Revaluation Of PP&E Assets: Principles And Risks

Principle: Recording PP&E Assets at Fair Value

Questions:

a). Should KGC Ltd. revalue its major PPE assets from historic cost to fair-market value? (Discuss the principles, potential issues, and risks). 

b) The PP&E is estimated to have a replacement value of $20.5 billion AUD and a value in use of $12.0 billion AUD under current expected operations (i.e. seven years) but rises to $30 billion AUD if the contract is renewed for 10 years in addition to the current seven years and new viable ore bodies are found. What is the “True and Fair” value of the PP&E? (Explain). 

c) Discuss the merits and risks of KGC Ltd. including a “Triple Bottom Line” aspect to its reporting approach.

d) Discuss the nature of “Legitimacy” and the importance of KGC Ltd. maintaining legitimacy in the eyes of the traditional land-owners, the government of PNG, and the people of Australia. 

e) Is the “Legitimacy” of KGC Ltd. at risk and what consequences may KGC Ltd. suffer if it loses “Legitimacy”.

f) Discuss how KGC Ltd. can restore its legitimacy (include a section on the two types of stakeholder theory in this discussion). 

g) List the various ways that KGC Ltd. could record the cost of the harm associated with the sludge spill in its GPFS, discuss the pros-and-cons of each method, choose a method and defend your choice.

Yes, KGC ltd. should revalue the major PP&E assets from historical cost to fair market value. Principle: According to International Accounting Standards 16, PP&E assets must be recorded at fair value until and unless the exchange transaction lacks any commercial substance or the fair value of the assets are non-measurable. The revaluation model suggests that the value of PP&E should be measured at fair value by deducting the accumulated depreciation and impairment losses from the fair value. Revaluation shall be made to ensure that the materiality is not differed therefore it should be determined by recording fair value instead of historical cost (Europa, 2009).

Potential Issues: Recording the assets at fair value signifies the exit value of the assets. Assets recorded on historical cost do not represent the market-based approach rather it is based on entity-based approach. Fair value solves the issue of compatibility between the future cash inflows and cash outflows. The assets recorded on the basis of historical cost lacks the clarity when compared with market assumptions. If the PP&E is not recorded on the fair market value then there is likely very less chance of selling those assets (Trinavis-crowehorwath, 2011).

Risks: The risk of revaluing the PP&E assets are that it would change the entire value at market price rather than recorded realizable value. The amount of depreciation will be altered and the increased depreciation would reduce the profit of the company. However, these risks will incur future benefits in the form of tax reduction and selling of the PP&E assets at market value (Don Herrmann, 2006). 

The true and fair value represents the correct statement of the financial position. Within the current expected years of operation, the replacement value has been estimated at $20.5 billion while the amount specified for use is $12 billion AUD. It is expected to increase at $30 billion AUD if the contract related to the PP&E assets are renewed for 10 years. In this case, the fair and true value of PP&E assets is $20.5 billion.

Potential Issues of Not Recording PP&E Assets on Fair Market Value

According to IFRS 13, the fair value of PP&E assets states the determination of timing when the assets were recognized and further determining the carrying amount. The depreciation charges associated with the assets along with impairment loss is also required to be recognized. The fair value in this case will be determined as the replacement value. As the fair value of the specific PP&E assets is missing therefore we will consider replacement value as the true and fair value.

Fair value can help the company in exchanging the assets, settle liabilities and willing parties to involve in the transaction. Another recoverable value of the assets is considered by estimating the supply of products and services (Fair value) less the value of use and cost to sell. In this case, the actual fair value is missing therefore it is assumed that replacement value is the Fair and true value. The recoverable amount in such case will be $8.5 billion AUD. Henceforth the information regarding the validity and affirmation of contract is missing therefore the exact fair value can be estimated in this case (GASAB, 2010).  

Triple Bottom Approach accounting has been adopted by profit and non-profit organization. The sustainability framework approach is used by the KCG L to evaluate the performance. TBL approach concentrates on comprehensive investment outcomes. The profits, shareholders value and the return on investments can be calculated on the comprehensive way. The TBL approach is used in KCG Ltd to incorporate the three major dimensions of performance including financial, environmental and social aspects (theconservation, 2014).

Following are the merits of using Triple Bottom Line approach:

• It reduces the risk profile
• Ensures identification of the cost savings technique and reduces the opportunity cost
• It provides improved financial and organizational information to the shareholders
• Aligning the needs of management focus and stakeholders requirement
• It increases the organization scope towards innovation.
• It helps in ascertaining the potential way of securing the social licensing
• It acts as a sound base for stakeholders decision making (Economist, 2016).

• The application of TBL approaches is based on ethnocentrism
• It requires the restructuring and demolition of the corporate environment
• TBL approach requires an extensive readjustment of the organizational policies therefore uncertain risk might emerge as possible threats (Pondent, 2016).
• It is corporate oriented technique therefore it is treated as a reductive method as it diverts the business attention from concentrating on its core competencies.
• Aligning both social and environmental aspects are difficult in real organizational settings (Vivian, 2012) 

The nature of legitimacy exists when the business possess clear and defined chain of management. KGC Ltd possesses clearly defined organizational structure. The person holding an authority possesses the right to perform any assigned task. The legitimacy in accordance to the people of Australia and government of PGC is performed by the KGC Ltd to serve the environmental and social accounting area. The power of legitimacy helps an organization to accomplish the social constructive system by serving the beliefs, values and norms of the society. It directly impacts the financial performance growth and enhancement of the company (UVA, 2006).

The KGC Ltd has paid 6 billion amounts to the PNG government in the form of tax whereas $4 million was paid in the form of royalty to the traditional land owners. Also, the company is licensed by the PNG that certifies the firm to operate legally. The company serves the social aspects by employing 3400 employees in its processing plant, offices and PNG mines. The environmental and social liabilities have been fulfilled by KGC Ltd in terms of infrastructural development. The operating and development activities include building of grade schools, hospitals, water processing plants and health centers.  

Yes, the legitimacy of the KGC Ltd. is at risk. For instance, the Christian-animist residents in the New Guinea were agitating for ensuring independence from the Indonesia. There was a possibility of conflicts and military actions due to the association of war tribes and PNG tribes. The irregularities of company in respect of the environment protection have been complained by the people of Australia. Approximately 5 million liters of the oil waste were dumped into the river which was the source of drinking water for the villagers.  The complaints went strident and loud when the company defended the misconduct. It was stated that sludge can be flushed quickly out to sea where it would get diluted soon. There are several consequences of the unfair practices conducted by the company.  These unfair practices of the KGC Ltd can be negative for the company in the form of deteriorating goodwill. The government might take serious action against the company as the waste generation and dumping in the sea can significantly affect the natives and adversely affect their health. Also, the company has to bare cost of remediating the sludge spills which is estimated between $6 billion to $ 60 billion. Therefore, the company can incur a loss in terms of expenses and public image. 

Risks Associated with Revaluation of PP&E Assets

The maintenance of legitimacy is very essential in the eyes of the government. To ensure the positivity on the part of government KGC Ltd should try to restore the legitimacy by carrying out best practices to serve the environment (Johnson, 2016). The company should try to serve the interest of the stakeholders and try to retain governmental support to enhance its operation more efficiently and effectively. The company should try to restore its legitimacy by renewing the political strategy. The company should follow the traditional belief, norms and value rational faith followed by the society.  The legality must be followed by determining the voluntary agreements on the part of interest party (Tilling, 2004). The discursive legitimacy strategies must be followed by the KGC Ltd. The organization can be treated legitimated only when it perseverance towards the people of Australia and the government is unbiased. It encompasses the psychology, philosophy and sociology of the institutions and actors. By launching the development and reconstruction vision for the stakeholders can allow the company to revive its legitimacy. Restoring the legitimacy is intended to ensure long-term sustainability towards the environment and society. Before taking any action the company should ensure that availability of alternative course of action. It is significant for the organization to identify the difference between actionable legitimacy and institutional legitimacy (Dugan, 2004).

The values and morals between the business ethics and organizational management must be maintained by application of Stakeholders theory.   The two types of stakeholder's theory are Instrumental and Descriptive theory. The descriptive theory suggests the way how managers deal with the stakeholders to represent their interests (Fontaine et al., 2006). The constellation of interest can be fulfilled by the organization in either cooperative or competitive manner. This theory can be implied by the KGC Ltd in order to deal the divergent stakeholder's interest. The instrumental approach can be utilized for restoring the legitimacy by aligning the corporate governance goals with the stakeholder's management practices (Egels-Zandén & Sandberg, 2009).   

The cost of harm associated with the sludge spills can be recorded by the KGC ltd in the form of following costs:

• Remediating cost
• Clean up cost
• Offsetting work
• Fines
• Expenses

These expenses can be met out of reserves and other sources of external borrowings. The harm of processing and mining should be covered by the KGC Ltd. If the sludge spills are not removed then it would result in shutdown of the mining process that would cause loss to PNG and the entire region. The company can treat this cost of harm as either abnormal loss or nonrecurring items.

Abnormal loss: it is the loss that is not expected by the business in its operating course of action. The loss that is realized over the normal loss is treated as the abnormal loss in the cost accounting. An abnormal loss is treated in the books of accounts to identify the net output results by deducting the abnormal loss from gross input (Basiccollegeaccounting, 2009).

Pros

• It is a controllable loss and can be recovered if corrective measures are adopted.
• On the basis of abnormal loss the company can charge the profit and loss incurred in the specific accounting period. 

Cons

• It shows the inefficiency of the company to access the bad working condition, environment issues and highlights the carelessness of the company.
• It is treated as unanticipated loss that can shake the budget of company

Non-recurring items: The item that appears on the financial statement and it is unlikely to happen again. It is onetime expense and records the expenses which are generally not encountered in the business course of action. The cost of harm can be treated as the nonrecurring item that would incur lump sum expenses for one time. These expenses are likely to be ignored in the future course of action (Fuhrmann, 2016).

Pros

• Unlike extraordinary items, the nonrecurring items are recognized under IFRS.
• Nonrecurring items are easy to be recognized and separated to ensure the efficiency of financial statements.

Cons

• It shows the inability of management to ignore the transactions recorded earlier in the form of non-recurring items.
• It allocates lump sum expenses and amount at specific time.
• It can put company at risk to meet the expenses occurred due to unusual transaction

The selection of appropriate method is depended on the two factors including the management expectation related to loss and the cause of loss suffered by the organization. However, in this case the KGC Ltd should record the cost of harm of sludge spill in its GPFS as an abnormal loss as these expenses have been occurred due to negligence and carelessness questioning the legitimacy of the company towards the organization and environment. 

References

Basiccollegeaccounting, 2009. Accounting Treatment for Normal Loss And Abnormal Loss In Consignment.

Don Herrmann, S.M.S..W.B.T.c., 2006. The quality of fair value measures for property plant, and equipment. Accounting Forum, 30, pp.43-59.

Dugan, M.A., 2004. Defining "Legitimacy".

Economist, 2016. Triple bottom line. 

Egels-Zandén, N. & Sandberg, J., 2009. Distinctions in Descriptive and Instrumental Stakeholder Theory:A Challenge for Empirical Research. Business Ethics: A European Review, 19(1), pp. 35-49.

Europa, 2009. International Accounting Standard 16 Property, Plant and Equipment. 16 Septemeber. p.13.

Fontaine, C., Haarman, A. & Schmid, S., 2006. Stakeholder Theory of the MNC. p.36.

Fuhrmann, R.C., 2016. Financial Statement: Extraordinary Vs. Nonrecurring Items.

GASAB, 2010. Property, Plant and Equipment. Indian Government Financial Reporting Standard (IGFRS), p.22.

Johnson, J., 2016. 5 Types of Power in Businesses. 

Pondent, C.S., 2016. Disadvantages of Triple Bottom Line Reporting. 

theconservation, 2014. Explainer: what is the triple bottom line? 

Tilling, M.V., 2004. Refinements to Legitimacy Theory in Social and Environmental Accounting. p.11. [Accessed 2016].