FINANCIAL STATEMENTS OF MINING INDUSTRY

BAO3309 ADVANCED FINANCIAL ACCOUNTING

Semester 1, 2012

INDIVIDUAL ASSIGNMENT – 20% (Due date week 10)

Research Assignment:

1. Review current AASB framework which is also known as “Framework for the Preparation and Presentation of Financial Statements” and provide a critical analysis of different measurement bases.

1. B.    From a review of 2011 annual reports/financial statements of twoAustralian firms listed in ASX from different industries, identify and briefly discuss different measurement bases used by these firms and provide explanation about the implications of using these measurement bases.

1. C.    Explore the relationship between accounting information and market reaction with reference to measurement issuesby usingthe relevant research literature.

The following matters should be given particular attention:

Assignment is due in the lecture week beginning (Wk. 9). 

1. 1.               Evidence of extensive research beyond the prescribed texts is required. Ensure these are referenced appropriately in your references using Harvard referencing.

1. 2.               Students should  use research databases available through the university’s library

1. 3.               Assignment must be typed and properly documented.

Students must submit both printed and electronic copy of assignment throughWeb-CT turnitin. Assignment should be no greater than 2000 words double-spaced with a 3cm left margin. A word count must be displayed on the title page of assignment.(Note: Word count does not include abstract, graphs, tables, and references). 

Warning: Failure to submit both printed and electronic copies of assignment through Web-CT Turnitin will result in a fail grade and where student’s printed copy of submitted assignment is different from Turinitinelectronic copy of the assignment then only Turnitin assignment will be marked.

1. 4.               NO extensions will be granted unless supported by appropriate documentation prior to the due date. An application for an extension must use an application for extension of assessment form, submit an application on or before a due date to unit coordinator, be accompanied by a medical certificate or similar evidence, be accompanied by any work completed to date.

Note: Poor organisation and work commitments are not grounds for an extension. Students’ are responsible to protect their work and save data by making necessary backup. Therefore, loss of data due to computer or storage devices problems will not be considered a valid reason for an extension.

1. 5.               This assignment must be handed in for successful completion of the subject before the due.  It will count 20% towards the final mark.

1. 6.               Recommendation: Students can submit their completed assignment or partially completed assignment through Turnitin at least five days before the due date to get a similarity report. This report will provide guidance and opportunity to students to withdraw their assignment before the due date and resubmit it before the due date after removing similarities and avoiding plagiarism. Remember you cannot withdraw an assignment after the due date.

1. 7.               Any assignments handed in late without prior permission of the lecturer/tutor will be penalised 2 (out of 20) marks per day.  Do not submit any assessable task by slipping it under the door of your lecturer’s or tutor’s office.

1. 8.              If you cannot submit your assignment through turnitin due to a technical problem then contact unit coordinator immediately.

Should students need assistance in writing research essay, please seek help from Student Learning Unit.

MARKING SCHEME RESEARCH ESSAY

SEMESTER 2, 2011

Student Name

Student Number

Tutorial group

Mark out of 100

Assessment criteria to be applied on Assessments 1 to 6

Excellent:                    Work fulfilling the above criteria to an outstanding degree, in particular demonstrating excellence in sustained argument, critical thought and synthesis of material from diverse sources.

Very Good:                 Work demonstrating extensive knowledge and understanding of major content areas and issues; the ability to appropriately synthesise material from a range of sources; a well developed capacity for critical analysis of key issues and concepts; the ability to present a defensible personal perspective on issues; evidence of wide reading in relevant areas of the discipline; high quality presentation.

Good:                          Above average work demonstrating good knowledge and understanding of major content areas and issues; demonstration of some capacity for critical analysis; the ability to present a perspective on issues; evidence of reading in relevant areas of the discipline; high quality presentation.

Average:                     Work of ‘average’ standard which demonstrates a average comprehension both of basic concepts and some issues, based on class work and some further reading in the area; some ability to compare key concepts and theoretical perspectives; average presentation, particularly in regard to structure, expression and referencing.

Marginal:                    Work which shows a basic understanding of key elements of the subject matter at a descriptive level, based mainly on attendance at lectures; satisfactory presentation with some deficiencies in structure, expression and referencing.

Poor:                           Work which shows little evidence of knowledge or understanding of the subject matter and is unsatisfactorily presented, particularly in regard to structure, expression and referencing.

Very poor:                  Work which shows no evidence of knowledge or understanding of the subject matter.

SOLUTION

Abstract:

The main objective of the essay is to provide a detailed analysis of the four major measurement bases that is used in financial reporting and a critical analysis of each is provided in detail. It also presents the forms in which these bases can be used to present the information in a true and fair manner in the financial statements of any firm. It further discusses the implications of using different measurement bases by comparing the financial reports of two different firms. It also studies the market reactions in relation to the measurement bases adopted by firms.

Part A:

Introduction:

Every firm is required to prepare their financial statement in accordance with the guidelines and rules framed by the AASB. The AASB emphasises the importance of the qualitative characteristics of accounting information which states that these are the characteristics that makes the financial information useful for taking some valuable decisions.( AASB, Accounting Policies)

Analysis:

The financial statements are prepared in order to satisfy the four main qualitative characteristics presented by the AASB framework that includes

• Understandability
• Relevance
• Reliability
• Comparability

The firms while selecting the measurement base must keep in mind that the above mentioned objectives are satisfied and their financial statement provide a true and fair view of their firm’s status as on the date.  Understandability refers to the information that is made understandable for the users though the users must possess some kind of financial knowledge in order to derive information. Relevance will encompass two important aspects namely the feedback for the investors, creditors and many more. It also enables the users to predict the future performance of the company based on its historical data.

The information also must be reliable which means that there should not be any kind of material error and it must also be verifiable. And finally the comparability emphasise on the ability of the users to compare the financial statements between two time periods and entities.(IFRS Framework,2010)

Measurement:

It’s defined as the method by which the elements mentioned in the financial statements are recognised in terms of monetary value. Assets and liabilities are the major items that come under this scope as they are the elements that need to be measured in a financial statement. There are basically four different measurement bases like:

A) Historical Cost:

The historical cost is the most popularly used measurement base. The main reason is that it’s the easiest method and can be applied without any difficulty. It takes into account the historical values and so there is no necessity to take the market values at any time. Understanding the principles of this method is also very easy. However, it does have some inherent pitfalls. The method assumes the value of money to be constant which can never be true. The changing money value is not represented on the financial statement if such a method is followed so the assets are ether under priced or overpriced.

b) Net realisable Value:

The realisable value is used as provides a good informational base for the entity regarding its liquidity position. Though it’s still used in many of the firms it comes with a lot of disadvantages. The net realisable value assumes the selling price at the net which cannot be applied all kinds of assets mentioned in the financial statements. Goodwill is one such item wherein the net realisable value cannot be a proper measurement base. So, unlike the former measurement base, the net releasable value is very difficult to apply as well as understand. When grouping the assets it’s not possible to reflect the true selling value as the group of assets may show a different value while the individual asset in that group may be sold at different price.

c) Present Value:

This method is most useful for capital budgeting decisions and long term product development of the firm. The operational decisions of the firm can be taken based on this method. The project that provides a maximum positive value is deemed to be the best. This makes the decision making process easier and that’s the reason they are used for capital budgeting decisions. Though, the assets and liabilities, if presented in the present values provide a genuine financial position of the firm it is also difficult to analyse.  The calculations involved in determining the present value is not that very easy. So, the financial reports may not be also that very easy to understand for the users. Deriving valuable information from such measurement base become even more difficult.

d) Current Cost:

The main benefit of using this measurement base is that it helps in differentiating the income from current operation into profit and also keeps the gains for running the business. The main benefit of such segregation is that the company can hold back the profit that need not be distributed as dividends. The current operating profit can be ploughed back into the business for meeting the running and operational expenses. But it is also comes with pitfalls. The measurement base is most difficult to calculate. Also, the method requires the calculation of value of the asset as if it’s new and also the current value in the second hand market. But, this method cannot be applied for some kind of assets like goodwill, trademark and even brand value. So, such items cannot be valued at a price below the current value. (BDO,Global)

Part B

Caltex in refining industry:

Caltex is an ASX listed company that purchases crude oil and refine them into petrol, diesel and other products like LPG and also bitumen.  The company is aiming at increasing the production of diesel and petrol by overcoming the hurdles in refinery process and also reducing the cost per unit to a greater extent.

The company engages Replacement cost and historical cost basis of measurement. The financial results hat are provide on the replacement cost basis has a greater benefit as it removes the implications of the fluctuations of the global oil prices. Since, these implications could have a greater impact on the profits of the companies, the Replacement cost bases of measurement is used and the profits are restated. The company follows the method that is consistent with the generally accepted rules by most of the refining companies.

When the Australian dollar value increases due to increase in the crude oil price then, the Caltex is benefitted by increase in profits. Similarly when there is a decline in the dollar value by reduction in oil price the Caltex is also affected by reduction in profits. The company follows first in first out cost methodology and so the revenues are the true representation of the current prices prevailing in the market.  However, as time gap that impacts the cost of sales and creates inventory loss or profit. To overcome this company applies Replacement Cost Base of measurement wherein the cost of goods sold is measured at new inventory cost rather than the actual cost of inventory.

In order to calculate the new inventory cost, Caltex applies a scientific process of measurement. The average of the monthly cost of cargoes that has been received during the particular period of sales is taken into account. For statutory purpose the company still reports in the historical cost basis only which is easy to calculate and also understandable for the general public.

The directors report clearly states the net profit as per the Replacement cost basis and it gives a clearer picture of the company financial position since the international oil price movements are completely excluded under such a measurement bases.  The historical cost of goods sold is shown that reflects the inventory gains and provides better statutory requirements. (Caltex Annual Report,2011)

Newcrest Mining Limited in Mining Industry

The Newcrest is the prominent name in the gold industry that produces low cost gold across the globe. It’s supposed to be the largest gold producing company in the entire Australia. The Financial report of 2011 of Newcrest clearly states that the company uses Historical cost basis for statutory requirements. However, the inventories which is the gold in liquid form, gold in ore form and those that are considered as work in progress is estimated at the cost or the net realisable value whichever is less.

The company also values the materials and other by products that comes out during the production process of Gold is also valued similarly. In this case, the Cost is said to be the weighted average cost and includes items such as direct expenses, fixed as well as variable costs, overhead expenses, and depreciation and so on that is incurred in order to convert the material into finished goods.  The net realisable value is termed as the selling price expected from sale of the item in course of business less all other related expenses such as cost for making the sale effective and cost for completing the product.

The method of measurement base adopted by Newcrest mining helps the company to provide a true and fair view of the financial position in the financial statements of the company. The company can get a clear idea about the liquidity position and it also gives a clearer picture about the financial position to its stakeholders who can draw meaningful inferences from such financial reports. The historical cost basis also helps in complying with the statutory requirements. (Newcrest mining Ltd, Annual Report,2011)

Part C:

Introduction:

The different measurement bases have different impacts on the market reactions. As every measurement base takes into account a particular period the accounting information also projects different implications to the market perceptions. Like, the historical cost takes into account the past and the current cost and realisable value takes into account the present cost while the present value base takes into account the future cost.  As a result the inflation and other market indicators in relation to such measurement bases tend to behave differently for different firms.

Explanation:

The effects of measurement base on the accounting information can be understood with a simple example. When a company purchases a machinery in year 1 for $2000 and in year 2 the same kind of machinery is bought at $3000 due to the inflation then it’s not logically right to add up these two figures as the financial statement will not project a true picture. The inflation or the additivity problem is completely ignored.  As a result in order to avoid such misstatement of asset values, it’s better to value them at the net realisable value or the current cost method. However, all the assets cannot be valued at this base since goodwill and trademark can never be valued at realisable value.

Similarly, when the financial report is prepared and the investors or the stakeholders analyse them they need to draw some inferences which can be done only after understanding the prevalent measurement base. Because only based on this the market reactions can be understood to know the exact value of the firm or the profit of the firm and so on. (Michael J Brennan,Accounting Review)

Similarly the measurement base also has an impact on other stakeholders in many other ways. The share price is the major market reactions that need to be analysed. Any kind of accounting information has a direct impact on the share price if the firm. The major benchmark for the market reaction towards the accounting information of a firm is in the form of share price or returns from share. If the reactions to the accounting information tend to be favourable then we can expect an increase in share price whereas if the reaction is unfavourable then the share price tends to decline.

Conclusion:

So the analysis of the financial report and the information therein is incomplete without understanding  the measurement base adopted by the firm. The market reactions for such information are also directly related to such base and correspond to the stakeholders of the firm. That’s is the reason the firm are required to clearly state in their financial report, the measurement base adopted by them.

References:

1.AASB, Accounting Policies retrieved from www.aasb.gov.au/admin/file/content102/c3/AASB1001_03-99.pdf

2.Conceptual Framework for Financial Reporting 2010 (the IFRS Framework) approved by the IASB retrieved from http://www.iasplus.com/en/standards/standard4

3.BDO Global retrieved from http://www.bdointernational.com/Services/Audit/IFRS/Comment-Letters-on-IFRS-Standard-Setting/SiteAssets/Pages/IASB-Discussion-Paper-Measurement-Bases-for-Financial-Accounting—Measurement-on-Initial-Recognition/DP%20Measurement%20Bases%20for%20Fin%20Acc%20-%20Measurement%20on%20Initial%20Recognition.pdfrefine

4.Caltex Annual Report,2011 retrieved from http://www.caltex.com.au/InvestorCentre/Pages/AnnualReports.aspx

5.Newcrest mining Ltd, Annual Report,2011 retrieved from http://newcrest.ice4.interactiveinvestor.com.au/Newcrest1101/2011AnnualReport/EN/body.aspx?z=3&p=73&v=2&pgl=&uid=

6.MichaelJ.Brennan retrieved from http://www.jstor.org/discover/10.2307/247706?uid=2129&uid=2&uid=70&uid=4&sid=47699049232877

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