First step to a new IFRS for mining? Part Two

To read the first part of this report click here

The following is an extract of a Deloitte paper, ‘Extracting value - Focussing on resources industry issues’.
There are a number of interesting issues and considerations arising from the draft Discussion Paper - such as potentially mandating capitalisation of exploration expenditure and much more information about the fair value of reserves and resources.

Is this only about the asset?
The Discussion Paper focuses on accounting for the ‘mining asset’ or ‘oil and gas asset’, including when and how it is recognised and measured. The paper consciously ‘avoids issues of general application’, such as revenue recognition, inventory accounting, decommissioning and restoration liabilities and joint venture accounting. The Discussion Paper takes the view that in these areas the issues facing the extracting industries ‘are not sufficiently different from those in other industries’.
Many standards have exclusions for extractive industries, or permit special treatments (e.g. scope exemptions from AASB 102, AASB 116 and AASB 138 for resources-related activities). It would appear these may be removed if any new IFRS is made as a result of the Discussion Paper.
Additionally, the issues arising in some areas may not be adequately dealt with under other Standards, such as:
• the farm-in/farm-out of a project in the exploration stages – because the ‘asset’ is a bit ‘rubbery’, the normal ‘purchase and sale’ principles can be hard to apply and many entities currently use a ‘cost accumulation’ approach
• the treatment of ‘pricing adjustments’ for the sale of commodities, where the prices are set by reference to an average market price well after the delivery of product to the customer
• the prohibition on including ‘expansionary capital expenditure’ in value in use models when testing for impairment under AASB 136 – resources projects are unique in that they are producing cash inflows before the asset (mine or field) is finally constructed, which may only occur close to the end of the life of the field or mine. Accordingly, resources companies will continue to test impairment with ‘one hand tied behind their back’ and regularly not be able to use ‘value in use’ to support the carrying amounts of their assets, particularly in the earlier stages of the life of a field or mine.

What about activities like geothermal?
The draft Discussion Paper only deals with extractive activities relating to minerals, oil and natural gas. It explicitly scopes out consideration of similar processes, such as geothermal energy projects and sea water extraction.
Australia has a growing geothermal energy sector, which is likely to continue to expand as the globe responds to the climate change challenge. These entities currently mostly apply AASB 6 when accounting for their activities and this narrowing of scope potentially leaves these entities in ‘no man’s land’, without a directly applicable standard and an uncertain hierarchy response.

Fair value accounting is not dead yet
The Discussion Paper concludes that historical cost is the best measurement model because it does the ‘least harm’ – it is not a resounding endorsement of the approach. The paper discusses the numerous possible measurement approaches (historical cost, current cost, fair value, etc), and finds, in light of discussions with analysts, users and preparers, that none of the possible measurement approaches is particularly useful.
During the earlier stages of the project, the IASB made it clear to the project team that it should not discount the use of fair value accounting in the Discussion Paper.
Some Board members even remarked at that time that ‘unless you recommend fair value accounting, you’re wasting your time’. The IASB has not endorsed the Discussion Paper proposals as yet and the paper itself is not ‘strong’ in its conclusion that historical cost is the right answer.
We have been in this boat before, both in Australia and globally, with agricultural assets.
There remains a clear possibility that fair value accounting will emerge as the measurement approach put forward in an exposure draft. Interestingly however, the Discussion Paper also concludes that if the historical cost approach is adopted, the optional use of the ‘revaluation basis’ should be prohibited.

The disclosures really are voluminous
The proposals in the Discussion Paper for disclosures find their genesis in the measurement problem – because no measurement basis emerges as a clear approach, extensive disclosures are proposed to rectify the dilemma. Proposals include:
• Reserves and resources quantities, how they were estimated and the main assumptions used with a sensitivity analysis and reconciliations of changes in reserve quantities – these details would be required by commodity, and further broken down by country or project where material
• A ‘current value measurement’ under various possible options, by major geographical region
• Production revenues by commodity
• Costs (interestingly by phase), disaggregated in the same manner as reserves and including a five-year time series.
The Discussion Paper continues the push towards disclosure overload, although much of the information disclosed would be of key interest to analysts and competitors.

The ‘publish what you pay’ proposals are political
The Discussion Paper devotes an entire chapter to the ‘Publish What You Pay’ (PWYP) campaign being waged by a coalition of non-governmental organisations.
PWYP seeks to help citizens of resource-rich developing countries to hold their governments accountable for the management of revenues from the mineral and oil and gas industries by requiring detailed country-by-country disclosure of amounts paid to government, along with other information which allows users to understand the scale of an entity’s operations in each country.
The PWYP coalition champions a noble, if highly political, cause. It unsuccessfully lobbied the IASB to introduce these sorts of requirements as part of the issue of IFRS 8 Operating Segments, which saw the issue referred to the extractive activities project team.
The Discussion Paper remains neutral on the PWYP proposals and instead leaves it open for constituent comment. It would appear this area will become a key issue as the project continues.

Where to from here?
The draft Discussion Paper on Extractive Activities is an unusual beast. It’s a case of the Clayton’s discussion paper, or ‘the discussion paper you have when you don’t have a discussion paper’.
The Discussion Paper is only in draft form and comments are not requested by the IASB at this stage. The conclusions and recommendations have not yet been agreed by the IASB. The Discussion Paper is a ‘working draft for information only’, will only be issued formally during 2010 and even then only as a Request for Views, i.e. without formal IASB ‘blessing’.
Unfortunately, the Discussion Paper is an indirect casualty of the global financial crisis. The IASB has brought forward numerous major projects to address critical concerns, such as the rewrite of IAS 39 Financial Instruments: Recognition and Measurement and associated projects on derecognition, consolidation and so on. Something had to give, and the extractive activities project is one of them – an easy target one might argue, because the project has not yet been formally added to the IASB’s agenda and it’s not in the Memorandum of Understanding with the Financial Accounting Standards Board (FASB) of the United States.
After publication of the Request for Views, the Board must make a decision about adding the project to its active agenda. Once that decision has been made, the project team estimates that an exposure draft would take at least 18 months to develop and that a final IFRS would take at least another 12 months to develop.
This places the timing for the ED in 2011–2012 and a standard sometime after that, perhaps 2013. With the usual implementation lead time, this could mean the earliest a new standard would be applicable is probably 2014.

For more information visit: www.deloitte.com.au

To read the first part of this report click here