Robb on Cooperation

Fair value shares

Posted by Alan Robb on 29 September 2009 | 0 Comments

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Traditionally it has been the practice for cooperative capital to be contributed and redeemed on the basis of ‘a dollar in – a dollar out.’

Increasingly though, New Zealand cooperators are considering membership in terms of fair value shares.

This concept deserves discussion as, wrongly calculated, it can enhance or endanger the financial stability of cooperatives.

Firstly, some comments on the principle of ‘a dollar in – a dollar out’.

This does not mean that all members should necessarily contribute the same amount, whether $1 or $100 or $100,000, although in some small cooperatives the same small amount could be appropriate.

In other situations, where members might make widely differing demands on the services of the cooperative, capital should be contributed in proportion to expected level of usage for there to be fairness between members.

The principle of ‘a dollar in – a dollar out’ implicitly recognises that membership of a cooperative is not an investment activity where a member’s contribution is capital invested and which could be expected to grow over time.

Is there anything wrong with ‘a dollar in – a dollar out’? Yes, there is one problem. Because of inflation, a dollar today is worth considerably less than what it was worth in the past.

This means that the capital contributions may need to be reviewed regularly so that new members contribute equitably to the asset base required.

Conversely, members leaving the cooperative will be treated equitably only if the dollar they withdraw has something like the purchasing power of the dollar they contributed.

A possible solution is to recognise the effect of inflation annually on the contributed capital so that admissions are made at the new rate – the fair value – and redemptions are paid out at the same rate.

The inflation adjustment would reduce the distributable rebate for the year; this would mean a more realistic operating result, and would also ensure that members’ equity would be stated more realistically.

Two possible further refinements could be considered, although these do conflict with traditional cooperative values.

They relate to retained profits or surpluses and asset revaluations.

To the extent that trading surpluses are not distributed but are ploughed back they can be looked on as distributions forgone by members.

To some, this is one of the natural responsibilities of good stewardship – to enhance the assets one is entrusted with so that they are left in a better condition for coming generations of members.

To others, amounts ploughed back are value they are morally entitled to when they leave.

Some observers of the cooperative movement would criticise this view as being selfish and contrary to cooperative values: members are getting out more than the dollar they put in.

If a board did consider that retiring members should be paid out for their proportionate share of retained surpluses, the fair value at balance date would be based on the initial capital contribution plus the inflation adjustments plus the retained surpluses.

Revaluing assets
The matter of asset revaluations is a little more complex. Revaluing fixed assets regularly is a good practice.

Some years ago the New Zealand Institute of Chartered Accountants said “assets should be revalued regularly, preferably annually, to net realisable value.”

I agree. Only then will the true financial position of the entity be shown. Only then will a board know if it meets the solvency test, when the value of assets is greater than the value of its liabilities.

But should the asset revaluation be considered something which rightfully “belongs” to members leaving the cooperative? I think not.

Cooperatives are not formed to capture windfall gains. I would therefore recognise the revaluation as a non-distributable reserve and exclude it from any measure of the fair value of the shares at balance date.

This would be consistent with the ICA statement that “some part of the reserves at least should be indivisible”, that is, kept permanently in the cooperative.

Some fair value calculations are based on estimates of future surpluses discounted back to a present value.

Such numbers are very subjective and incapable of being verified. They can generate values far in excess of the net assets per share.

Consequently members surrendering their shares are paid out more per share than remains in the cooperative for transacting members.

That is inequitable and must inevitably weaken the cooperative financially.

The fair value computation I have suggested above uses objective data readily discoverable by the board of a cooperative.

It involves no inequalities as between members.

Neither does it have an adverse effect on the cooperative’s financial position.

It would be, I believe, an improvement on ‘a dollar in – a dollar out’.

– from the August/September 2008 Cooperatives News