
5.1 This statement is not supported by any
evidence other than the writer's opinion on the treatment of Member
capital contributions. Milk Link's published accounts reflect
accurately the financial impact of its business transactions,
including transactions with its Members. As noted above, the gain
arising on revaluation of its properties was not included in the
P&L Account.
5.2 The audit process is overseen by an
Audit Committee, comprising an independent director and two elected
farmer directors. In this context we would point out that Milk
Link regularly publishes its annual Report and Accounts on a timetable
fully in line with that of comparable publicly quoted companies
rather than taking advantage of the generous timetable allowed
by the Industrial and Provident Societies legislation.
6. Milk Link has a generous bonus scheme
6.1 The bonus arrangements for executive
directors and senior executives were developed by the Remuneration
Committee (comprising the Chairman and three elected farmers directors),
which had advice from MM & K Ltd, as external advisors, to
provide benchmark data and guidance on the design and implementation
of short and long-term incentive plans. It should be noted that
these are based on achievement of a "balanced scorecard"
of objectives, directly aligned to advancing Members' interests.
6.2 Current best practice suggests that
a significant proportion of executive compensation should be contingent
on performance and Milk Link's remuneration policy is in accord
with that principle.
7. Raising Funds for Co-operatives
7.1 The remainder of this note responds
to the suggested proposals from Ignacity for the raising of funds
by co-operatives.
7.2 Milk Link is interested in any constructive
suggestions that would facilitate raising the funds necessary
to support Co-operatives' growing Balance Sheets. Any such proposal
should, however, bear in mind the fundamental principle that a
co-operative exists primarily to add value to its Members' businesses
rather than to make profits in its own right. The principle means
of returning value to Members should be through Members trading
with the co-operative rather than through the payment of interest
or dividends on amounts invested. These principles are best achieved
if the co-operative is owned by its Members rather than by external
investors, whose interests may diverge from those of the members.
7.3 To date UK co-operatives have been subject
to a restriction that no Member may hold more than £20,000
of equity in the co-operative. There is no restriction on amounts
that may be lent to co-operatives and most have used the loan
route to raise capital. These loans are repayable to Members when
they leave or retire from the Society and this does require that
such capital is replaced. It does, however, maintain the principle
of the Society being owned and funded by its supplying Members.
7.4 The Ignacity proposal appears to anticipate
capital being retained by former members or even being subscribed
by external investors as the writer refers to a market being created
and mentions analysts commenting on the investments in a similar
way to analysts commenting on PLC performance.
7.5 Milk Link would be concerned that such
a proposal would introduce a number of issues:
— There would be a potential conflict between
the interests of supplying Members and external investors, with
the latter being more concerned with profitability than, in Milk
Link's case, the milk price.
— It is unclear whether these investments
would be equity or debt—if the latter would they rank after
bank borrowings but ahead of Member debt?
— How would the banks that lend to co-operatives
view this new form of paper and would it affect the terms on which
they are prepared to lend?
— If they are to be regarded as equity,
it would suggest that the holders of this paper would be the ultimate
owners of the business rather than the Members whose enterprise
had created it. We think this is unlikely to be acceptable to
Members, as has been evidenced by the reaction of Fonterra members
to that company's proposals for a partial floatation.
— If this paper is "quasi equity"
how would the return on it be treated for tax purposes? At present
interest paid to Members on loans is allowable against tax in
the accounts of the co-operative. If the new paper is entitled
to receive dividends these may have to be paid out of taxed profit
adding a further burden to the co-operative.
7.6 Milk Link believes it is possible to
allow Members to trade their loans without creating any new type
of paper and in fact introduced such a system three years ago.
Since then over £1 million of Qualifying Loans have been
traded between Members.
7.7 Milk Link also considers that a preferable
method of introducing external capital (if needed) would be to
issue a minority interest in the share capital of a processing
subsidiary. Such companies tend to be organised under Companies
Act legislation and so issuing equity is a tried and trusted process.
This structure has been adopted by Glanbia and Kerry and appears
to work well. The top company in the organisation remains a co-operative
wholly owned by its Members but the principal operating subsidiary
has minority shareholders (in Glanbia's and Kerry's case the shares
are listed but this is not essential).
Milk Link
February 2010
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