Expository Essay Sample on Revaluation of Assets

Introduction

Accounting has a set of principles that guide how entities report their performance and how they account for their various items (KPMG, 2013). Overall, the requirement is that the reports that they paint a true and fair picture of the nature of their operations. As such, some events may make it impossible for firms to project an image of fairness in their reports. One of the critical provisions in the accounting standards is that firms report their performance on a going concern basis meaning that there is nothing that the entity sees will curtail its operations into the future. If there is an event that may have a material effect on the ability of the company to operate into perpetuity, the requirement then is that it should issue its report on a break up basis. That would mean that it would value its assets depending on how much they would fetch on the market if the firm disposed of them (KPMG, 2013).

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Property, plant, and equipment, shortened as PPE, forms the bulk of the assets that many mining and oil and gas firms hold (Pwc, 2012). In the case of Karrick Gold Limited, it holds significant amounts of PPE worth 16. 5 billion AUD, and thus it is important to determine their appropriate treatment. IFRS 6 and IAS 16. In a nutshell, IFRS 6 would require KGC to perform some tests on its PPE to determine the treatment that it shall accord to the assets. In choosing whether or not to impair, there is an elaborate process that the firm must follow so as to determine the best treatment. As a rule, a company should write down an asset to its fair value, less any costs to sell it if there are no commercially- viable reserves where it can be put to use. As such, the entity concerned may not group such an asset together with other producing properties or cash-generating units (Pwc, 2012).

IFRS 6 is progressive and introduces an alternative regime to test for impairment of assets used in exploration, and that would apply to KGC. Under this method, the organization has to assess a host of factors that may indicate the existence of impairment. The first issue that the firm should look out for is the expiry of rights to explore in an area or the expiry in the foreseeable future without the prospect of renewal. That would mean that the company will have to cease its operations in that locality and may thus struggle to find a use for the PPE there. This is the case for KGC as the authorities in Papua New Guinea have indicated an unwillingness to extend the company's prospecting license in the Star Mountain Range. The second consideration is when the entity itself has no plans or has not aside budgeted for exploration activities. KGCs management has already decided to discontinue prospecting because its license expires in eight years (Pwc, 2012).

The decision to proceed with the development of a mine depends on the existence of commercially-viable deposits of whatever mineral a company is exploring. As such, if the mining enterprise realizes that an area no longer has economically- feasible quantities of the mineral, it may choose to discontinue operations in which case it would have to impair the PPE there (KPMG, 2013). The last reason for impairment is if the concerned entity has scientific data that indicates the inability to recover the book value of its assets from future development and production. KGC thus has enough ground to begin evaluations of its operations for impairment.

The impairment process is a deliberate one, and KGC has several steps that it has to follow when carrying out the whole undertaking. IFRS 6 affords companies the choice of choosing a policy based on cost or depreciation (KPMG, 2013). However, the standard requires that the entity concerned applies whatever model it chooses consistently once it adopts it. Firms have leeway when it comes to larger cash-generating units (CGUs) where they may group assets considered for impairment with production assets (Pwc, 2012). The cardinal rule here, however, is that they have to show consistency in applying the policy, and they should also make sure that they fully disclose the actions that they carry out regarding the PPE. Most importantly, a firm has to note that a CGU cannot be larger than an operating segment before aggregation. The benefit of the grouping of assets is that it can help a firm like KGC avoid having to impair assets for a long time. However, the entity would need to have other continuing operations where they are not considering impairing the PPE there (Pwc, 2012).

The decision on commercial viability is usually the greatest consideration in this kind of undertakings. Once a company ascertains that the reserves do not meet the requirement for viability, it then has to reclassify the PPE from the category of exploration and evaluation. It then conducts the impairment test under the policy it adopts according to the provisions of IFRS 6 before the reclassification (Pwc, 2012). After that, the company follows the requirements of IAS 36 on impairment. The company reclassifies successful PPE to development while writing down the unsuccessful assets to the higher of fair market value less the selling costs or value in use (Pwc, 2012).

Several issues arise in the impairment of PPE for a mining company, and they may pose risks. First, the company has to apply the policy treatment consistently it opts for in the impairment process (KPMG, 2013). Deviating from the model of choice may cause problems in valuing the assets and result in the company not presenting a fair picture of its state of affairs. Secondly, the entity has to disclose any changes that may affect the status of its mining operations such as the expiry of its licenses or the discovery that a mine no longer has reserves of commercial value (KPMG, 2013). It is of particular importance if the management learns of such information before the issuance of published financial statements for public companies. In such an event, the company would have to follow the requirements of IAS 10 on events after the reporting period and determine if such news is adjusting or non-adjusting to the entity's reported information (Pwc, 2012).

True and Fair Value

IAS 1 sets out the requirements for the way firms should publish their financial statements and has the cardinal rule that they should present the true and fair position of the reporting company (Wilkinson-Riddl, 2008). According to Wilkinson-Riddl, (2008), the overall truthfulness and fairness of the statements reflect the nature of the constituent components of the statements. As such, the company must apply the proper measurement, valuation, and cutoff procedures for its income statement and balance sheet items, meaning that their values as carried in the records also have to be true and fair.

KGC faces a decision on the value which it should assign to its PPE so as to reflect the position. Having followed the requirements of IFRS 6 and IAS 36 that guide the process of revaluation of their PPE, it is then important to assign the appropriate value to the revalued PPE. IAS 36 is the guiding principle that provides for the measurement of asset value after revaluation. It proposes two measures that a company has to consider and then pick one. The final decision would be the higher of either the fair value or value in use (Pwc, 2012). Fair value is the amount at which two knowledgeable as well willing parties would exchange an asset or settle a liability in an arms-length transaction. It reflects the net selling price as it is what the firm would receive when it sells the asset less any costs it incurs in the sale of the asset. According to IAS 36, the value in use is the discounted cash flows accruing to a user from the continued use of the asset and its eventual disposal at the end of its useful life (Pwc, 2012). The value which KGC should assign to its assets is thus the replacement or fair value at 20 billion AUD as it is higher than the 12.5 billion AUD value in use. The company cannot consider the 30 billion AUD because the accounting standards disallow contingent valuation of assets (Wilkinson-Riddl, 2008).

Triple Bottom Line

The triple bottom line framework presents an approach in which organizations not only report on their financial performance but also on their social and ecological performance (Savitz & Weber, 2012). As such, they report profits, people, and planet to meet the three aspects of assessment respectively. KGC is a company involved in mining activities that touch the social and ecological aspects in many ways. In choosing to report based on the triple bottom approach, also known as 3BL, the company would be in a position to account for its impact on the environment and also on the people living around the areas it mines and even further away (Savitz & Weber, 2012).

Operating in a region with delicate ecosystems and exotic plants and animals, KGC has to remain careful of what it does and ensure that it protects the environment. 3BL would require it to report on such measures. The company has an involvement in the local community, providing jobs as well as other amenities such as hospitals and schools. It can capture all these details in its reports under the 3BL model and thus gain even more legitimacy from the locals as well as the authorities. One downside of the 3BL reporting model for KGC is that it would require the company to report on cases where it has occasioned harm to the environment and the people such as with the spill of the sludge into the river.

The Need for Legitimacy

Any business needs to have a sense of legitimacy or sanction of its business activities from the local communities as well as the authorities. KGC operates in the extractive industry which often involves going into communities and conducting activities that may interfere with their normal lives and livelihoods. As such, the company needs to have the feeling that all stakeholders approve of its doings, and there is little or no resistance to its activities.

Threat to Legitimacy

The collapse of the tailings pond and the dumping of the 5 million liters of sludge into the river is a real risk to the legitimacy which KGC had previously enjoyed. The damage caused by the flow of the sludge into water sources and the consequent loss of livelihoods is something that will not go down well with locals as well as the authorities. The refusal by the company management to own up for the spill may further infuriate the residents and mean even more loss of legitimacy for KGC.

How to Restore Legitimacy

KGC finds itself in a place where it has lost its credibility and needs to fix its image quickly. First, the company should acknowledge its responsibility for the spill and issue a public apology. While it is clear that the company will incur hefty fines for its mistake, such a move could help its position in negotiating a more favorable settlement. The primary stakeholders in this scenario consist mainly of the locals drawn from communities living near the mines and who feel the direct effects of the spill. There are also secondary stakeholders comprising of government and regulatory authorities as well as lobby groups and civil society organizations.

Recording the Environmental Costs

Local laws and international standards do not have explicit requirements compelling companies to quantify and report their environmental impact. KGC can develop a means of reporting on its environmental impact even after the spill using the Puma model of an environmental profit and loss statement (Pedersen, 2016). It should have an independent party perform an audit of the reported information. The advantage of such a move is that it would help clean up the company's image in the short- run and build it more goodwill and legitimacy longer-term. However, a potential challenge lies in...