As the gold industry leader, Barrick Gold Corporation has the largest production of gold (7.7 million ounces recorded in 2008) obtained from its portfolio of 26 mines, allowing investors incredible leverage to higher gold prices. Barrick wishes to provide sustainable economic development centered around environmental stewardship, as well as a culture of safety superior to those of competitors. An accounting policy examined in this project is the pension benefit plan employed by Barrick Gold, and how it is accounted for using industry trends, practices and the economic situation in order to determine the plan cost and the obligations requiring accruement.
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While the assets of the plan are recorded at fair value, Barrick uses the analysis of actuaries to determine the losses and gains influenced by the plan. Another accounting policy which will be discussed is the method Barrick utilized to determine its goodwill, as well as its intangible assets. By using a combination of the market-based and cash flow (discounted) approach, Barrick is able to establish the goodwill, as well as the value of the intangible assets. While impairment is correctly recognized when the market value of the assets is higher than the fair value, both the intangible assets and goodwill are assessed every year to determine whether impairment is necessary. Barrick’s capitalization vs. expense policy considers three different costs; exploration costs, project expense, and environmental cost. In regards to exploration costs, they examine two different types of sites. Brownfield sites contain mineral reserves whereas Greenfield sites do not. The exploratory costs that they incur at Brownfield sites are capitalized and costs related to Greenfield are expensed. Their second expense, the project costs, is usually capitalized when mineralization of proven and probable reserves has occurred. Finally, the environmental costs are usually expensed as incurred. During the third quarter of 2008, Barrick Gold confirmed their conversion to IFRS in the future. As outlined in the annual report, Barrick has approached the conversion and considered the things that would be affected by IFRS like reporting of financial statements, internal controls and procedures, information technology and data systems, disclosure, financial reporting training curriculum, and downstream business activities. After considering the impact of IFRS, they have taken a few steps to get ready for the IFRS conversion such as completing an initial assessment of the merits of a potential conversion to IFRS. They also employed an IFRS team to deal with all the issues, and performed a technical analysis of the accounting differences between GAAP and IFRS statements. With regards to performance, Barrick’s liquidity ratios are decreasing due to the allocation of capital towards investing activities. In terms of solvency, debt-to-equity has been stable, allowing their liabilities to remain steady with investments being financed mainly with equity. However, some of Barrick’s ratios are below the average for the industry, potentially indicating poor financial performance. In addition, Barrick has seen a decrease in net income and earnings per share yet the company’s dividends are increasing due to positive future expectations.
Barrick Gold Corporation was founded in 1983 by Peter Munk. Its headquarters are in Toronto, Canada with regional business units located in North America, South America, Africa, and Australia. It is the largest company in the industry with 27 mines worldwide and 139 million ounces of proven and probable of gold reserves. It became the largest gold producer after acquiring Placer Dome in 2006. This report will discuss the overall gold industry, Barrick’s strategies in the near future, some of their accounting policies, transition to IFRS, performance, and financial analysis.
Barrick Gold is one of the three major players in the industry with accumulated 2008 sales of $7.9 billion, 16,300 employees, and a market cap of $45 billion. Other main players in the industry include Goldcorp and Newmont Mining, with market caps of $33 billion and $27 billion respectively. Additionally, there are several other mining companies such as Agnico-Eagle Mines Ltd., Yamana Gold Inc., Randgold Resources Ltd., and Harmony Gold Mining Company Ltd., with market caps ranging from $2.4 – $12 billion. Most of the gold producing companies have seen increasing profits since 2001 due to rapidly rising gold prices. In 2001, one ounce of gold cost $271 compared to today’s $1,100/ounce price. However, there is a possibility that these profits will not be sustained by most companies for five reasons: Rising labour cost, energy cost, raw material cost, depletion of the world’s natural gold reserves, and loss of operations due to environmental restrictions. In addition, gold is a non-renewable resource meaning that as more gold is explored and mined out of the ground, it becomes harder to find. The increased use of technology has greatly simplified the process of exploring gold, contributing to greater quantities of mined gold. However, the extraction of millions of ounces of gold has decreased the earth’s natural gold deposits. This forced companies to search for gold in areas where mining is prohibited, thus raising environmental and political issues along with several outstanding lawsuits. This further increased the operational expense of gold mining. In fact, Newmont Mining Corporation (second largest gold mining company) is depleting its current reserves by 10 ounces per minute without discovering gold deposits as large as it used to. Due to increasing operating costs and companies’ desperate attempts to increase profits, there was marginal expenditure on environment preservation resulting in colossal damages. Tons of heavy metals such as cyanide and mercury are deposited into the environment annually as a result of spills during the mining process. Cyanide and Mercury increase gold production rates, but both of them are incredibly poisonous to humans, animals, and the overall surroundings.
Since 2008, the value for the employee pension plan provided by Barrick Gold has seen a decrease due to the lower value of the assets. These pension assets appear to be valued at their fair value, and when pricing is not possible, market estimations are used. Furthermore, support from actuaries is used in order to determine both the losses and gains, which would be influenced due to the pension. Barrick Gold takes into consideration the economic situation, as well as industry trends and practices, when establishing suppositions for the cost of the reported pension, as well as the obligations, which will need to be accrued. These suppositions include the rate of return (long-term), compensation increases in the future (rate) and estimates of the market, all of which are consulted to uncover the pension cost. Both the assets of the pension plan and the accrued obligations would be regulated if the future presented a discrepancy in costs as compared to Barrick’s initial estimations. In order to establish the accrued obligation, the discount rate needs to be known, and is actually set annually by utilizing the present value to uncover the contribution needed in the present in order to be able to deliver the outlined future benefits. Competitors, such as Goldcorp, and Newmont mining, have taken similar action to accrue their respective obligations listed as benefit plan for employees. These companies also use discount rates, as well as estimations of the performance of the investment, in order to determine the cost of the pension.
Barrick Gold appears to use industry-specific methods in order to valuate its goodwill. It used both the market based and the discounted cash flow method (DCF) in order to establish the fair value. Market estimations and trading prices (equity) for both Canadian and American companies in the same industry are consulted for the market based method. While the cash flow approach utilizes Barrick’s best estimation of its asset’s expected future cash flow, as well as its discount rate. Furthermore, both goodwill and intangible assets are assessed every year to determine impairment. Barrick has stated that due to the decline of the reserves of gold in one of its mines (Plutonic gold mine in Australia), there is an increased chance that there will be a goodwill impairment. This impairment would only occur if there was a persistent decrease of the economic factors influencing the mine, however Barrick has already began to assess the carrying amount of goodwill associated with Plutonic for future impairment if necessary. Both goodwill and intangible asset impairment is recorded when it is found that the carrying sum (amount) exceeds the fair value (net realizable value) of the asset. Other competitors, such as Goldcorp Inc. and Newmont Mining, utilize the same approach since it has now been considered a standard for this industry. The future implementation of IFRS will provide new recommendations on how Barrick Gold should assess their goodwill and intangible assets. Barrick has begun preparing for new rules such as identifying when an intangible asset should be recorded as expenditures (and how they qualify).
The final accounting policy discussed is the decision process defined by Barrick Gold to establish whether to capitalize or expense their assets. Expenses such as project expenditures, environment costs and exploration expenses are all examined in detail. Exploration expenditures involve recording the initial search for the mineral deposits and any other costs that were incurred at the sites. There are two different types of sites that are defined by Barrick Gold: Brownfield (containing mineral reserves) and Greenfield (no mineral reserves). Costs related to the exploration of the Greenfield site are expensed as incurred. Exploratory costs related to Brownfield sites are capitalized as incurred if there is a high probability that the mineral resource will develop into a “proven and probable reserve”. In terms of project expenses, costs related to projects are capitalized only when reserves are converted into mineral substance but they have to be “proven and probable reserves”. Before mineralization is classified as such, the projects are expensed, excluding the costs that are incurred in order to construct tangible asset. Capitalized costs related to tangible assets are accounted for in the account, “Property Plant and Equipment”. Furthermore, Barrick Gold expenses costs related to the environment during their production phase of mining. In certain cases, if the cost to acquire or install a plant during the production phase prevents future environmental contamination, it is actually capitalized. When a contingent loss occurs due to an asset, a loss accrual is recorded if it is reasonably estimable and updated when new information is received. Competitors in the same field, such as Goldcorp Inc. and Newmont Mining Corporation, state that their exploration costs are always expensed as incurred. However, they do not provide detail as to why it is expensed or whether capitalization should be a consideration.
Starting from January 1, 2011, all public companies in Canada are required to report in accordance with IFRS instead of GAAP. In early 2008, Barrick Gold performed a preliminary analysis on the impact of IFRS, and later confirmed its conversion. In 2011, Barrick will prepare its financial statements using IFRS, which will improve the comparability of their financial statements with other companies that are also following the standard. These new reporting standards will affect many areas of the company, such as reported figures for financial position and performance, internal controls, procedures for financial reporting, information technology and data systems, disclosure controls and procedures, financial reporting training curriculum, and other business activities that depend on reported figures. Barrick Gold has created an IFRS team which has taken a few initiatives to address the issues pertaining to IFRS and to ensure a smooth conversion process. This team is going to be responsible for preparing a detailed plan for IFRS conversion and are planning on completing this plan by the end of first quarter of 2009. Another project undertaken by the team is to perform a technical analysis of the accounting differences between the GAAP and IFRS statements. This report is scheduled to be completed by the third quarter of 2009. Additionally, the IFRS team will be constantly monitoring the IFRS conversion process over the years and will update the conversion plan as well as inform the public of any new developments.
Significant financial strength is one reason why Barrick Gold is considered an industry leader in the gold and rare metal industry. In the following section, we will scrutinize their financial statements and discuss key elements such as liquidity, solvency, and leverage to understand their performance trends. (See Appendix A for Financial Statements & Appendix B for Financial Ratios)
The liquidity of the company has marginally deteriorated over the years. The current ratio (2.23, 3.32 and 2.59 in 2008, 2007, and 2006 respectively) and quick ratio (1.49, 2.42 and 2.07 in 2008, 2007 and 2006 respectively) are both decreasing indicating that the company is losing its ability to meet its short term obligations. This is the result of decreasing current assets (loss of cash and highly liquid cash equivalents) and increasing current liabilities (mainly notes payable and accounts payable). Although this may seem worrying, Barrick seems to be allocating lots of capital (generated through day-to-day operations as reflected in increasing cash from operations (CFO)) towards its investing expenditures. Examples of heavy investing includes the initiation and construction of three new mines (Buzwagi, Cortez Hills, Pueblo Viejo) with potential gold reserves of 3 million ounces a year. Aside from that, CFO is influenced by market prices for commodities such as copper and silver (by-products of gold mining). If their prices decrease, CFO will reduce which Barrick hopes to offset by increasing gold production.
With regards to their solvency and the ability to meet long term obligations, Barrick has been relatively stable as indicated through their debt-to-equity ratios (0.51 in 2006, 0.44 in 2007, and 0.58 in 2008). This is a good sign because, at a time when both short and long term investments are increasing, Barrick has managed to retain their liabilities to reasonable levels. This is also a further reinforcement of their strategy of pumping as much cash (mainly from income and equity) for their investments. Interest coverage is another interesting point to consider. According to the financial statements, the interest coverage ratio has increased drastically in 2009 (15.71, 13.92, and 66.48 in 2006, 2007, and 2008 respectively). This hike would be reflective of their improved ability to pay interest (the cost of borrowing), but the actual interest incurred has remained quite stable over the years (Annual Report, p.52). The main difference is that Barrick has increased the proportion of interest costs that it capitalizes within their property, plant, and equipment (PP&E). Barrick also uses its gold inventory and mines as a form of leverage. Due to the current financial turmoil, gold prices are at record highs as investors demand more gold (a safe haven) to hedge against capital losses. The increasing cash flows and inventory values presented Barrick with an exceptional chance to attract investors as well as issue debt to support the creation of mines to increase their gold production. Barrick thus promised high returns to their investors through expectations of rising gold prices to mitigate any potential risks.
We can look for several different financial ratios to evaluate their overall performance. Barrick’s earnings per share (EPS) have been decreasing over the last three years (1.79, 1.29, and 0.90 in 2006, 2007, and 2008 respectively). This is the result of a sharp decrease in net income due to the financial crisis, coupled with the issuance of more shares in 2009. That being said, Barrick’s basic and diluted EPS are fairly similar ensuring a very low risk of dilution because there are not a lot of dilutive hybrid securities that could be exercised. Another effect of decreased net income is the decline in the profit margins. However, Barrick’s gross margin has been quite consistent at the 0.5 mark. This tells us that although revenue is steadily increasing, the direct unit costs for generating that revenue have been increasing proportionally to a level where cost of sales (value of mined gold) is half the revenue. The reason for seeing diminishing profit margin with a consistent gross margin is the increase in write-downs and impairment of assets and investments, along with higher development expenses and amortization. Efficiency is another measure of performance evaluation. Barrick’s efficiency in using its equity to generate income has been declining since it has generated about $0.17 of income for every dollar of equity in 2006 versus on $0.05 in 2008. Their assets’ capability for generating revenue has also decreased from 0.11 in 2006 to 0.03 in 2008. The reason for such low returns on equity and asset is the inherent nature of the mining industry which requires the expenditure of large amounts of capital to finance expansion (which it is doing now for the three new mines). This is essentially decreasing returns in the present with the expectation of seeing increases in the future. As far as dividends are concerned, Barrick is considered a safe bet because of the increasing demand for gold, along with potential rise of its future gold reserves. The positive trend is emphasized through the increases in the dividend pay-out ratio; 0.13, 0.23, and 0.44 in 2006, 2007, and 2008 indicating higher proportions of net income paid to shareholders. Despite the economic downturn and decreasing net income, Barrick still managed to increase the dividends per share every year (11¢ in 2006, 15¢ in 2007, 20¢ in 2008, and 40¢ in 2009) due to its immensely positive future outlook. This also portrays the company’s confidence in their cash flow, because although cash balance is decreasing today, the main reason is the outflow towards capital investments.
In comparison to the industry, Barrick has the only ‘A’ rated balance sheet illustrating very low risk, along with stability as a result of having the largest market capital, gold reserves and production. All companies in this industry have seen decreasing levels of cash due to large increases in capital expenditure. In addition, the current ratio has decreased over the past few years for all three companies indicating a trend of poorer liquidity in the industry. However, companies seem to be different with regards to their solvency and leverage. For example, Goldcorp has seen decreasing levels of debt to equity while Newmont’s have almost doubled since 2005. Despite variable trends, most gold companies are consistently providing stable dividends as they still continue to see net income on their statements rather than net losses, despite the deep financial crisis. Goldcorp, especially, have seen their income increase by as much as $1 billion in 2009.
Overall, Barrick Gold is a relatively stable and reliable company. Their business strategies and global focus contributed to their expansion over the years. Just like many of its competitors, Barrick’s debt has grown over the past few years but it is still considered a safe company for investors with reasonable risk. Furthermore, IFRS conversion will significantly impact the company as the entire reporting process of financial statements along with internal control procedures and information system will all change. This analysis has revealed that Barrick Gold seems to have a successful combination of policies and strategies, therefore making them far more superior than its competitors.
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