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ACC/ACF3100 Week 9 Tutorial Solutions Extractive Industries Henderson et al. Chapter 19 Questions 2(a) What is the main accounting issue for entities involved in the extractive industries? The main issue is how to account for the significant costs incurred during both the preproduction and production phases. Should the costs be recognised as expenses or as an asset? What criteria should be used in answering this question? Conceptually, the Framework should be applied to see if the expenditures give rise to assets. Differences in opinion relate mainly to the treatment of pre-production costs and in particular exploration and evaluation costs. By the time development commences, the deposit is obviously considered by management to be worth exploiting. Variations in opinions on how to account for these costs are likely due primarily to differing interpretations of the degree of risk inherent in the extractive industries. (b) Briefly outline the four broad approaches to accounting for pre-production costs, identifying the approach advocated in AASB6. Broadly speaking, there are four approaches to accounting for pre-production costs: 1. The expense (or costs written-off) method, which recognises the costs as expenses in the period in which they are incurred; 2. The expense-and-reinstate method, which recognises the costs as expenses in the period in which they are incurred, but reinstates them as assets if subsequently those costs give rise to economically recoverable reserves; 3 The full-cost method, which recognises the costs as an asset irrespective of the likely success of the exploration program; and 4. The successful-efforts method, which limits asset recognition to those costs that are likely to result in the discovery of economically recoverable reserves (the other costs are recognised as expenses). The current approach advocated in AASB 6, the area of interest method, is a special case of the successful-efforts method.

7. Northern Mining Ltd (NML) (a) NML should recognise the estimated costs of restoration in its statement of financial position as at 30 June 2017. The restoration will require an outflow of economic benefits to those undertaking the restoration. NML has a constructive obligation to restore the company’s mine sites based on community expectation and company policy, and the need for restoration has arisen because of site development work. Assuming that the $1 million of future work is necessitated by development at the mine site that has already occurred, the need for restoration is probable and the costs can be measured reliably. The obligation would be measured at either: (i)

face value of expected future outlays = $1 million or

1

(ii)

$ 1 000 000 =$ 385543 ( 1. 1 )10 present value of expected future outlays =

As the Framework is effectively silent on the choice of an appropriate measurement base, students may prefer to measure restoration costs either in accordance with option i) or to recognise that restoration is deferred for a considerable time (option ii). (b) The need for restoration has arisen as a result of development activities. Because AASB 6 only deals with exploration and evaluation, the accounting standard does not specify requirements in relation to this issue. Instead, the obligation for restoration costs would be recognised in accordance with AASB 137 ‘Provisions, Contingent Liabilities and Contingent Assets’. Also, consistent with the treatment in AASB 6, the $1 million should be included in development costs and amortised over the life of the deposit once production commences. In brief, AASB 137 requires that a provision for removal and restoration to be recognised when ‘(a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation’ (para. 14). As discussed in the answer to part (a) of this question, these three recognition criteria have been met. Therefore, the provision for restoration costs would be recognised as follows: Development assets Provision for restoration costs

Dr Cr

Paragraph 36 of AASB 137 requires that a provision be measured as ‘the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.’ In addition, if the effect of the time value of money is material, the amount of the provision is measured as the present value of the expected future expenditures (para. 45). The appropriate discount rate is a pre-tax rate that reflects the current market assessment ‘of the time value of money and the risks specific to the liability’ (para. 47). Since the time value of money is likely to be material in the extractive industries, the provision for provision for restoration costs should be reported at net present value, i.e.: $385 543

2

*Deegan Chapter 20 13(a) Area-of-interest method 2017 Dr Exploration and evaluation assets—Good Site 23 Dr Exploration and evaluation assets—Bad Site 16 Dr Exploration and evaluation assets—Indifferent Site 25 Cr Cash, payables, accumulated depreciation, etc. (To account for the initial exploration and evaluation costs incurred in each site initially measured at cost) 2018 Dr Impairment loss—exploration and evaluation assets

16

Cr Exploration and evaluation assets—Bad Site Dr Assets under construction—PPE (Good Site)

16 18.4

Dr Assets under construction—intangible assets (Good 4.6 Site) Cr Exploration and evaluation assets—Good Site 23 (To reclassify the balance of the exploration and evaluation expenditure at Good Site to ‘assets under construction’ and to recognise an impairment loss in relation to Bad Site as the site has been abandoned. Because Indifferent Site has not reached a stage where a reasonable assessment can be made of the existence of recoverable reserves, then there is no reclassification of the related expenditure.) Dr Assets under construction—PPE (Good Site) Dr Assets under construction—intangible assets (Good Site)

20 7

Cr Cash/Payables/accumulated depreciation, etc. 27 (To recognise the development costs incurred in relation to Good Site. Such capitalised costs will be reclassified when the development phase concludes. Because the assets are not ready for use they will not be depreciated; however, they will be subject to impairment testing. The capitalised costs will ultimately form part of the cost of inventories as a result of applying the entity’s amortisation/depreciation policies.) Dr Property, plant and equipment (Good Site)(18.4+20) Dr Intangible assets (Good Site)(4.6+7) Cr Assets under construction—PPE (Good Site)

38.4 11.6 38.4

Cr Assets under construction—intangible assets (Good 11.6 Site) (To reclassify the assets as a result of the movement from the preproduction phase to the production phase)

3

64

Dr Inventory of crude oil 10 Cr Accumulated depreciation—property, plant and equipment (Good Site) Cr Accumulated depreciation—intangible assets (Good Site) (3 m × $3.3333 where $50 m/15 m = $3.3333 per tonne) Dr Cr Dr Cr

Inventory of crude oil Cash, payables, accumulated depreciation, etc. Cash/receivables Sales revenue (1.9 m × $30)

Dr Cr

Cost of goods sold Inventory of crude oil [(10 + 4)/3] × 1.9 = 8.87

*Deegan Chapter 20 14(a) Area-of-interest method 2017 Dr Exploration and evaluation assets—Ian site Dr Exploration and evaluation assets—Eddie site Cr Cash, payables, accumulated depreciation, etc.

7.68 2.32

4 4 57 57 8.87 8.87

1 500 2 000 3 500

2018 Dr Dr Cr

Exploration and evaluation assets—Ian site Exploration and evaluation assets—Eddie site Cash, payables, accumulated depreciation, etc.

2 000 3 000 5 000

2019 Dr Dr Cr Dr Dr Cr

Exploration and evaluation assets—Ian site Exploration and evaluation assets—Eddie site Cash/payables Assets under construction—PPE Assets under construction—intangible assets Exploration and evaluation assets—Ian site

3 000 4 000

Dr Cr

Impairment loss—exploration and evaluation assets Exploration and evaluation assets—Eddie site

9 000

7 000 5 200 1 300 6 500 9 000

4

2020 Dr Cr

Property plant and equipment Cash, payables, accumulated depreciation, etc.

Dr Cr

Buildings Cash/payables

Dr Dr Cr Cr

Property, plant and equipment Intangible mineral assets Assets under construction—PPE Assets under construction—PPE

2 000 2 000 500 500 5 200 1 300 5 200 1 300

Dr Cr

Inventory of crude oil 2 268 Accumulated depreciation—PPE (2000+5200)/1500*400 Accumulated depreciation—intangible assets (1300/1500*400) (400 × $5.67, where ($5200 + $1300 + $2000)/1500 = $5.67 per tonne)

1 920 348

Dr Inventory of crude oil 50 Cr Accumulated depreciation: portable buildings (It is assumed buildings were acquired at the commencement of the year. 50 = 500/10) Dr Inventory of crude oil Cr Cash, payables, accumulated depreciation, etc. (400 × 5.00)

2 000

Dr Cash/receivables Cr Sales revenue (250 × 25.00)

6 250

Dr Cost of goods sold Cr Inventory of crude oil [(2268 + 50 + 2000)/400] × 250 = 2699

2 699

50

2 000

6 250

2 699

5

*Deegan Chapter 20 15 2017 $ million Dr Exploration and evaluation assets—Green site 9 Dr Exploration and evaluation assets—Tree site 10 Dr Exploration and evaluation assets—Frog site 10 Cr Cash/payables/accumulated depreciation, etc. (To account for the initial exploration and evaluation costs incurred in each site) Dr

Assets under construction—property plant and equipment (Green site)

3

Dr

Assets under construction—intangible mineral assets (Green site)

6

$ million

29

Cr Exploration and evaluation assets (Green site) 9 Dr Impairment loss—exploration and evaluation assets 10 Cr Exploration and evaluation assets (Tree site) 10 (To signify that a judgement has been made that economically recoverable resources exist. Also, to write-off the carried forward costs in relation to Tree site) 2018 Dr Property, plant and equipment (Green site) 12 Cr Cash/payables/accumulated depreciation, etc. 12 Dr Dr Cr Cr

Property, plant and equipment (Green site) 3 Intangible mineral assets (Green site) 6 Assets under construction – PPE (Green site) Assets under construction – intangible assets (Green site) Dr Inventory of crude oil 2.1 Cr Accumulated depreciation – PPE (Green site) Cr Accumulated depreciation – intangible assets (Green site) (Amortisation of costs carried forward. The amount is calculated as 5000 × $420 where $21m/50 000 = $420 per tonne.)

3 6 1.5 0.6

Dr Inventory of crude oil 2 Cr Cash/payables/accumulated depreciation, etc. (To recognise the production costs which are treated as a cost of the inventory, rather than being written-off directly) Dr Cash/receivables 12 Cr Sales revenue (To recognise sales made, where $12 million equals 4000 tonnes multiplied by $3000 per tonne)

2

12

Dr Cost of goods sold 3.28 Cr Inventory of crude oil 3.28 (To acknowledge the cost of goods sold, which is calculated as: ($2.1 million + $2 million)/ 5000 × 4000 = $3.28 million)

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