Accounting theory

Accounting Theory

  1. Revaluing PPE assets from historical to fair-market value

The historical cost principle calls for recording liability, equity, or asset initially at its original acquisition cost. This principle is widely applied in recording of transactions since it is easy to use the original purchase price as verifiable and objective evidence of value. Historical cost makes it easy to ascertain credibility of results and the pace at which they can be checked with regard to reference documents. Following initial recognition, a firm chooses to measure property, plant and equipment (PP&E) at either cost less accumulated depreciation and accumulated impairment (cost model) or fair value less subsequent accumulated depreciation as well as accumulated impairment (revaluation model). Revaluations has to happen with sufficient regularity to make sure that the carrying amount of an asset does not differ materiality from that which will be determined with a fair value in the course of the elapse of the period (Gavrea, Ilies & Stegerean, 2011). When item of property, plant and equipment is revalued, the International Accounting Standards calls for asymmetric treatment of fair value changes for any losses or gains hence it provides for different treatment when decreases and increases in value happen. Representational faithfulness shows that there should be some kind of agreement between a measure or value and the events being represented. Historical cost is less subject to manipulation as compared to fair value measures hence historical cost is regarded a more faithful representation of PP&E.

Fair value refers to the price that would be received to sell an asset or that paid in transferring a liability in an orderly transaction between market participants at the measurement date. Fair-value is market-based measurement and not an entity-specific measurement. Therefore, the firm’s intention of holding an asset or settling or otherwise fulfilling a liability is not relevant in case of measuring fair value. Fair value measurement offers relevant, reliable, comparable as well as understandable measurement of future economic benefits. Historical cost cannot accurately capture the value of an accreting asset (Aswath, 2009). Revaluation increases are acknowledged in comprehensive income and accumulated in equity (revaluation). Revaluation decrease has to first reduce the credit balance of the revaluation surplus to zero and then recognized as profit or loss. Impairment and depreciation considerations are similar to those applied to cost model. Most of the time intangible assets are normally measured applying the cost model. A firm can choose to revalue (measuring the asset at fair value), when only fair value can be determined with reference to active to an active market. In case an intangible asset is revalued, all the assets in the same class of intangible assets have to be revalued.

However, historical cost may actually impair comparability of assets through failing to accurately point out differences and similarities among them. The characteristic of consistency favours the application of fair value in the measurement of items of property, plant as well as equipment. Accounting using fair value reports all transactions both present and past applying the fair value approach (Aswath, 2009). On the other hand, historical cost leads to reporting past transactions at historical amounts while other transactions at fair value. Fair values measurements are superior to historical cots within accounting for items of property, plant and equipment.

  1. True and fair value of the PP& E

The property, plant and equipment is approximated to have a replacement value of $20.5 billion AUD in the current expected operations (fair value) but rises to $30 billion AUD if the contract is renewed for ten years in addition to the current seven years as well as new viable ore bodies are found. PP&E value will go up after revaluation using the fair value revaluation. Land appreciates with time and land that has mineral deposits will appreciate more. If the contract is renewed for 10 more years in addition to the current seven years it means the company will prospect more and find more deposits of minerals that can be extracted. The expiry time of their operations would have been extended by ten years (Aswath, 2009). Currently there is no active prospecting for additional reserves of ore since the firm license is expected to expire in eight years. But when the contract is renewed for more ten years prospecting will continue and more mineral deposits will be added hence the value of the PP &E will go up. The value of PP&E is expected to rise to $30 billion AUD when the contract is renewed for 10 years. The true and fair value of PP&E will be determined will the amount of deposits found within the area. The renewal of the contract for 10 years opens an opportunity for exploring for more mineral ores within the Star Mountain region in Papua New Guinea. As stated by the mine manager it is expected that in the next years large deposits of commercially-viable silver-and-lead ore will be found in the mine property or adjacent. The value of PP&E will soar when the time of operation of the company is extended.

  1. Merits and risks of KGC Ltd including a ‘triple bottom line’

KARRICK Gold & Copper Ltd (KGC Ltd) is facing a big challenge in its operations in Papua New Guinea (PNG). Triple bottom line approach is an accounting framework with three parts including social, environmental and financial. Organizations adopt triple bottom line framework in order to evaluate their performance in a wider perspective to build greater business value. Relying on production of cheap products made products made from fossils fuels that are becoming increasingly scarce or raw materials that come from at a region that will be affected by climate change will pose a challenge for the firm. Whereas there have been rich ‘shows’ for lead and silver ore, nothing can be said to be of commercial quality and quantity. According to prospecting news the mine managers expects that over the next eight years huge deposits of silver and lead ore that is commercially viable will be found in the mine property or adjacent. This is purely speculative and the company can spend so much money on corporate social responsibility and end up making colossal losses in the long run (Dutta, 2012). Seeming there is no active prospecting for more reserves of ore since the current license of the firm from the Papua New Guinea government allowing mining in that region is expected to expire within eight years. The pollution report where the company is accused of polluting a river from which two villages depends on for drinking water is catastrophic.

Many environmental groups are of the opinion that KGC Ltd is environmentally responsible. Flushing the sludge through the ocean is not a good solution to the problem since it is endangering aquatic life. The sludge has to be treated to remove toxics before it is released to the ocean instead of the General Manager of the company claiming that the sludge is diluted in the sea. Such remarks from a senior member of the company tarnish the reputation of the company in the triple bottom line approach and jeopardize its business. An ecological group from Australia has final a case in Papua New Guinea claiming that the benefits of mining offset the harm and shutting down operations will be devastating. Whereas triple bottom line reporting builds a platform of engaging in dialogue with stakeholders, there are challenges to the approach. There is no universally accepted method for measuring hence there is no social, environmental and ethical equivalent to expenses, revenues, equity, liabilities and assets (Scerri & James, 2010). Moreover, there is no way of completely or accurately describing consumer, community or environmental benefits using a number. Within Australia companies do self-report and there is no mandatory auditing mechanism. The TBL report has the potential of exposing KGC Ltd to additional risk with regard to reliability of the report when the information is lacking credibility, may not be substantiated, erosion of brand, risk of reputation damage, negative media coverage as well as general loss of stakeholder trust and support.

  1. Importance of KGC Ltd maintaining legitimacy in the eyes of government, traditional land owners and Australian people

The nature of legitimacy is making sure that KGC Ltd engages in legal business that is not harmful to the local citizens of Papua New Guinea. KGC Ltd pays $4 billion in terms of royalties to traditional owners of the land where mining is done and processing of ore as well as $6 billion in taxes to the PNG government. Maintaining legitimacy makes sure that the activities of the company are accepted within Papua New Guinea and it has the support of the people for its products to be accepted in the world. Respect for human rights and protection of natural habitats has been the goal of environmental conservationists. Taking part in community development activities like building schools, healthcare facilities and operating water-processing plants is important in making sure that legitimacy of the company remains intact. The government, traditional land owners and the Australian people play an important role in having the products of the company accepted in the international market. When the company exploits people, people can boycott their products.

  1. The legitimacy of KGC Ltd

The legitimacy of KGC Ltd is at risk considering the kinds of concerns being raised by environmental conservationists and the local residents whose source of livelihood is being interfered with by the operations of the company. 5 million litres of ore-waste sludge dumped into the river has affected two villages that depend on the river for their drinking water, fish, and harvest of lotus root and watering of yam, cassava and yam crops. The management of the company taking lightly the environmental impact of the company is an insult to the resident of Papua New Guinea and undermines environmental conservation. Although the residents of Star Mountain Range in Papua New Guinea depend on operations by KGC ltd for their clean potable water, jobs, education and healthcare, it is important for the company to listen to the concerns raised by environmental groups and resolve them in an amicable manner. The legitimacy of the company is at stake; the Christian-animist of the Indonesian half have been lobbying for independence from Indonesia. The Papua New Guinea tribes near the border with the country are closely related to tribes across the border and there is fear that conflict and the police actions by the Indonesia military will spill over into PNG portion of the Star Mountain Range. If a new government in put in place, it will not acknowledge the operations of a foreign company without the renewal of the contract (Freeman & Moutchnik, 2013).

  1. How KGC Ltd can restore legitimacy

It is important for KGC Ltd to restore its legitimacy in order to continue operating peaceful in Papua New Guinea. KGC Ltd provides employment to 3,400 full-time employees within the mine, offices, as well as processing plant. 3,000 of the employees are citizens of Papua New Guinea. The unemployment rate is 45 percent. If the company shuts down mining operations in the Star Mountain Range in the country, the employment will rise to 95% and there are few alternative sources of employment. Already the company is playing a big role in creating employment and providing a source of livelihood for the people within the Star Mountain Range region. The company must make sure that it engages in business that is legal. Contaminating a river that two villages depend on is careless on the part of the company (Mansell, 2013). Despite what is going on across the border, the company should not be involved in any political activities that will seem partisan in any form to any of the warring sides. The company has to continue supporting community development activities that are beneficial to the citizens.

Stakeholders refer to the groups without whose support the firm would cease to exist. A stakeholder approach will help managers though promoting analysis of how the company fits into the wider environment, standard operating procedures as well as immediately beyond procedures. This is what is referred to analytical theory (Miles, 2012). According to Friedman’s view if the corporate manager concentrates only on maximizing stockholder wealth, other corporate constituencies like stakeholders will be overlooked. Overlooking of the stakeholders is unwise or imprudent or unjustifiable ethically. Corporate social responsibility is important in supporting the activities of the firm in the community. The normative theory explores the responsibilities of the companies in respect to shareholders and why companies have to take care of other interests besides the shareholders’ interests (Miles, 2012). The normative theory is important to stakeholder concept. The relationship between the stakeholders and the firm is based on moral commitment. Both normative and analytic theories are important to KGC Ltd to restoring its legitimacy in the wider community.

  1. Recording cost of harm associated with sludge spillage

There are various ways that KGC Ltd can record the cost of harm associated with the sludge spillage in its GPFS and the methods have their pros and cons. Some of the triple bottom line options available include: combined social and environmental reports, separate environmental and social reports, inclusion of social and environmental information within annual reporting to shareholders; full TBL report, and any other form of communication with stakeholders. Most of the methods include a lot of work safe of a way of communicating with the stakeholders (Aswath, 2009). The company has to understand the international, national and industry sector trends in TBL reporting. Relevance and completeness has to the target of the accounting team.

Documenting of environmental liability transaction needs more detail as compared to traditional transaction. Environmental liabilities are majorly based on estimates. Estimates are subjective and possess an element of uncertainty. Development of the estimates has to maintain records on cost itemization as well as assumptions together with documentation of estimators’ qualifications and management reviews (Freeman & Moutchnik, 2013). Management reviews are critical to the internal control process. Mistakes occur but reviewing of the estimates can detect mistakes before being reported as a liability.

References

Scerri, Andy and James, Paul (2010). «Accounting for sustainability: Combining qualitative and quantitative research in developing ‘indicators’ of sustainability». International Journal of Social Research Methodology 13 (1): 41–53.

Miles, Samantha (2012). «Stakeholders: essentially contested or just confused?». Journal of Business Ethics 108 (3): 285–298

Mansell, S. (2013) Capitalism, Corporations and the Social Contract: A Critique of Stakeholder Theory. Cambridge: Cambridge University Press.

Dutta, S. (2012). Triple Bottom Line Reporting: An Indian Perspective. Interdisciplinary Journal of Contemporary Research in Business, 3(12), 652-659.

Dutta, S. et.al. (2011). Triple Bottom Line Reporting: an innovative accounting initiative. International Journal on Business, Strategy and Management, 1(1), 1-13.

Gavrea, C., Ilies, L.. & Stegerean, R. (2011). Determinants of organizational performance: The case of Romania. Management & Marketing, 6(2), 285-300.

R. Edward Freeman, Alexander Moutchnik (2013): Stakeholder management and CSR: questions and answers. In: UmweltWirtschaftsForum, Springer Verlag, Bd. 21, Nr. 1.

Aswath Damodaran (2009) The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, FT Press,