mcdonalds financial reort analysis

Analysis of McDonald’s Annual Financial Report
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Analysis of McDonald’s Annual Financial Report
Presentation of the Information Related to the Company’s Derivatives
Derivatives can either be financial assets or liabilities. Fair value is relied on by the Company to recognize variations of financial assets and liabilities as well as non-financial assets and liabilities. Fair value constitutes the money that the Company would receive for the sale of an asset in a rational market or the money the Company would pay for the acquisition of a liability in a similar market. To optimize the application of observable inputs, the company ranks fair value disclosures based on three hierarchies (McDonald’s Corporation 2015 Annual Report, 2015). A valuation hierarchy relies on the transparency of input during the valuation of asset or liability at the measurement date. The three hierarchies are stipulated as follows:
1. Level 1 – Inputs are valued based on the quoted prices of similar asset or liability in a rational market.
2. Level 2 – Inputs are valued based on the quoted prices of similar asset or liability in a rational market and prices of an asset or liability are also valued based on models.
3. Level 3 – The methodology used to value an asset or liability is unobservable and significant to the fair value valuation of the asset or liability.
Types of Derivatives Used By the Company
The Company is predisposed to volatility in foreign exchange rates and interest rates since it operates in a global economy.

The Company relies on debt denominated in foreign currency as well as derivative instruments to cushion itself against these risks. However, the Company neither holds nor sells derivatives instruments to make a profit (McDonald’s Corporation 2015 Annual Report, 2015).
The Company not only maintains records for its risk management criterion and strategy for engaging in hedging transactions but also documents the links between hedging instruments. The primary derivatives of the Company used for hedge accounting are interest rate swaps, foreign currency forwards, foreign currency options, and cross-currency swaps (McDonald’s Corporation 2015 Annual Report, 2015).
The Company also relies on other derivatives not recognized for hedge accounting. To this end, the Company has relied on equity derivative contracts, including total return swaps to mitigate against risks caused by the volatility of the market (McDonald’s Corporation 2015 Annual Report, 2015). Further, the Company relies on foreign currency forwards to minimize the risk loss in the depreciation of foreign currency assets and liabilities.
Reasons behind the Company Using Derivatives
First, the Company uses derivative instruments to minimize risk in the underlying asset or liability (Tuckman, 2016). The Company enters into a contract where the price of the underlying assets advances in the opposite direction thus offsetting all or part of the risk. Second, the Company uses derivative instruments to create options whereby the value of the options is pegged on the occurrence of a given event (Tuckman, 2016). Third, the Company uses derivative instruments to create leverage (or gearing). Consequently, the underlying asset achieves a significant difference from minimal movement in the underlying asset (Tuckman, 2016). Fourth, the Company uses derivative instruments to allow asset allocations between different classes of assets without affecting underlying assets (Tuckman, 2016). The Company operates in a global economy whereby it has numerous subsidiaries and branches in other countries. Thus, derivatives are necessary to facilitate the convenient transfer of assets during transition management. Lastly, the Company uses derivative instruments to save on the income tax expense. For instance, equity swaps allow the Company to receive periodic payments without remitting capital gains tax while retaining the ownership of the stock.
The Amount of Income or Loss Recognized In the Income Statement Related To Derivatives
The Company categorizes derivatives as hedging instruments and non-hedging instruments respectively. Further, derivatives categorized as hedging instruments or non-hedging instruments exhibit derivative assets and derivative liabilities. The total (income) for derivative assets designated as hedging instruments was $60.9 in 2015 and $108.2 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015). The total (loss) for derivative liabilities designated as hedging instruments was $38.9 in 2015 and $42.3 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015).
The total (income) for derivative assets not designated as hedging assets was $144.4 in 2015 and $137.9 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015). The total (loss) for derivative liabilities not designated as hedging liabilities was $5.5 in 2015 and $7.9 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015). The overall total (income) for derivatives was $205.3 in 2015 and $246.1 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015). The overall total (loss) for derivatives was $44.4 in 2015 and $50.2 in 2014 (McDonald’s Corporation 2015 Annual Report, 2015).
Derivative Contracts That Do Not Meet Hedge Accounting Criteria
The primary role of derivatives is to cushion the Company against risk (interest rate and currency risk) that arise from operations in a volatile global market. Changes in the fair value of hedge instruments are recorded in the Profit and Loss (P&L) (Panaretou, Shackleton & Taylor, 2013). On the contrary, hedged assets or liabilities are recognized on cost (amortized) or fair value through equity (Panaretou, Shackleton & Taylor, 2013). Consequently, a mismatch arises between the value of the hedged item (asset or liability) and hedge instrument. Hedge accounting eliminates this undesirable mismatch in the P&L stemming from the valuation differences.
The Company exhibits certain derivatives that do not meet the hedge accounting criteria. Consequently, there is an immediate recognition of the variations in the fair value of these derivatives where the earnings and gain or loss from the balance sheet are recorded concurrently. For instance, the Company relies on equity derivative contracts such as total return swaps to mitigate risks in the volatile global economy. Fair value changes in these derivatives are recognized in selling, general & administrative expenses as well as variations in the supplemental benefit plan liabilities (McDonald’s Corporation 2015 Annual Report, 2015). Also, the Company relies on foreign currency to minimize the risk of depreciation in value of foreign currency assets and liabilities. Consequently, variations in the fair value of these derivatives are recorded in non-operating income or expense as well as recognition in the balance sheet for currency gain or loss (McDonald’s Corporation 2015 Annual Report, 2015).
References
McDonald’s Corporation 2015 Annual Report. (2015) (1st ed., pp. 30 – 39). Retrieved from
http://corporate.mcdonalds.com/mcd/investors/financial-information/annual-report.htmlPanaretou, A., Shackleton, M. B., & Taylor, P. A. (2013). Corporate risk management and hedge
accounting. Contemporary Accounting Research, 30(1), 116-139.
Tuckman, B. (2016). Derivatives: Understanding Their Usefulness and Their Role in the
Financial Crisis. Journal of Applied Corporate Finance, 28(1), 62-71.