(Ac)counting for extractives
25 September 2024
The closure phase of the IASB’s Extractives Project
Why extractive industries?
Minerals and oil & gas (‘O&G’) extractive activities form an important part of many economies around the world. Yet, apart from IFRS 6 Exploration for and Evaluation of Mineral Resources (‘IFRS 6’) addressing exploration and evaluation (‘E&E’) activities and IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine addressing mine waste material costs incurred during the production phase of a surface mine, there are no industry specific IFRS® Accounting Standards addressing this industry.
Extractive activities include the exploration, evaluation, development and production of natural non-regenerative resources such as minerals, oil and natural gas. Although there are many differences between the minerals mining and oil and gas industries, they share similarities in the main business activities as well as geological and other risks.
Extractive activities have distinct phases and various IFRS Accounting Standards address these phases:
| Phase | Definition | Relevant IFRS Accounting Standards | |
| 1 | Prospecting | Geological analysis in the search for minerals, oil or gas | IAS 38 |
| 2 | Exploration and evaluation (E&E) | Acquisition of rights, exploratory drilling and feasibility studies | IFRS 6 |
| 3 | Development and construction | Development drilling, development of mine sites and construction of facilities | IAS 16, IAS 38, IFRS 15 |
| 4 | Production | Extraction of resources, processing, treatment, storage and transportation | IFRS 15, IAS 2, IFRIC 20 |
| 5 | Closure | Rehabilitation the mine or production site, plugging of wells and removal of infrastructure | IAS 37, IAS 16, IFRIC 1 |
A discussion paper (“DP”) was issued in 2010 containing the views of an IASB international project team. Feedback on the 2010 discussion paper was considered by the IASB when they once again included “Extractive Industries” on their research project pipeline in 2016. The project was finalised in December 2023.
What does IFRS 6 address?
IFRS 6 was originally issued as an interim measure for extractive industries. With the divergence in accounting for E&E activities across the industry, the IASB provided a temporary exemption from applying paragraphs 11 – 12 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (‘IAS 8’) to prevent disruption to the existing practices.
In terms of IFRS 6, entities must develop their own accounting policy for E&E activities. While some entities expense their E&E costs, others capitalise them as separate assets. When E&E assets are capitalised, the entity chooses to measure them using a cost model or revaluation model. IFRS 6 also provides a tailored list of impairment indicators to be considered. When an impairment test is required, IAS 36 Impairment of Assets is applied to calculate the recoverable amount. Once the technical feasibility and commercial viability of extracting a mineral resource can be demonstrated, the E&E asset is reclassified to either IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets, depending on the nature of the amounts incurred.
Diversity also exists in the type of expenditures capitalised, when capitalisation begins and ends, and the unit of account applied, for example some aggregate by oil well, license area, region, country or etc.
Why no extensive amendment to IFRS 6?
As part of the IASB’s extensive research, they found that the diversity allowed by IFRS 6 is not ideal, but the costs of developing and implementing any changes to IFRS 6 would exceed the benefits of such changes. The extractives industry has well-established accounting practices that predate IFRS 6.
Although E&E assets or expenses are often quantitatively material, it is not necessarily material information for the users of the financial statements. By way of an illustration:
- Large extractive entities primarily engage in production activities, and may have E&E activities too, but due to the production activities’ size, the E&E activities are rarely material.
- For small entities engaged in E&E activities, the users of the financial statements focus more on the nature and results of these activities, including its underlying finding and liquidity, including cash flows. Differing accounting policies are therefore not material information.
There is only one proposed amendment to IFRS 6. When IFRS 6 was first developed, it included a temporary exemption from applying paragraphs 11 and 12 of IAS 8. This meant that when entities developed their accounting policies for E&E activities, the selected policy needed to provide relevant and reliable information, without specifically referring to IFRS Accounting Standards dealing with similar and related topics, the Conceptual Framework or the most recent pronouncements of other standard-setting bodies. The word “temporary” will be removed from the heading included in IFRS 6, thereby making this exemption permanent. This will be addressed in a future annual improvements project, and was not included in the Annual Improvements Volume 11, issued during July 2024.
Why no expansion to disclosure of reserves and resources?
Disclosures of reserves and resources would be useful information – why was this not expanded? Many investors requested consistent disclosure by extractive entities on reserve and resource information, including the distinction between proved and probable when assessing it. This is expected to be an important input in determining subsequent depreciation, impairment, and decommissioning expenses. This issue is, however, not considered unique to extractive industries, and may also be applicable in, for example, the pharmaceutical industry where the research pipeline has similar accounting implications.
Furthermore, most jurisdictions with significant extractive industries have regulators who already require detailed disclosures of reserves and resources. The IASB considered that compiling their own reserves and resources disclosures may diverge from local requirements, thereby creating confusion for users of financial statements. Having reserves and resources information audited would also be difficult and expensive. On this basis the IASB decided not to include such disclosure requirements.
Consistent disclosure of E&E assets
The IASB decided the disclosures of more detail on E&E amounts incurred may also not provide valuable information when comparing entities as the nature of the type of extractive industry plays a big role. For example: The E&E for a surface (“open cast”) mine is likely less expensive than for shaft mining. Similarly, onshore E&E for oil and gas would likely be cheaper than off-shore E&E. This will severely distort values incurred by entities, thereby making disclosure of these amounts less relevant.
Missed opportunities
There are a number of contentious topics in the extractives industry on which additional guidance would have been helpful. The table below summarises some of these:
| Topic | Relevant standards | Summary of the issue |
|---|---|---|
| Asset acquisitions vs. business combinations | IFRS 3 / IAS 16 | Acquisitions in extractive industries, especially those in the E&E and development phases, may not meet the definition of a business. This would result in these acquisitions not being accounted for as business combinations at fair value, but rather asset acquisitions under e.g. IAS 16. The concentration test in IFRS 3 may help in this assessment. |
| Byproducts and joint products | IAS 2 | The extraction of joint products and by-products is common in extractive industries as some minerals and O&G are not found in isolation. Joint products are additional main products, whereas by-products are secondary less-important products. By-products are normally immaterial and accounted for as negative costs. If they are material, they should be treated as joint products. |
| Care and maintenance | IAS 16 / IAS 36 | This term refers to a suspended operation when the operation becomes uneconomical. The operation is curtailed until it becomes economical again. This is an indicator of impairment, and useful lives of the assets are also possibly extended. |
| Core inventories | IAS 16 / IAS 2 | Core inventories are inventories not held for sale but held at minimum levels allowing the infrastructure to operate. An example is the minimum levels of oil or gas kept in a pipeline to allow the free flow of the product. These inventories are usually recognised as property, plant and equipment instead of inventories. |
| Decommissioning on indefinite life assets | IAS 37 | In the O&G industry pipelines are continuously replaced and repaired, which would make the calculation of the underlying decommissioning liability complex as it is not always possible to determine the period when the decommissioning will take place. |
| Full cost versus successful efforts for E&E assets | IFRS 6 | Applying the full cost method, all costs incurred during the E&E phase are capitalised in large cost centres. Once technical feasibility and commercial viability is proven, the E&E asset is tested for impairment before transferring the asset to other categories. The full cost method may result in large impairment expenses as unsuccessful projects will not be capitalised with successful ones. The successful efforts method only capitalises directly attributable costs of successful projects in smaller cost centres. |
| Joint operations | IFRS 11 | Joint operations in extractive industries often have a lead operator who takes responsibility of implementing some decisions made by the parties. Depending on the contractual requirements, this may result in the lead operator having control over the arrangement instead of joint control. |
| Mineral leases and royalty agreements | IFRS 15 | Royalties can be payable under production sharing agreements, mineral leases, or other arrangements and are generally payable to the owner of the mineral reserve, which is often the government. The recognition of revenue on a gross or net basis, after deducting royalty payments, will depend on the facts and circumstances of the arrangement. |
| Production sharing agreements | IFRS 11 | A contract between a government or a large corporation and a contractor whereby exploration and production is shared between the two parties. If the counterparty is a government, they require the payment of a royalty which is paid in cash or in kind. Depending on the nature of the agreement, it may be a joint operation. |
| Provisional pricing on the selling of concentrate | IFRS 15 / IFRS 9 | When a mining entity sells concentrate instead of refined metal, the arrangements often include ‘provisional pricing’ mechanisms. This means that the final invoiced price will be based on the quantity of refined metal within the concentrate and the pricing of the metal at the refinery completion date. The quantity aspect is usually accounted for under IFRS 15, and the pricing is an embedded derivative under IFRS 9. |
| Shipping terms on sales contracts | IFRS 15 | Depending on when control over the sold goods transfers to the customer, contractual shipping arrangements may result in an additional performance obligation under IFRS 15 which would be recognised separately from the sale of goods and would normally be recognised over time instead of at a point in time. |
| Stripping costs for surface mining | IFRIC 20 / IAS 16 | ‘Stripping’ refers to the removal of overburden when operating a surface (open cast) mine. The IFRIC interpretation requires the capitalisation of such costs incurred during the production phase. The stripping activity asset is depreciated over the useful life of the identified component of the ore body that is now more easily accessible. Pre-production or development stripping costs would already be capitalised and depreciated under IAS 16. |
Although the accounting for extractive industries remains complex, due to the long-standing practice of accounting for extractives the IASB did not provide any additional IFRS Accounting Standards guidance. Entities in the E&E industry should carefully research judgemental issues and clearly disclose any judgements and estimates made when applying and implementing accounting policies.
The counting of extractives, such as measuring stockpiles or O&G volumes, determining the quantum of extracted but not yet refined minerals, etc. is already difficult. The IASB had an opportunity to clarify the accounting for extractives but opted not to.
Author:
Sonica Schoeman, Director
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