Extract Tar Sands is an extraction plant company located in Athabasca, Alberta. It is a leading extraction plant, and one of the worlds most global industries. Large investments are required but the future outcomes are unknown. Athabasca has the largest reservoir of crude bitumen in the world. The tar sands go through a refining process to separate the bitumen (black viscous oil) from the mixture of clay, sand and water. Extracting oil from tar sand is much more complex than pumping oil from an oil well. When the oil is separated from the mixture of sand, normally from the use of hot water, it goes through a thinning process in order to be transported through pipelines.
There are many environmental concerns with regards to the mining of tar sands which include global warming, greenhouse emissions, water and air quality from the surrounding communities as well as effects to wildlife. Extract Tar Sands Ltd. has shares on both the New York stock exchange as well as the Toronto stock exchange. They are a publicly owned company and generate high net incomes. The statement users would be potential investors, as well as current shareholders and creditors of the company. Problem identification, issues
Extract Tar Sands is in need of additional capital in order to expand their facilities. They are contemplating whether to do this by issuing more shares of the company, getting financing or combining the two. They also have to determine how they will be valuing their assets under the new International Financial Reporting Standards. Although ETS has had a successful switch over to IFRS for the January 2011 deadline, they have still not determined the accounting policies they will be following. The focus of the question is to determine the differences between pre-IFRS and IFRS that pertain to ETS’s accounts and what is allowable for the company. Analyze the Data
There are many changes to the reporting, recording and presentation of the financial statements. Being an oil extraction plant, the conversion to IFRS may be more difficult than any other company in any other industry. Some of the accounts of Extract Tar Sands have no significant changes with regards to the differences from the Pre-IFRS to the new standards of IFRS that are to be effective as of January 1, 2011. There are however, quite a few that do have differences that will affect the presentation of financial statements, disclosure requirements, reporting and recording of transactions, which are outlined in the following paragraphs.
Property, plant and equipment have significant changes from Canadian GAAP to IFRS although there are many similarities as well. They both state that property, plant and equipment are initially recorded at cost, and any costs required to get that asset functioning for its intended use are recognized as part of the cost. Gains and losses on the disposal of an asset are treated the same under IFRS as the Canadian GAAP. Depreciation policies are also the same under both principles, over their useful life. If the property, plant and equipment is a held for sale item, it is not amortized at all. Under IFRS depreciation of an asset is based on cost less residual value over the useful life of that asset, where-as under GAAP it would be based on the greater of cost less residual value over the useful life, and the cost less the salvage value over the useful life. Reviews are done annually to determine the useful life, residual values and depreciation methods, any changes are reflected as changes in estimates.
Under GAAP, residual values are only reviewed if there is reason to believe there has been a change in condition that would affect the current estimates. GAAP does not allow revaluation to fair value but IFRS does. There are two methods for valuation under property, plant and equipment, the cost model or the revaluation model. The cost model is when the asset is carried at cost less depreciation and impairment. The revaluation model is when the asset is carried at fair value, if there is an active market for valuation, less the depreciation and impairment. Valuation under this method would require the whole class of assets to be revalued and not just a specified asset in that class. When it comes to mineral resources IFRS does not have many guidelines with regards to the exploration of financial reporting where under Canadian GAAP, this area is more in depth. So, in comparison to the pre-IFRS and IFRS, there are substantial differences in this category.
Intangibles and Goodwill under Canadian GAAP cannot be revalued to fair value, but it is allowable under IFRS where there is an active market for valuation. Relocation and organization expenses are recorded as they occur under IFRS but under GAAP, they are not. An impairment loss under IFRS is determined if there is excess of the carrying amount over and above the amount able to be recovered from the cash generating unit to which the goodwill is allocated to, under GAAP it would be the difference from the carrying amount to the fair value of the unit to which the goodwill has been reported.
Employee future benefits must be measured at fair value for plans at all reporting dates for all purposes. Costs relating to past service must be recognized on a straight line basis until the adjusted benefits become entrusted.
Inventory under both IFRS and the Pre-IFRS, the last in first out method is not allowed, they both allow measurement at net realizable value and lower of cost, and any expenses and recognized overhead related to the preparation of the inventory to make it ready for use are included in the cost. What is different under IFRS is that any costs incurred in the production of inventory relating to the restoration or removal would be included in the cost as part of the initial recognition of that inventory. Any interest would be capitalized as part of the cost as well. If the removal of service or restoration of inventory costs were recognized under GAAP, the amounts would be indirectly added to the carrying amount when initially recognized.
Financial instruments under Canadian GAAP and IFRS are converged except for the fact that under IFRS some instruments have restrictions whether they are to be measured at fair value through profit and loss. Impairments are identified when the recoverable amount of the asset falls below the carrying value. This is when the impairment loss is recognized. Impairment losses must be reversed when there is a change in the recoverable amount. For derivatives, no exemption is made if the contract does not have a speculative amount, and does not result in a different treatment for that contract. Under both GAAP and IFRS, derivatives are measured at fair value on the statement of financial position. Foreign exchange gains and losses on available for sale investments are immediately recognized in net income.
Some financial instruments are exempt in GAAP but are covered under IFRS. There are similarities for the classification of instruments under both, but under IFRS they must be recognized at fair value through profit or loss. Loans and receivables, for which the holder may not recover all of its initial investment, are classified as available for sale. With regards to equity and financial liabilities, most principals are converged. One difference when it comes to non controlling interest is that under GAAP it would be the balance sheet would be regarded as outside equity, where-as under IFRS the non controlling interest would be separate from the parents shareholder equity but on the consolidated statement of financial position the non controlling interest would be classified within the equity. Contracts will be treated as derivatives when they are issued by a party that may be settled in its own equity.
Canadian GAAP does not indicate how derivatives are classified. Income taxes are mostly converged except for the fact that under IAS 12, if a transaction occurs for an asset or liability that is not part of a business combination or doesn’t change the accounting or taxable income a deferred tax asset, it is not allowed to be recognized. An income tax asset or liability is recognizable if there are intercompany transfers of assets that have temporary differences only. Deferred taxes on the classified statement of financial position are treated as non-current. Under GAAP they are classified as both, current and non-current. This depends on how the asset or liability that it pertains to, is classified. Some similarities with regards to GAAP and IFRS are that temporary differences are treated the same under both principles, the difference of the tax base of an asset or liability to its carrying amount. Initial recognition of goodwill does not allow for a deferred tax liability to be realized, but if goodwill has any temporary differences, deferred tax is recognized and the differences that come from the goodwill are tax deductible. If an entity has changes in their tax status, it has to be allocated based on where it originated from.
When a financial instrument, such as a convertible bond, has temporary differences from the initial recognition, a deferred tax liability is recorded to the carrying amount of the equity portion. Tax rates are applied by an average under IFRS. On the profit and loss and comprehensive income statement, expenses need to be classified by the nature or function of the item on the front of the statement for comprehensive income or in the notes to the financial statements. Under GAAP, this is not a requirement. Extraordinary items are not allowed as a category as part of presentation of disclosure on income items, instead the disclosure should state income or expense items as “unusual items” and under IFRS may occur frequently. Revenues under IFRS have differences in applying accounting treatments opposed to GAAP. Fair value must be used as measurement for receivables or items received. Even though costs for Extract Tar Sands Ltd. are very high, the price of oil has also significantly increased in the last couple of years.
The high costs associated are a requirement in order to fulfill the economic needs. Raising capital in order to expand the facilities would help to increase revenues in the long term and may be appealing to the shareholders for the potential of higher dividends. For the company’s property, plant and equipment on whether to use the cost method or the revaluation method, there are some things to consider. Under the revaluation model the assets are measured at fair value on the balance sheet date, but it’s not necessary on every balance sheet date. What is required is that the asset value for presentation on the balance sheet not be significantly different from the fair value at the balance sheet date.
This method is only allowable if the asset can be reliably measured to fair value, and has an active market. For intangible items, this cannot be used because of an inactive market. This method may be more appealing because to investors the fair value would be current. When cost model is used, the assets are valued at the cost of acquisition and then adjusted for accumulated depreciation and accumulated impairment loss. The fair values however, still need to be disclosed on the footnotes, even if they are not used. Both models can be used for different classes of property, plant and equipment but it cannot be applied to separate items in the same class. The cost model has no significant costs involved but with revaluation method, the costs can be quite high especially if there isn’t an active market to determine the values. Recommendations
The switchover to IFRS from GAAP may be a difficult process but the benefits of having financial statements the same throughout the globe will make it easier for investors, potential investors, foreign companies as well as national companies to compare and understand the way organizations function, record and report transactions in that company. There will be more consistency and flow with the harmonization of the financial statements. Although the costs may be high initially, it will make the future of investing more prominent because there will be more understanding of foreign markets. Investors will be more interested in investing because they will have a better understanding, which in turn will make the company being invested in, more productive. Whether to choose the cost model or the revaluation model, both methods are acceptable and have benefits for use however, the revaluation model may be more informative and current with the valuation of the company’s assets for the users of the financial statements.
Expansion of the facilities would be beneficial to the company as well as the shareholders. If ETS would like to gain funds through issuing additional shares, ETS will be diluting the ownership of the company in order to gain the funds. The issuance of additional shares will cause the previous percentages of ownership to decline. The decline of ownership depends on how many shares will be issued on top of what is already owned by the shareholders. The advantage to issuing more shares for the purpose of gaining funds would be that ETS would raise the funds for their expansion without the liability of borrowing. The disadvantage would be the ownership distribution, by issuing more shares, ownership changes. The unknowns, depending on the economy and market would be that by issuing shares, the value of the shares may increase or decrease.
If ETS borrows the funds for the expansion from the credit facility, there is now a liability involved. The advantage would be that the ownership of the current shares that have been issued doesn’t change, the depreciation and interest is an expense therefore reduces the net income so there is a tax benefit. There is however, a debt repayment. If ETS has a significant amount of debt with regards to the expansion, it may limit any other financing needs the company has in the future, until the debt is repaid or reduced considerably. They may be somewhat restricted with any future endeavors that may be profitable to the company if they hold a large liability.
If ETS decides to utilize both options available to do an expansion, it would have less of a liability by not borrowing the whole amount required, the restrictions that may be involved for the future by borrowing, would be minimal, if any at all. Although they would still be issuing shares, they wouldn’t be drastically changing the ownership of the company. They would receive funds from the shares sold and still get a tax benefit from utilizing the expenses recorded from the cost of borrowing.