Fixed asset registers Finding hidden value in LNG assets

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1 Fixed asset registers Finding hidden value in LNG assets

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3 Australia s emerging LNG industry could be missing out on millions of dollars in value as a result of procurement practices and the accounting treatment of large-scale engineering works. Large engineered assets, such as power plants, camps, LNG facilities, gas plants, built under contract by engineering, procurement and construction (EPC) operators firms are handed over to the customer on completion, accompanied by operating manuals and maintenance instructions. But the bookkeepers might only record this as a single, lump sum accounting entry: One (1) gas-fired power plant, steel and copper, 250 megawatt, silver trim: $1 billion. This sounds like a slightly simplistic approach (and it is) that could be booked in a much more sophisticated and granular way that actually delivers value. Why the accounting matters This most basic, single accounting entry for a big, complex and expensive asset actually hides a lot of value calculations and drives a lot of management decisions. Here are just a few. Spares management Embedded assets that might require a far greater inventory of spare parts (because they break down more frequently) can mislead managers into miscalculating inventory needs if they were to apply the higher inventory need against the whole asset. Business management Absent a detailed financial view of assets, managers get a distorted view of the business. For example, a single large asset might deliver an adequate return but, based on their operating cost and maintenance needs, some parts of the asset don t have a high enough return, and others may be commanding too high a return. The risk is managers misallocating time and money against that asset in improvement initiatives. Depreciation With so little detail, the accountants are limited to depreciating this big asset over its useful life (40 years for a power plant, for example). But some bits and pieces inside the asset might actually have far shorter useful lives and can legitimately be depreciated much, much faster, or perhaps on a different basis altogether. Revenue measurement Measuring revenues in the gas world is always a challenge, and involves meters, pricing agreements, market rates, contracts, and so on. Sometimes, the depreciation charge is also incorporated into calculating revenue. But if depreciation is understated, then revenues may be overstated, and vice versa. Insurance With some parts of the asset more susceptible to damage, or the subject of more frequent repair, insurance premiums could be more targeted, and even lower, improving the overall risk profile of the business. 3

4 Joint venture management Joint venture participants who may be operating under different financial compliance and reporting schemes in their home countries may benefit from having more granular visibility of their joint venture accounts. Some shared services, product sales and tax calculations that apply to a joint venture will depend, in part, on granular asset information. Tax risk mitigation Governments everywhere are becoming more vigilant about tax collections. A position on the tax treatment of an asset that is not based on hard engineering evidence could be open to challenge by tax authorities, and even result in penalties. Cost allocations In some scenarios, getting cost allocations right can help. For example, the Petroleum Resource Rent Tax (PRRT) calculation is based on allowable expenses which need to be reflected in the accounts. If the allocations are not correct, then the tax position may be over or under stated. Asset valuations based on cost allocations might matter when assets are purchased, transferred or sold off. Research and development Many governments offer research and development (RD) tax credits to promote industrial development. But to claim the credits, companies need to offer evidence (both on the research side and the cost side) to support a claim. Lump sum financial records might prevent an operator from claiming legitimate RD savings. Claims need to be for specific parts of larger assets where legitimate RD might have taken place. The accounting versus engineering miscue So how is it that a major asset can end up on the books as a lump sum rather than delivering detail that can drive decision making and value? Construction project directors are entirely measured in their ability to hit construction schedules, scope requirements and budgets. If it s in the contract, they ll deliver it. But a lot of engineering contracts are oddly silent on how much detail they need to provide finance and accounting teams about the as-built assets. There are many reasons for this: Inexperienced contracting teams don t always incorporate a requirement for better and more detailed accounting data The EPC provider strips an accounting data service from their contracts to lower their overall bid cost When project budgets blow out and teams start looking for productivity and cost improvements, they might decide that accounting detail can be safely sacrificed The immediate pressures of capital project execution simply dominate the project agenda, and drown out the voices pointing out future operating needs The future asset owner who will be accountable for asset performance hasn t been hired when the contracts are put in place, so there s no internal champion Accounting and tax professionals are simply not asked if they can find ways to improve capital execution. Financial reporting Detailed fixed asset information may be needed to meet some financial reporting obligations imposed by, for example, capital markets. Financial records help confirm that assets exist and are carried on the books at the right value. But they also need to be maintained over time so that they always reflect the actual business. 4

5 The solution s really simple All the accountants need is a detailed fixed asset register that breaks an asset down into its component parts, along with a cost breakdown to match. A power plant, for example, would include sub assets such as the building structure, turbines, utility boilers, transformers, piping, control panels, circuit breakers, pumps and condensers. A register is easy to build, on the go, as the asset is being built, but much harder after the asset has been delivered and the build team has been disbanded. It s so difficult, in fact, that most companies simply don t bother. Engineers need to be convinced that fixing up accounting is a priority. Tax and accounting teams need to be taken away from other, equally important, work. Insurance providers and joint venture partners will also want to know what you re doing. And you d want to back it up with appropriate engineering diagrams and other technical documentation. The hack We recently figured out a type of hack around this problem for recently built assets, and that could be applied to many heavy assets such as mining kit, transport infrastructure assets, electricity assets, and LNG. It does come with a cost, but the return on investment can be significant one of our Australian LNG clients recently applied the hack, built a new asset register, and improved their first year depreciation position on just one large asset by $40 million. Rather than just accounting for a single lump sum asset, it was converted it into dozens of different assets, as required for tax and accounting purposes. The return was 200 times the cost, and the client is now looking to apply this approach to other large assets. There s likely a few more subtle impacts too. More detailed financial data may trigger a need to improve or change financial reporting, performance metrics, or performance-based compensation schemes. 5

6 The fix But the best approach a permanent, and valueadding, fix is to simply build the fixed asset register at the same time the assets are being built, and keep financial and operations asset registers aligned. For EPC firms Ensure that your contracts include detailed financial records so you can claim credit for the eventual cash flow benefits, and position your bid as offering a lower total cost of ownership. If you don t know all the different ways that detailed financial data can enhance the value of your bid, get some accounting and tax help. For asset owners and contracting teams Insist that detailed fixed asset financial registers be part of your contracts. Resist the temptation to skinny out accounting and finance issues from the scope of work, and work with your EPC contractor to capture fixed asset data to your standard, not theirs. Get your accounting and tax teams involved at the contracting stage so they can help develop the requirements for financial data and validate EPC contract compliance with contract terms for financial data. Investors Ensure your expectation of detailed financial data in the form of a fixed asset register is a condition of participation. 6

7 Contacts Geoffrey Cann National Director, Oil and Gas [email protected] Jonathan Schneider Partner, Tax [email protected] Lauren Folkard Director, Tax [email protected] 7

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