Topic 9 - Exploration & Evaluation for mineral resources PDF

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Measurement Issues – Agriculture

Key Definitions
Scope
Recent IASB amendments to IAS 41 and IAS 16 announced in June 2014
Recognition of AASB 141
Measurement Concept
Measurement agricultural activity
Inability to measure fair value reliab...

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Topic 9 Measurement issues -Exploration for and evaluation of mineral resources https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/reporting/ifrs-6-exploration-evaluation-mineral-resources.pdf http://www.iasplus.com/en/binary/au/0909extractingvalue.pdf https://www.hlb.com.au/getattachment/c47a52eb-376b-4a0c-b823-ea2001037bf0/The-Resource-May-2015;.aspx http://www.mrzllp.com/blog/oil-and-gas-accounting-the-full-cost-method

Extractive industries - 708 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.

Characteristics 708 •

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Searching for deposits generally involves considerable expenditure on geological and other studies (e.g. exploratory drilling) to determine whether areas are suitable for commercial development Other expenditure (post-exploration) often required before production possible Often lengthy period between initial exploration of area and production—possible changes in demand for product—could become uneconomical or less profitable than expected Need to consider whether preproduction expenditure (exploration, evaluation and development) results in an asset having been acquired AASB 6 Exploration for and Evaluation of Mineral Resources only addresses exploration and evaluation phases Need permits to explore 3-4 years to start production

Phases - 707 Five terms are used to describe different phases of extractive industry operations: 1. EXPLORATION The search for a mineral deposit or an oil or natural gas field which appears capable of commercial exploitation by an extractive operation and includes topographical, geological, geochemical and geophysical studies and exploratory drilling; 2. EVALUATION The determination of the technical feasibility and commercial viability of a particular prospect and includes determination of the volume and grade of the deposit or field, examination and testing of extraction methods and metallurgical or treatment processes, surveys of transportation and infrastructure requirements, and market and finance studies; 3. DEVELOPMENT The establishment of access to the deposit or field and other preparation for commercial production and includes shafts, underground drives and permanent excavations, roads and tunnels, advance removal of overburden and waste rock, and drilling of oil or natural gas wells; 4. CONSTRUCTION The establishment and commissioning of facilities including infrastructure, buildings, machinery and equipment for the extraction, treatment and transportation of product from the deposit or field; 1

5. PRODUCTION the day-to-day activities directed to obtaining saleable product from the deposit or field on a commercial scale and includes extraction and any processing prior to sale;   AASB 6 restricts its guidelines to the first two phases  The Last three phases relate to the reference of other accounting standards such as AASB, 102, 116,136,137,138 (See next table

Relevant accounting standards for Phases of the extractive industries (other than exploration and evaluation) - 708

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Some issues related to extractive activities are not specifically dealt with in other Australian Accounting Standards. Consequently, entities may need to refer to the AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors hierarchy in determining their accounting policies in these cases. Paragraphs BC10—BC13 of the Basis for Conclusions to IFRS 6 Exploration for and Evaluation of Mineral Resources provide some guidance on the treatment of expenditures incurred before the exploration for and evaluation of mineral resources.

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Objective of AASB 6 1. 2.

The objective of this Standard is to specify the financial reporting for the exploration for and evaluation of mineral resources. In particular, the Standard requires: a) limited improvements to existing accounting practices for exploration and evaluation expenditures. b) entities that recognise exploration and evaluation assets to assess such assets for impairment in accordance with this Standard and measure any impairment in accordance with AASB 136 Impairment of Assets. c) disclosures that identify and explain the amounts in the entity’s financial statements arising from the exploration for and evaluation of mineral resources and help users of those financial statements understand the amount, timing and certainty of future cash flows from any exploration and evaluation assets recognised.

Scope of AASB 6 AASB 6 shall apply to exploration and evaluation expenditures incurred. This standard does not apply to expenditures incurred: • before the exploration for and evaluation of mineral resources, e.g. expenditures incurred before the entity has obtained the legal rights to explore a specific area, • after the technical feasibility and commercial viability of extracting a mineral resource are demonstrable

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Major Accounting Issue A major problem of accounting for extractive industries • How to account for costs incurred in exploration and evaluation: • Part of preproduction costs? • An asset or an expense?

Economically recoverable reserves -709 Economically Recoverable Reserves: The estimated quantity of product in an area of interest that can be expected to be profitably extracted, processed and sold under current and foreseeable economic conditions. Area of Interest: 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. It is the discovery of ‘economically recoverable reserves’ that enables an entity to treat exploration and evaluation expenditure as an asset  Exploration phase: The costs incurred to discover reserves  Evaluation phase: The costs incurred to prove the reserves o Costs incurred in the Exploration & Evaluation Phases are least likely to benefit as  Development & Construction Phase: Costs incurred to prepare the area of interest for exploration of the reserves o Costs incurred during Development & Construction Phase provide greater benefits to the entity.  Inventory: Each unit of product sold by an organisation should bare its proportional share of costs incurred during production Exploration, Evaluation, Development & Construction Phase costs, are subject to impairment testing, should be carried forward and amortised of depreciated during the production phase Unsuccessful project costs should be written off as a loss as soon as it is known that the area of interest is not economically viable (Conservation principle)

Methods to Account for Preproduction costs - 709 Potentially five major alternative methods of accounting for preproduction expenditure in the extractive industries: 1. Costs-written-off method  All exploration and evaluation costs written off as incurred  Advocates for this approach argue that costs should not be carried forward due to the low probability of success during exploration and evaluation activities  the argument is consistent with asset recognition in the conceptual Framework which requires assets to be recognised when future economic benefit is deemed probable  If additional information becomes available regarding the future economic benefit would be probable, it would not meet the conceptual framework  This method fails to match costs with the benefits that flow from them

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2. Costs-written-off-and-reinstated method  Exploration and evaluation (preproduction) costs written off as incurred, and reinstated if economically recoverable reserves found  It has the effect of reversing the expenses recognised in previous periods  Not Permitted in Australia,  Has consistencies with the conceptual framework  Assets to be recognised when future economic benefit is deemed probable even if it has been previously written off  Therefore, the asset will qualify even though amounts may have been previously expenses  Following the strict definitions in the conceptual framework will lead to more initial write offs of exploration and evaluation activities expenditure than AASB 6 would.

3. Successful-effort method  Only exploration and evaluation costs resulting directly in the discovery of economically recoverable reserves are carried forward, all other costs are written off as incurred.  Allows preproduction expenses to be carried forward as long the activities are ongoing and have not been abandoned or economically recoverable reserves found  The approach is inconsistent with the conceptual framework because it recognizes assets only to the extent of future economic benefits are probable at the end of the period  Through amortisation costs carried forward will be matched against the income of the period that benefit from those costs 4.

Full-cost method •

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Matches all exploration and evaluation costs incurred against by and entity to be matched against revenue from the total economically recoverable reserves discovered by the entity across all sites. All exploration and evaluation costs may be carried forward in one pool as an asset and amortized against production revenue  Costs carried forward should not exceed Net realisable reserves of all economically recoverable reserves.  May be no assurance that the economically recoverable reserves exist or will be found  May match costs and revenues for current or previous periods or from different areas. • Followed by United States – not permitted in Australia

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5. Area-of-interest method – Most likely in exam!!!! (syed) Area of interest is an individual geological area which is considered to constitute a favorable environment for the presence of a deposit or field Will usually comprise a single mine or deposit, or a separate oil or gas field—each to be considered separately. - It is the method that is used in Australia - AASB require that each area of interest to be considered separately when deciding what costs should be carried forward or written off that arise from exploration and evaluation expenditure - More volatility in earnings compared to Full cost method - Recognise Impairment immediately -

Exploration and evaluation costs shall be expensed as incurred except that they may be carried forward (capitalized), provided that rights of tenure of the area of interest are current, and one of the following two conditions are met (AASB 6, par. Aus 7.2): – such costs are expected to be recouped through successful development and exploitation of the area of interest or, alternatively, by its sale, or – exploration and/or evaluation activities have not yet reached a stage that permits a reasonable assessment of the existence or otherwise of economically recoverable reserves, and active and significant operations in, or in relation to, the area are continuing

See: Treatment of exploration and evaluation expenditures (AASB 6) 7.1 & 7.2 for further detail (Next page)

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The option in AASB 6 of allowing an organisation to carry forward exploration and evaluation expenditure on the basis that – “activities in the area of interest have not at the end of the reporting period reached a stage which permits a reasonable assessment of the existence or otherwise of economically recoverable reserves’” The Conceptual Framework’s recognition criteria for assets require that it be ‘probable’ at the end of the reporting period that the future economic benefits embodied in an asset will eventuate. AASB 6 requires exploration and evaluation costs to be either expensed or partially or fully capitalised (subject to the tests in paragraph Aus7.2) – Allowing the management the choice between Costs-written-off method & Area of interest method ‘Area of interest’ is fairly loosely defined in AASB 6 – allowing management with some latitude in determining to carry forward or write off the expenditure It is also possible for management to write of preproduction expenditure for periods it would prefer to show reduced profits – in order to gain government funding that may not have been forthcoming in the previous periods

Treatment of Development & Construction Phase (other preproduction costs) -

Costs should be carried forward to the extent that these costs, together with costs arising from exploration and evaluation carried forward in respect of an area of interest, are expected to be recouped through the successful exploration of the area of interest, or by its sale

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Types of expenditure that would be seemed to be part of exploration and evaluation • Acquisition of rights to • Trenching explore • Sampling • Topographical and other • Activities in relation to technical and studies commercial feasibility and viability of extracting a • Exploratory drilling mineral resource -

General and administration costs only if they can be related directly to operational activities of area of interest to which exploration and evaluation relates

After recognition, an entity shall apply either the cost model or the revaluation model to the assets. The assets shall be classified as tangible or intangible according to the nature of the assets acquired. Examples of tangible and intangible exploration and evaluation assets are: • Tangible: vehicles and drilling rigs • Intangible: drilling rights

Treatment of exploration and evaluation expenditures (AASB 6) 7.1 & 7.2 - Area of Interest An entity’s treatment of the exploration and evaluation expenditures for each area of interest shall be either: i. expensed as incurred, or ii. partially or fully capitalized and recognised as an exploration and evaluation asset if specified conditions are met. An exploration and evaluation asset shall be recognised if the following conditions are satisfied: a) the rights to tenure of the area of interest are current, and b) at least one of the following two conditions is also met: i. the exploration and evaluation expenditures are expected to be recouped through successful development and exploitation, or by sale; or ii. exploration and evaluation activities in the area of interest have not at the reporting date reached a stage of reasonable assessment to determine the recoverable reserves, but active operations are continuing.

Abandoning an area of interest - 712 • •

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Abandoned when the search is unsuccessful or evaluation produces a negative result If an area is abandoned, costs carried forward relating to that area should be expensed in the period in which the decision to abandon is made. That is an impairment loss should be recognised Although not specifically mentioned in AASB 6, this would necessarily occur with annual impairment testing, as the carrying value of costs carried forward would have no future economic benefit and would therefore be recognised as an impairment loss If some expenditures incurred in relation to an area of interest have alternative uses, e.g. machinery has been constructed which can be dismantled and used on other sites, such expenditure would not be expensed when an area is abandoned as, consistent with AASB 116 Property, Plant and Equipment, the useful life of the asset would not be tied to the life of the area of interest

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Accumulation of costs and revenues from preproduction - 712 • • •

Costs (both direct and indirect) arising from exploration and -of interest General and administrative costs must relate directly to operations in an area before they can be capitalized. In all other cases – written off as expenses as they occur (9.4) As operations progress it is common for the area of interest to contract in size • Costs continue to accumulate in respect of an area of interest even though the size might contact as operations progress to production. • Therefore, costs to date should be equitable between such operations and future cost accounted for separately (7.3)

AASB 6 para 9.4 General and administrative costs are allocated to, and included in, the cost of an exploration and evaluation asset, but only to the extent that those costs can be related directly to operational activities in the area of interest to which the exploration and evaluation asset relates. In all other cases, these costs are expensed as incurred. For example, general and administrative costs such as directors’ fees, secretarial and share registry expenses, and salaries and other expenses of general management are recognised as expenses when incurred since they are only indirectly related to operational activities. AASB 6 para 7.3 An area of interest refers to an individual geological area whereby the presence of a mineral deposit or an oil or natural gas field is considered favourable or has been proved to exist. It is common for an area of interest to contract in size progressively, as exploration and evaluation lead towards the identification of a mineral deposit or an oil or natural gas field, which may prove to contain economically recoverable reserves. When this happens during the exploration for and evaluation of mineral resources, exploration and evaluation expenditures are still included in the cost of the exploration and evaluation asset notwithstanding that the size of the area of interest may contract as the exploration and evaluation operations progress. In most cases, an area of interest will comprise a single mine or deposit or a separate oil or gas field.

Measurement at Recognition - 713 Exploration and evaluation assets shall be measured at cost (Para 8) However, once exploration and evaluation expenditure has been recognised initially at cost, an entity may subsequently choose to use either the ‘cost model’ or the ‘revaluation model’ to account for exploration and evaluation assets (Para 12) • The Framework for the Preparation and Presentation of Financial Statements and AASB 138 Intangible Assets provide guidance on the recognition of assets arising from development. • An intangible asset is an identifiable non-monetary asset without physical substance. • The existence of an active Market is required if and intangible is to be revalued. • Active Market: A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. • Once an intangible asset had been expensed it may not subsequently be revalued • •

Para 12: After recognition, an entity shall apply either the cost model or the revaluation model to the exploration and evaluation assets. If the revaluation model is applied (either the model in AASB 116 Property, Plant and Equipment or the model in AASB 138), it shall be consistent with the classification of the assets (see paragraph 15).

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Classification of exploration and evaluation assets - 713  

15 An entity shall classify exploration and evaluation assets as tangible or intangible according to the nature of the assets acquired and apply the classification consistently. 16 Some exploration and evaluation assets are treated as intangible (e.g. drilling rights), whereas others are tangible (e.g. vehicles and drilling rigs). To the extent that a tangible asset is consumed in developing an intangible asset, the amount reflecting that consumption is part of the cost of the intangible asset. However, using a tangible asset to develop an intangible asset does not change a tangible asset into an intangible asset.

Reclassification of exploration and evaluation assets - 713 - where an entity has decided to develop a project beyond the exploration and evaluation phase subsequent expenditures will not be covered by AASB 6. Further, all exploration and evaluation activities incurred prior to the decision to develop the site will not subsequently by covered by AASB 6 17. An exploration and evaluation asset shall no longer be cl...