Newcrest Mining Limited Analysis: Impairment of Assets - Case Study Example

NEWCREST MINING LIMITED CASE ANALYSIS: IMPAIRMENT OF ASSETS By Student’s Name Code + Course Name Professor’s Name University Cite, State Date 1. Right Time To undertake Impairment Tests According to both the Australian Accounting Standards Board and the International Financial Reporting Standards (IFRS), the process of impairment testing should be conducted at the following periods; first, impairment testing is exercised at each reporting dates and whenever there is a possible indication that there might exist a triggering event for the entire process at hand (KPMG, 2013). Second, the process of impairment is executed on annual basis for a group of specific assets irrespective of whether or not there exists a pressing event that prompts for the exercise to go ahead. These assets include; intangible assets that depict a distinctive and indefinite useful life and those intangible assets that is not yet put into utilization in business operations (KPMG, 2013). Consequently, it includes the allocated assets for which there was goodwill acquired in the course of a business combination exercise. Certainly, there are significant aspects that can be used to depict the possibility of a business that requires impairing its assets-base. These indicators include; an unexplained increase in the cost levels of borrowing as well as the carrying amounts of the underlying net assets of a given firm that exceeds its immediate market capitalization (KPMG, 2013). Notably, distinctive adverse alterations in the business operating environment may also act as a perfect indicator for possibility of impairment tests. For this reason, under the present market conditions, it is believed that most of the firms will be conducting impairment testing processes of their immediate non-financial assets (KPMG, 2013). For the case of Newcrest Mining Limited, the possible indicator for a possible engagement into executing impairment testing rests with the fact that the Lihir’s cost of operations have continued to increase significantly hence affecting the once calm and material business climate it enjoyed in the past. Another strong indicator that the firm might be forced to engage in the impairment testing rests with the rather strong Australian dollar that has forced it to engage in the review of its book values downward. The assumption that the Australian currency would be trading at around $US 0.8 did not seem to see the light of the day hence affecting the firm’s operational assumptions greatly reflected within its book values (Maiden, 2014). It is important to realize that the process of impairment of assets is critical for the purpose of bringing the underlying carrying value of a given firm in line with its immediate recoverable worth, which is mainly the higher of fair values minus the costs related to such activities as sale and use-value. This basically means that the underlying book value for such a company as Newcrest Mining Limited should not be left to surpass the worth the immediate owners expect to access either from the immediate sale of the firm in open markets or through its continuous utilization to generate profits. 2. Newcrest Mining Limited Impairment Causes For the case of Newcrest Mining Limited, the causes of the impairment of its immediate assets are both operational and financial in nature. First, the cause for impairment is deemed operational given that the Lihir production plant in Papua New Guinea, which was expected to be operating at a lower cost, was in fact spending lots of cash resources to maintain a steady supply of gold ores. For instance, it is ascertained that the takeover process of Lihir valued the site at more than $10.5 billion but after a $ 6 billion plus charge that involved goodwill write downs on the site’s immediate acquisition process of about $ 3 billion lowered its current market value to about $7.6 billion. Consequently, the company, within the June quarter, was only able to produce about 174,601 ounces of gold at an all-inclusive cost of $ US 1225 an ounce. In comparison to the costs incurred in producing ounces of gold in other production sites, it can be vehemently concluded that Lihir’s production cost remained relatively higher. For example, at Cadia Valley site that nears Orange in New South Wales, the production cost for an ounce of gold was stated at only $US304 while in Gasowong Mine within Indonesia, the production of an ounce of gold remained at a low of $US 522 (Ker, 2014). Clearly, the aforementioned statistics postulates that the firm’s production costs were rather highly placed. Significantly, it is noted that within a span of three financial years, Newcrest Mining Limited has spent a total of about $ US 1 billion in upgrading processes. The development’s made in conjunction with Lihir’s Kapit deposits that exists within the same stockpiles requires a whopping $ US 1.3 billion in preparation costs alone. The cause of impairment for Newcrest Mining Limited are also attributed to the financial aspect given that the long-term assumptions used in the firm’s operational environment needed to be reviewed within its book values due to the rather strong Australian dollar. The assumptions of the firm prompted an operation that set its book values at a value that was worth around $US 0.8. However, this did not happen as the Australian dollar gained worth in relation to the US dollar hence affecting the book values to a rather lower-side. 3. Effects of Impairment on Cash flows, Balance sheet and Financial Performance In regards to the cash flows of the company, for this case Newcrest Mining Limited, the effect of impairment is considered null. There is no direct or indirect effect of the impairment on the cash flow financials of the firm given that it is non-cash item in the course of conducting accounting treatment. This, therefore, means that the company will continue to operate without any hitch due to non-effect on its finances as a whole (Orzechowski and Lyster, 2012). In regards to the balance sheet of Newcrest Mining Limited, the effect of impairment is manifested holistically on long-term assets given that they are reduced relatively by the impairment process. For this case, a deferred tax is developed, and in the event that there was an existing deferred tax liability then it would reduced significantly (Orzechowski and Lyster, 2012). Another item that is greatly affected by the impairment in the balance sheet is the stockholder’s equity that is reduced immensely due to the creation of an impairment loss that is later included within the income statement of the firm altogether. In regards to the financial performance of the firm, the impairment process has significant effects that are expounded as below; first, the entire process leads to a subsequent increase in both the current and future fixed –asset turnover of a firm (Orzechowski and Lyster, 2012). Second, the debt-to-assets ratio will be higher given that the impairment process translates to a significant reduction in the total value of long-term assets that forms a section of the total assets used in finding the aforementioned ratio. Third, impairment process leads to a lower debt-to-equity ratio since the underlying stockholder’s equity remains to be lower also due to insufficient capital raisings (Orzechowski and Lyster, 2012). Fourth, the future values of return on assets and return on equity ratios for an impaired firm will likely increase. Fifth, the past set of ratios that are used to analyze and evaluate fixed assets and depreciation policies for a given firm will likely be distorted by the entire impairment write down processes (Orzechowski and Lyster, 2012). Sixth, the future net income of a given firm that has undergone impairment process will be depicted on the higher side due to the rather reduced long-term assets that decreases the total asset values used in determining profitability levels. This also has the effect of lowering the immediate depreciation expense of a firm (Orzechowski and Lyster, 2012). It is Newcrest Mining Limited’s preference to maintain a debt ratio of 15 per cent, which is a lower value compared to its current 30% debt ratio, since it depicts a positive outlook to potential investors. A 15% debt ratio indicates that the firm has tried to ensure a balance between its debt structure and the immediate values of both stockholder’s equity and overall total assets. A favorable debt ratio postulates a firm, such as Newcrest Mining Limited, is able to pay-off its immediate borrowing commitments with the size of its assets value rather than use owner’s equity to pay-off the debt. Potential investors usually would like to put their immediate investments with firm’s that need to expand their projects so that the returns from these projects would be used to maximize their wealth. Thus, they do not expect to put their investments in a firm that would rather use them to pay-off outstanding debts since in this case there is a risk of return on investments made. For this purpose, a company like Newcrest Mining Limited would ensure that the debt ratio is maintained within the industry averages so that it might be able to attract potential investments from the securities market. 4. Effects Of Impairment On Strategic Decision Making Of NCM Ltd The impairment of assets is a process that significantly affects the process of strategic decision making for the management team like that of Newcrest Mining Limited. The management team is tasked with the responsibility of ensuring that the firm’s capital structure is balanced at all times. This means that they are tasked with the responsibility of maintaining a perfect asset-base that is needed for future survival operations of a firm (Orzechowski and Lyster, 2012). However, in this case, the impairment is likely to affect the long-term assets of the firm in a great deal possible. The strategic decision to maintain a lower debt ratio will not likely materialize since the assets-base needed to offset the effects of enormous borrowing structures. Consequently, the management team is tasked with the responsibility of maximizing shareholders’ wealth while at the same minimizing the levels of operational costs (Orzechowski and Lyster, 2012). This means that their respective strategic decisions should be focused on ensuring that the net income is at times higher. However, this decision is met with challenges given that impairment lowers the net income of the company due to the relative lower asset values. Newcrest Mining Limited is under pressure to engage in capital raising process from potential investors within the securities market. This is because the process of sourcing funds from the potential investors will increase the stockholder’s equity and asset-base of the firm hence lowering its debt ratio significantly to a manageable size. The firm can engage in capital raising from suck creditors like bank borrowings, however; this is not a positive notion given that it will result to a further increase in the level of the company’s debt hence a likelihood of increasing its interest expense that has negative effects on the immediate net income of the company. Hence, accessing capital raisings from potential investors hence owners will promote its asset-base and equity hence lowers the debt ratio to15 %. 5. Materiality and Disclosure of Impairment in NCM Limited For the case of Newcrest Mining Limited, the impairment is material in nature. This is subject to the requirements set in AASB 136 for which assets tested for impairment and the resultant total change in the immediate written down values of the NCM for the underlying class of assets or the overall impact on the depreciation effect of the aforementioned assets is deemed consequential (NCAP-Impairment of Assets, 2014). The materiality is further postulated whenever the resultant impairment loss is effectively brought to the books of account of the company; for this case, the material loss is stated at about $US 6 billion in impairment loss for that year. A further disclosure requirement subject to the impairment, as stipulated under AASB 136 states that a firm should ensure to avail an additional line of disclosure included within the notes section of its immediate financial statements so that the accumulated impairment loss is presented in distinctive position from the overall accumulated depreciation. This is meant to ensure transparent model of reporting for a firm (NCAP-Impairment of Assets, 2014). References List KPMG. 2013. Corporate finance: Impairment testing. Retrieved from https://www.kpmg.com/AL/en/IssuesAndInsights/ArticlesPublications/Factsheet/Advisory/Documents/Impairment%20testing.pdf Ker P.2014. Newcrest CEO facing tough questions in his first big outing.Retrieved from http://www.smh.com.au/business/newcrest-ceo-facing-tough-questions-in-his-first-big-outing-20140723-3cfwa.html#ixzz38R2Bx7vY Ker, P. 2014. Newcrest warns of $2.5b in write-downs. Retrieved from http://www.smh.com.au/business/markets/newcrest-warns-of-25b-in-writedowns-20140724-zw8x4.html#ixzz38LUuXBGY Maiden, M.2014. All that glitters is not gold at Newcrest's Lihir. Retrieved from http://www.smh.com.au/business/all-that-glitters-is-not-gold-at-newcrests-lihir-20140724-zw97y.html#ixzz38R1kxs3r NCAP-Impairment of Assets, 2014. AASB 2014. Retrieved from http://www.treasury.qld.gov.au/office/knowledge/docs/draft-non-current-asset-policies/draft-ncap-4-impairment-of-assets.pdf Orzechowski, BJ and Lyster, P. 2012. Impairment testing: Effectively using the qualitative assessment. Journal of Accountancy, Retrieved from http://www.journalofaccountancy.com/Issues/2012/Dec/20126497.htm Read More