Cost And expenditure associated with mineral resources adopting IFRS6

The adoption of IFRS 6, “Exploration for and Evaluation of Mineral Resources,” has significant implications for how companies in the extractive industries account for costs and expenditures associated with mineral resources. This standard provides guidance on the recognition, measurement, and disclosure of exploration and evaluation (E&E) expenditures, which can vary widely among companies due to the nature of the industry. Below, we explore the key aspects of cost and expenditure recognition under IFRS 6, including the types of costs that can be capitalized, the criteria for capitalization, practical examples, and the implications for financial reporting.

Types of Costs and Expenditures Under IFRS 6

Under IFRS 6, companies can incur a variety of costs related to the exploration and evaluation of mineral resources. These costs can generally be categorized as follows:

1. Acquisition Costs:
   • Costs incurred to acquire rights to explore specific mineral resources are capitalizable. This includes payments made to acquire exploration licenses or permits.
     
   • Example: A mining company pays $1 million to acquire the rights to explore a mineral-rich area. This cost is capitalized as an exploration asset.
     
2. Exploratory Costs:
   • Costs associated with geological and geophysical studies, exploratory drilling, trenching, and sampling can be capitalized if they are directly attributable to E&E activities.
     
   • Example: If a company spends $500,000 on exploratory drilling to assess the viability of a mineral deposit, this amount can be capitalized.
     
3. Evaluation Costs:
   • Expenditures related to determining the technical feasibility and commercial viability of extracting mineral resources are also capitalizable.
     
   • Example: A company incurs $300,000 on feasibility studies that demonstrate the potential for profitable extraction of minerals. This cost is capitalized.

Criteria for Capitalization

To capitalize E&E expenditures under IFRS 6, companies must meet specific criteria:

1. Direct Attribution:
   • The costs must be directly attributable to the exploration and evaluation activities. Companies must ensure that the expenditures can be linked to specific projects or mineral resources.
     
2. Future Economic Benefits:
   • The expenditures must be expected to generate future economic benefits. Companies need to assess whether the exploration activities are likely to lead to commercially viable discoveries.
     
3. Technical Feasibility:
   • The costs must relate to activities that are technically feasible, meaning that the company has the capability to evaluate the mineral resource effectively.
     
4. Intention and Ability to Develop:
   • Companies must demonstrate the intention and ability to develop and extract the mineral resource once its feasibility is established.
     
5. Assessment of Recoverability:
   • There must be an adequate assessment of future economic benefits, and the expenditures must be expected to be recoverable based on the expected cash flows from the resource.

Practical Examples of Cost and Expenditure Recognition

1. Acquisition Example:
   • Scenario: Company X acquires exploration rights for a new mineral deposit for $2 million. This expenditure is directly attributable to the exploration activity and is capitalized as an exploration asset.
     
2. Exploratory Drilling Example:
   • Scenario: Company Y spends $750,000 on exploratory drilling in an area where it holds exploration rights. The drilling results are promising, indicating the presence of a viable mineral resource. This cost is capitalized as it meets the criteria for capitalization under IFRS 6.
     
3. Feasibility Study Example:
   • Scenario: Company Z incurs $400,000 in conducting a feasibility study to evaluate the commercial viability of a mineral deposit. Since the study demonstrates that the extraction is feasible and likely to be profitable, this cost is capitalized.

Implications for Financial Reporting

The treatment of E&E expenditures under IFRS 6 has several implications for financial reporting:

1. Balance Sheet Presentation:
   • Capitalized E&E expenditures are recorded as intangible assets on the balance sheet. This can significantly impact a company’s asset base, potentially improving financial ratios such as return on assets and debt-to-equity ratios.
     
2. Impairment Testing:
   • Companies must assess capitalized E&E assets for impairment when facts and circumstances suggest that the carrying amount may exceed its recoverable amount. This requires ongoing evaluations of the viability of exploration projects.
     
   • Example: If a company has capitalized $2 million in E&E costs but later determines that the mineral deposit is not commercially viable, it must recognize an impairment loss, reducing the asset’s carrying value.
3. Disclosure Requirements:
   • IFRS 6 requires companies to disclose their accounting policies related to E&E expenditures, including the nature of the costs capitalized and the basis for their capitalization. This enhances transparency and allows investors to better understand the financial implications of the company’s exploration activities.
     
4. Flexibility in Accounting Policies:
   • IFRS 6 allows companies to continue using their existing accounting policies for E&E costs, provided these policies result in relevant and reliable information. This flexibility can lead to diversity in practices among companies in the extractive sector.

The flexibility in accounting policies under IFRS 6, “Exploration for and Evaluation of Mineral Resources,” allows companies in the extractive industries to adopt practices that best fit their specific circumstances while still adhering to the overall framework of International Financial Reporting Standards (IFRS). This flexibility is particularly important given the diverse nature of exploration activities and the varying stages of development across different companies. Below, we explore how this flexibility manifests in practice, the implications for financial reporting, and some practical examples.

Flexibility in Accounting Policies

1. Continuation of Existing Policies:
   IFRS 6 permits entities to continue using their existing accounting policies for recognizing exploration and evaluation expenditures as assets. This means that companies can maintain the practices they were using before adopting IFRS, provided these policies result in relevant and reliable information.
   
   1. Example: A mining company that has historically capitalized all exploration costs can continue to do so under IFRS 6. If it has a policy that allows for capitalizing costs related to geological surveys and exploratory drilling, it can maintain this practice without needing to conform to a strict new standard.
      
2. Diverse Recognition Practices:
   The standard allows for different approaches to recognizing E&E expenditures, which can lead to a variety of practices across the industry. Companies can choose to capitalize costs that are directly attributable to specific exploration activities or opt for a more conservative approach by expensing certain costs.
   
   1. Example: Company A might capitalize costs associated with successful exploratory drilling, while Company B may choose to expense similar costs if they do not lead to a viable resource. Both companies are compliant with IFRS 6, as the standard does not mandate a single approach.
      
3. Impairment Testing Modifications:
   IFRS 6 modifies the application of IAS 36, “Impairment of Assets,” specifically for exploration and evaluation assets. Companies are allowed to determine their impairment testing policies, including the timing and level at which they assess these assets for impairment.
   
   1. Example: If a company has capitalized $1 million in exploration costs and later finds that the project may not be commercially viable, it can decide when to perform an impairment test based on the specific facts and circumstances surrounding the project.

Implications for Financial Reporting

1. Impact on Financial Statements:
   The flexibility in accounting policies can lead to significant variations in how companies report their exploration and evaluation expenditures. This can affect their balance sheets, income statements, and overall financial ratios.
   
   • Example: A company that capitalizes all exploration costs may show a higher asset base and improved financial ratios compared to a company that expenses similar costs. This discrepancy can create challenges for investors trying to compare financial performance across companies.
     
2. Disclosure Requirements:
   While IFRS 6 allows flexibility, it also requires companies to disclose their accounting policies related to E&E expenditures. This transparency is crucial for investors to understand the basis of the financial statements and the implications of the chosen accounting policies.
   
   • Example: A mining company must disclose its accounting policy for capitalizing exploration costs, including the types of costs it capitalizes and the rationale behind its decision. This disclosure helps investors assess the reliability of the reported financial information.
     
3. Risk of Misinterpretation:
   The flexibility provided by IFRS 6 can lead to potential misinterpretation by investors if they are not aware of the specific accounting policies adopted by each company. This can result in confusion when comparing financial statements.
   
   • Example: If two mining companies report vastly different asset values due to their differing capitalization policies, investors may misinterpret the financial health of one company compared to the other without understanding the underlying accounting practices.

Practical Examples

1. Capitalization of Exploration Costs:
   Scenario: Company X incurs $2 million in costs related to geological surveys and exploratory drilling. Under IFRS 6, if these costs are deemed directly attributable to exploration activities, Company X can capitalize them as exploration assets on its balance sheet.
   
2. Expense Recognition:
   Scenario: Company Y spends $500,000 on exploratory drilling but finds no commercially viable resources. If Company Y has a policy of expensing costs related to unsuccessful exploration efforts, it would recognize this expenditure as an expense in its income statement.
   
3. Impairment Testing:
   Scenario: After capitalizing $1.5 million in exploration costs, Company Z learns that the mineral deposit is not economically viable. Company Z must assess whether to perform an impairment test based on the specific circumstances surrounding the project, potentially leading to an impairment loss being recognized.

Conclusion

IFRS 6 provides a comprehensive framework for accounting for costs and expenditures associated with mineral resources, allowing companies to capitalize E&E expenditures that meet specific criteria. By establishing clear guidelines for the recognition, measurement, and disclosure of these costs, IFRS 6 enhances the transparency and comparability of financial reporting in the extractive industries. Companies must navigate the complexities of capitalizing E&E expenditures while ensuring compliance with the standard’s requirements, ultimately impacting their financial position and reporting practices. As the IASB continues to evaluate the need for a comprehensive standard for extractive activities, the principles established in IFRS 6 will remain critical for companies engaged in exploration and evaluation of mineral resources.