Topic 9 - Accounting for Mineral Resources Lecture Slides PDF

Preview

Summary

Lecture slides for topic 9...

Description

11/12/2020

UNSW Business School

Topic 9 Accounting for mineral resources

1

Reference readings TEXTBOOK: • Loftus Chapter 34 ACCOUNTING STANDARD: • AASB 6 Exploration for and Evaluation of Mineral Resources

2

2

1

11/12/2020

Learning Objectives •

Explain that entities involved in extractive activities are often faced with unique and challenging accounting issues

•

Describe the objective of AASB 6

•

Apply the necessary judgement in determining the nature of the activities and related costs considered to be within the limited scope of AASB 6

•

Evaluate the accounting policy options available for exploration and evaluation assets under AASB 6

•

Analyse costs incurred during the exploration and evaluation phase of extractive activities in order to apply the area of interest method as set out in AASB 6

•

Demonstrate understanding of the presentation requirements of AASB 6

•

Evaluate the appropriateness of continued capitalisation of costs incurred during the exploration and evaluation phase of extractive activities

•

Apply the disclosure requirements of AASB 6

•

Discuss the possible future developments related to accounting for the extractive industries

3

3

Mineral resources in context and the nature of extractive industries • Mineral resources industry is a key pillar of Australian economy • Employs more then 200,000 people • In 2017 over half of Australia’s export revenue was from mineral resources • Extractive industries engage in the search for natural substances of commercial value such as minerals, oil and natural gas, and in extracting these substances from the ground. 4

4

2

11/12/2020

Characteristics of extractive industries • High degree of risk • Lengthy period between discovery and sale • Long period to exploit the deposit fully

5

5

Phases of activity in extractive industries Phase

Explanation of phase

Exploration

Search for mineral deposit or oil or gas field

Evaluation

Technical feasibility & commercial viability of prospect

Development Establishment of access to deposit or field and and commissioning of facilities construction Production

Day-to-day activities aimed at obtaining saleable product from the deposit or field on commercial scale

Restoration

Restore the area after the cessation of operations

The first three phases are collectively referred to as the ‘pre-production’ phases of activity 6

6

3

11/12/2020

Phases of activity in extractive industries Exploration

Evaluation

7

7

Phases of activity in extractive industries Development and construction

8

8

4

11/12/2020

Accounting issues in extractive industries • The key accounting issue is how to account for costs incurred during each phase. • The treatment of pre-production costs, particularly exploration and evaluation (E&E) is most disputed. •

Some examples of E&E expenditure in FY 2019 Woodside Petroleum

US$582 million

BHP

US$516 million

Rio Tinto

US$617 million

9

9

Accounting issues in extractive industries • AASB 6 is concerned principally with whether E&E costs: – may be capitalised (carried forward as assets) or – written off (expensed) as incurred. • Before reviewing the requirements of AASB 6 it is worth noting: – In Australia the extractive industry contributes significantly to the economy – The industry requires significant investment and involves significant risk – Many believe that we should account for mining activities in a way that ensures that the sector remains an attractive investment. 10

10

5

11/12/2020

Accounting issues in extractive industries • Before reviewing the requirements of AASB 6 it is also worth reviewing the accounting treatment of research expenditure under AASB 138 Intangible Assets • AASB 138 defines research as: – “Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding” • Under AASB 138 all costs incurred in the research phase must be expensed. • This treatment is consistent with the Conceptual Framework 11

11

Accounting for E&E costs under AASB 6 • AASB 6 requires the use of the ‘area-of-interest’ (AOI) method. • This method is unique to Australia. • This is achieved through the insertion of Australian specific paragraphs into AASB 6 (identified by the ‘Aus’ prefix, i.e., paras Aus 7.1-7.3). • Area of interest is defined in para Aus. 7.3 as an individual geological area » which is considered to constitute a favourable environment for the presence of a mineral deposit or an oil or natural gas field; or » has been proved to contain such a deposit or field 12

12

6

11/12/2020

Accounting for E&E costs under AASB 6 Under AASB 6 Aus7.1, for each AOI, E&E costs must be either: – expensed as incurred; or – partially or fully capitalised as an asset.

13

13

Accounting for E&E costs under AASB 6 Under AASB 6 Aus7.2, E&E costs for an AOI may be carried forward as an asset if: 1. Rights to tenure of the AOI are current; and 2. At least one of the following is also met: a. E&E costs are expected to be recouped; or b. E&E activities have not yet reached a stage permitting a reasonable assessment of the existence of reserves, and active and significant operations are ongoing.

14

14

7

11/12/2020

Accounting for E&E costs under AASB 6 Criteria for capitalisation - example GEM Limited (GEM) is a miner of diamonds and other precious gemstones. GEM is currently undertaking E&E activities in the following areas of interest: Site Details A In 20X3 GEM acquired Site A. E&E activities have indicated that this site has significant deposits of economically recoverable reserves of sapphires. In January 20X6 the government enacted legislation preventing development in the area where Site A is located due to environmental concerns.

• Due to the legislation preventing development in the area there is no right of tenure for Site A. • All E&E costs for Site A must be expensed.

15

15

Accounting for E&E costs under AASB 6 Criteria for capitalisation - example GEM Limited (GEM) is a miner of diamonds and other precious gemstones. GEM is currently undertaking E&E activities in the following areas of interest: Site Details B In 20X4 GEM discovered diamonds at Site B. Geologists estimate that 100 carats of diamonds are located at the site. A minimum benchmark of 75 carats is required for GEM to proceed with the development. At 30 June 20X6 GEM is waiting on the issue of a mining permit. They plan on commencing development and construction activities on Site B as soon as the permit is issued.

• As GEM are waiting on the issue of a mining permit there is currently no right of tenure for Site B. • All E&E costs for Site B must be expensed.

16

16

8

11/12/2020

Accounting for E&E costs under AASB 6 Criteria for capitalisation - example GEM Limited (GEM) is a miner of diamonds and other precious gemstones. GEM is currently undertaking E&E activities in the following areas of interest: Site Details C In January 20X6 GEM acquired Site C. E&E activities have indicated that this site has significant deposits of economically recoverable reserves of emeralds. The area is conveniently located near an existing mine and GEM will need to commit only limited funds towards development and construction prior to commencing mining activities.

• As GEM own Site C (and there does not appear to be any restrictions placed on mining) it is assumed that there is a right of tenure for Site C. • It is expected the E&E costs will be recouped (as evidenced by the significant deposit of economically recoverable reserves) • E&E costs for Site C may be capitalized. 17

17

Accounting for E&E costs under AASB 6 Criteria for capitalisation - example GEM Limited (GEM) is a miner of diamonds and other precious gemstones. GEM is currently undertaking E&E activities in the following areas of interest: Site Details D In July 20X5 GEM commenced initial exploration activities on Site D after obtaining regulatory approval to mine in this area. To date some deposits of gems have been found but geologists are yet to determine the quality and quantity of the deposits.

• As GEM have regulatory approval to mine in this area there is a right of tenure for Site D. • At this stage the existence of economically recoverable reserves has not been determined but operations are ongoing. • E&E costs for Site D may be capitalized. 18

18

9

11/12/2020

RIO TINTO’s E&E policy

19

19

RIO TINTO’s E&E policy

20

20

10

11/12/2020

RIO TINTO’s E&E policy

21

21

Measurement of capitalised E&E costs • E&E assets are required to be initially measured at cost. • E&E assets to be classified as either tangible or intangible. • Entities to apply either the cost model or the revaluation model to E&E assets subsequent to initial recognition. Note: difficulty associated with FV measurement and lack of an active market for such assets.

22

22

11

11/12/2020

Measurement of capitalised E&E costs Worked example – GEM mining •

GEM Mining has elected to capitalised the E&E costs in relation to Sites C and D.

•

During the year ended 30 June 20X6 GEM incurred $15m E&E costs in relation to Site C and $10m in relation to Site D.

•

All costs incurred to date are classified as intangibles. Date 30.6.X6

Description

Dr $

E&E asset – intangible, Site C

15,000,000

E&E asset – intangible, Site D

10,000,000

Cash/Payables

Cr $

25,000,000

(Recognition of E&E assets)

23

23

Impairment of capitalised E&E costs • E&E assets are not amortised (if intangible) or depreciated (if tangible) until production commences. • They will however be subject to impairment testing. • Impairment testing is undertaken for each separate capitalised AOI. • Impairment test performed when an indication of impairment is present. • AASB 6 indicators of impairment are different to those for other assets under AASB 136 Impairment of Assets.

24

24

12

11/12/2020

Impairment of capitalised E&E costs The period for which the entity has the right to explore has expired or will expire in the near future, and is not expected to be renewed

Expenditure on further E&E activity is neither budgeted nor planned

E&E activity has not led to the discovery of commercially viable quantities of mineral resources and the entity has decided to discontinue activities Although development is likely to proceed, the carrying amount of the E&E asset is unlikely to be recovered in full from successful development or by sale.

25

25

Impairment of capitalised E&E costs Worked example – GEM mining •

During the year ended 30 June 20X7, following evaluation of Site D, it is abandoned.

•

None of the E&E asset costs can be shifted to alternative uses.

Date 30.6.X7

Description Impairment loss E&E asset – intangible, Site D

Dr $

Cr $

10,000,000 10,000,000

(Impairment due to abandonment of Site D)

26

26

13

11/12/2020

Reclassification of capitalised E&E costs •

Once the technical feasibility of and commercial viability of extracting a mineral resource are demonstrable, and a decision is made to progress to development and construction, E&E assets must be reclassified into the Development asset account.

27

27

Reclassification of capitalised E&E costs Worked example – GEM mining • During 20X7 further evaluation costs of $5m are incurred for Site C, and then the decision is made to develop the site for mining. Date 30.6.X7

Description E&E asset – intangible, Site C

Dr $

Cr $

5,000,000

Cash/payables

5,000,000

(Recognition of further E&E assets) Site C development asset - intangible E&E asset – intangible, Site C ($15m +$5m)

20,000,000 20,000,000

(Reclassification of E&E assets on commencement of development and construction)

28

28

14

11/12/2020

Reclassification of capitalised E&E costs Worked example – GEM mining •

During the 20X8 financial year development costs of $8m that satisfy the requirements of AASB138 are incurred in relation to Site C. Date

Description

30.6.X8

Site C development asset - intangible

Dr $

Cr $

8,000,000

Cash/payables

8,000,000

(Recognition of further development costs for Site C)

29

29

Plant & equipment acquired in development and construction phases Worked example – GEM mining • During the 20X8 financial year the following GEM mining purchased $1 million of plant & equipment and a building costing $2 million for Site C. • Plant & equipment could be relocated and has a 10-year useful life and zero residual value. It is impractical to move the buildings. Date

Description

30.6.X8

Plant & equipment

1,000,000

Buildings

2,000,000

Cash

Dr $

Cr $

3,000,000

(Reclassification of E&E assets on commencement of development and construction) 30

30

15

11/12/2020

Reclassification of capitalised E&E costs Worked example – GEM mining • • •

In the 20X9 financial year, Site C moves into the production phase. It is estimated that Site C can produce 800kg of emeralds in total. 200kg are mined during the year ended 30 June 20X9. Date

Description

30.6.X9

Site C production asset - intangible

Dr $

Cr $

28,000,000

Site C development asset - intangible

28,000,000

(Reclassification of development and construction costs on commencing production)

31

31

Depreciation/amortisation of capitalised costs • Depreciation and amortisation commence when production commences. • The depreciation/amortisation expense represents a production cost and forms part of the cost of inventory. Useful life of PPE

Depreciation term

Depreciation method

… less than life of AOI OR …. more than life of AOI AND asset can be removed at end of AOI life …. more than life of AOI BUT asset cannot be economically removed

Useful life of the item of PPE

Straight-line method

Useful life of the AOI

Unit-of production method

32

32

16

11/12/2020

Depreciation/amortisation of capitalised costs Unit-of-production method This method is used for: •

All intangibles

•

PPE where the useful life of the PPE is more than the life of the AOI but the PPE can not be economically moved at the end of the AOI life.

Unit-of-production depreciation/amortisation expense = Costs carried forward x (current period production ÷ estimate of total available output)

33

33

Depreciation/amortisation of capitalised costs Worked example – GEM mining Asset

Method

Workings

Annual charge

Plant & equipment

Straight line

( $1mill -$0 )/10 years

$100,000

Building

Units of production

( $2mill -$0) x 200kg /800kg

$500,000

Site C production asset - intangible

Units of production

($28mill -$0) x 200kg/800kg

$7,000,000

34

34

17

11/12/2020

Depreciation/amortisation of capitalised costs Worked example – GEM mining Date 30.6.X9

Description Inventory - emeralds

Dr $

Cr $

7,600,000

Accumulated depreciation – P&E

100,000

Accumulated depreciation - building

2500,000

Accumulated amortisation – production asset

7,000,000

(Recognition of depreciation and amortization for 20X9)

35

35

Production costs Worked example – GEM mining • Production costs (e.g. wages) amounting to $500,000 were paid during 20X9. Date 30.6.X9

Description Inventory - emeralds Cash

Dr $

Cr $

500,000 500,000

(Recognition of production costs for 20X9)

36

36

18

11/12/2020

Production costs Worked example – GEM mining Total costs of inventory produced during 20X9 Element

Amount

Depreciation and amortisation

7,600,000

Production costs Total cost of inventory

500,000 8,100,000

Production (kg)

200kg

Cost per kg

$40,500

37

37

Sale of inventory Worked example – GEM mining • 150 kg of emeralds were sold during the 20X9 year at $400,000/kg. Date 30.6.X9

Description Cash/receivables

Dr $

Cr $

60,000,000

Revenue

60,000,000

(Sale of 150kg x $400,000 of emeralds) Cost of goods sold

6,075,000

Inventory - emeralds

6,075,000

(Recognition of cost of emeralds sold = 150/200 x $8,100,000 )

38

38

19

11/12/2020

Removal and restoration costs •

Where there is a present obligation to undertake restoration of an AOI at the end of the life of the AOI a provision for those future costs should be recognised in accordance with AASB 137 (covered in topic 2).

•

The provision should be attributed to the phase giving rise to the expected future costs.

•

Phase

Treatment of expected future costs

Exploration & evaluation

Capitalised into intangible E&E account per AASB 6

Development & construction

Capitalised into cost of PPE under AASB 116

Production

Capitalised into inventory (as a production cost) under AASB 102.

Provisions for restoration are to be measured at present values. 39

39

Removal and restoratio...