1. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–1 Chapter 19 Deegan with Tempone modifications for AASB6 Accounting for the extractive industries AASB 6 changes in Arial underlined

2. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–2 The chapter and original slides for this chapter were based on AASB 1022. The amendments in these slides reflect changes resulting from the newly released AASB 6.

3. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–3 Objectives Understand that the extractive industries pose some unique accounting issues, particularly how to account for those costs incurred in the preproduction phases of operations Understand how to account for preproduction costs according to the area-of-interest method, as prescribed by AASB 1022 (pre-2005) – From 1 January 2005: AASB 6 (continues)

4. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–4 Objectives (cont.) Understand the tests that must be met before expenditure incurred in the preproduction phases can be carried forward to subsequent periods Understand that if a decision is made to abandon an area of interest all costs associated with that area must be immediately written off (continues)

5. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–5 Objectives (cont.) Be able to provide the journal entries necessary to amortise expenditure carried forward by an entity in the extractive industries Acknowledge that entities in the extractive industries will often also make non-financial disclosures in relation to such issues as their environmental performance (continues)

6. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–6 Status of newly converged accounting standards As of September 2004 there was no international equivalent to AASB 1022 ‘Accounting for the Extractive Industries’ Exposure draft issued in January 2004, ED 6 ‘Exploration for and Evaluation of Mineral Resources’ Expected that entities would be required to undertake annual impairment testing of exploration and evaluation assets in accordance with AASB 136 ‘Impairment of Assets’; however, entities may elect to perform the impairment testing at a level other than ordinarily permitted under AASB 136 Ultimate accounting standard relating to ED 6 is not expected to be released until late 2005 This now brought forward and issued December 2004 for operation from 1 January 2005

7. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–7 Extractive industries defined Governed by AASB 1022 ‘Accounting for the Extractive Industries’ until December 2004 Now AASB 6 ‘Exploration for and Evaluation of Mineral Resources’ 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 (continues)

8. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–8 Extractive industries defined (cont.) Characteristics 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) result in an asset having been acquired AASB 6 only addresses exploration and evaluation phases as these are the only phases unique to the extractive industries (continues)

9. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–9 Extractive industries defined (cont.) Five phases of extractive industry operations (AASB 1022): 1. Exploration – Search for mineral deposit or oil or gas field 2. Evaluation – Determination of technical feasibility and commercial viability of prospect The following phases are no longer part of AASB 6 as they are not unique to the industry 3. Development – Establishment of access to deposit or field 4.Construction –Establishment and commissioning of facilities 5.Production –Day-to-day activities aimed at obtaining saleable product from the deposit or field on commercial scale (continues)

10. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–10 AASB 6 (pending completion of comprehensive project on extractives) AASB 6 only relates to exploration for and evaluation of mineral resources. Development and Construction now covered by other standards – AASB 116 Property, Plant and Equipment – AASB 136 Intangibles – AASB 102 Inventories – AASB 118 Revenue – AASB 137 Provisions, Contingent Liabilities and Contingent Assets See Table 1 (p.8 of AASB 6) for details

11. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–11 New table from AASB 6 Table 1Other aspects previously covered in AASB 1022 Phase of operation / transaction or eventRelevant Standards 1 Activities that precede exploration for and evaluation of mineral resources 2 Framework AASB 116Property, Plant and Equipment AASB 138Intangible Assets Development and construction costsAASB 116Property, Plant and Equipment AASB 138Intangible Assets Amortisation of capitalised costsAASB 116Property, Plant and Equipment InventoriesAASB 102Inventories Revenue RecognitionAASB 118Revenue Restoration costsAASB 137Provisions, Contingent Liabilities and Contingent Assets AASB 116Property, Plant and Equipment UIG Interpretation 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities 1.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. 2.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.

12. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–12 Extractive industries defined (cont.) Major problem of accounting for extractive industries— How to account for costs incurred in exploration and evaluation – Known as pre-production costs AASB 1022 is concerned principally with whether preproduction costs may be carried forward as assets (and systematically amortised) or written off as incurred AASB 6 is only concerned with these two phases (continues)

13. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–13 Extractive industries defined (cont.) Economically recoverable reserves Ultimate source of revenue for firms in extractive industries Costs in exploration phase incurred to discover reserves, costs in evaluation phase to prove reserves (continues)

14. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–14 Objectives of Standard To specify financial reporting for exploration and evaluation. In particular the standard requires: Limited improvements to existing accounting practices Entities that recognise exploration and evaluation assets assess for Impairment under AASB 138 Disclosures that identify and explain amounts arising from exploration and evaluation to assist users understand the amount, timing and certainty of future cash flows from any exploration and evaluation

15. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–15 Alternative methods to account for preproduction costs Potentially five major alternative methods of account- ing for extractive industries under AASB 1022: 1.Costs-written-off method ▪ All exploration and evaluation costs written off as incurred 2.Costs-written-off-and-reinstated method ▪ Exploration and evaluation costs written off as incurred, and reinstated if economically recoverable reserves found 3.Successful-effort method ▪ Only exploration and evaluation costs resulting in the discovery of economically recoverable reserves are carried forward (continues)

16. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–16 Alternative methods to account for preproduction costs (cont.) 4.Full-cost method ▪ Matches all exploration and evaluation costs incurred against revenue from the total economically recoverable reserves across all sites—one cost centre 5. Area-of-interest method ▪ Area of interest is an individual geological area which is considered to constitute a favourable 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 ▪ Method used within Australia ▪ Now area of interest underpins AASB 6 with application of AOI generally the same as under AASB 1022 (continues)

17. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–17 Measurement at recognition Shall be measured at cost Elements of cost of exploration and evaluation – Acquisition of rights to explore – Topographical and other studies – Exploratory drilling – Trenching – Sampling – Activities in relation to technical and commercial feasibility and viability of extracting a 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

18. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–18 Accumulation of costs and revenues from preproduction Costs (both direct and indirect) arising from exploration, evaluation and development activities and specifically related to an area of interest should be allocated to that area of interest General and administrative costs must relate directly to operations in an area before they can be capitalised This is confirmed in AASB 6 (continues)

19. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–19 Asset only to be recognised if: Rights to tenure of area of interest are current; and At least one of the following is met: – Expenditures expected to be recouped through successful development or by its sale; and – Activities have not, at reporting date, reached a stage which permits reasonable assessment of existence or otherwise of economically recoverable reserves

20. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–20 Alternative methods to account for preproduction costs (cont.) Exploration and evaluation costs under area-of- interest method Exploration and evaluation costs shall be written off as incurred except that they may be carried forward (capitalised), provided that rights of tenure of the area of interest are current, and one of the following two conditions are met (AASB 1022, par. 11): – 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. (continues)

21. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–21 Alternative methods to account for preproduction costs (cont.) Development costs under area-of-interest method Costs arising from the subsequent development related to an area of interest 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 successful exploitation of the area of interest, or by its sale (AASB 1022, par. 12) These no longer come under the ambit of AASB 6, but are dealt with under ▪ AASB 116 Property, Plant and Equipment ▪ AASB 138 Intangible Assets as they are not unique to extractive industries (continues)

22. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–22 Alternative methods to account for preproduction costs (cont.) Abandoning an area of interest If an area is abandoned, costs carried forward relating to that area should be written off in the period in which the decision to abandon is made (AASB 1022, par. 15) Although not specifically mentioned in AASB 6, this would occur naturally with annual impairment testing, as the carrying value of costs carried forward would have no future economic benefit and would therefore be written off to impairment expense

23. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–23 Differences between AASB 1022 and AASB 6 Generally same application as AASB 1022 Area Of Interest (AOI) – AASB 6 also requires any capitalised exploration and evaluation expenditures (known as ‘exploration and evaluation assets’) to be tested for impairment when facts and circumstances suggest that the carrying amount of an exploration and evaluation asset may exceed its recoverable amount. – Further, the level at which exploration and evaluation assets are to be tested for impairment is to be no larger than the area of interest to which the exploration and evaluation asset relates. ▪ Consequently, the recognition and measurement requirements for capitalised exploration and evaluation expenditures are largely equivalent under AASB 6 and AASB 1022.

24. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–24 Differences (cont.) The primary difference between AASB 6 and AASB 1022 relates to the scope of the Standards. – AASB 6 is an activity ‑ based Standard that relates only to the exploration for and evaluation of mineral resources. In contrast, AASB 1022 is an industry ‑ based Standard that applies to all phases of extractive activity operations as well as specifying the treatment of inventory and sales revenue. AASB 6 permits impairment of evaluation and exploration assets at cash generating unit or group of cgu’s level, provided it is not larger than the AOI or segment

25. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–25 Impairment testing: AASB 6 One or more of the following facts and circumstances indicate that an entity should test exploration and evaluation assets for impairment (the list is not exhaustive): (a)the period for which the entity has the right to explore in the specific area has expired during the period or will expire in the near future, and is not expected to be renewed; (b)substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned; (c)exploration for and evaluation of mineral resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources and the entity has decided to discontinue such activities in the specific area; (d)sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale. In any such case, or similar cases, the entity shall perform an impairment test in accordance with AASB 136. Any impairment loss is recognised as an expense in accordance with AASB 136.

26. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–26 Restoration costs May be either a legal or moral obligation to restore area after cessation of operations. Required: – Estimate total restoration costs at commencement of project – Provision for this cost throughout operations ▪ Restoration costs are to form part of the cost of the respective phases of operations – Once production commences, restoration costs to be treated as cost of production No longer appropriate under AASB 6. Dealt with under: – AASB 137 Provisions, Contingent Liabilities and Contingent Assets – AASB 116 Property, Plant and Equipment – UIG Interpretation 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities

27. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–27 Sales revenue Sales revenue should not be brought to account until the product is in the form in which it is to be sold (requires no further processing by vendor) and legal title in the product has passed to the purchaser Revenue now dealt with under AASB 118 Revenue

28. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–28 Inventory Inventory must be actually extracted before being classed as inventory. Inventory to be classed as such at stage when product can be measured with reliability and the quantities of materials can be determined by physical measurement or reliable estimate Now dealt with under AASB 102 Inventory

29. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–29 Presentation Classification Tangible or intangible, depending on nature of assets Reclassification Where technical feasibility or commercial viability demonstrable – Assessed for impairment and any impairment loss recognised before reclassification Impairment Where facts and circumstances suggest carrying amount may exceed recoverable amount, Impairment loss measured under AASB 136

30. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–30 Disclosure An entity shall disclose – Accounting policies including recognition of assets – Amounts of assets liabilities income and expense and operating and investing cash flows arising from exploration and evaluation – Explanation that recoverability of carrying amount is dependent on successful development and commercial exploitation; or sale of respective areas of interest Exploration and Evaluation assets shall be a separate class of assets

31. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–31 Measurement after recognition Cost model OR revaluation model If revaluation model – AASB 116 Property, Plant and Equipment model, OR – AASB 138 Intangible Assets model

32. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–32 Accounting for extractive industries Comparison of full-cost method and area-of-interest method Refer to Worked Example 19.1 on pp.704–5—Comparison of the full-cost method and the area-of-interest method Application of area-of-interest method Refer to Worked Example 19.2 on pp.706–8—Application of the area-of-interest method

33. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–33 Does the area-of-interest method provide a realistic value of reserves? When resources are found the cost of assets shown would understate actual value of reserves Uncommon for Australian companies to revalue reserves to expected fair value Has implications for profit – Upward revaluation goes to RR, not profits If revalued, cost of sales increases – Results in reduced profit (continues)

34. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–34 Does the area-of-interest method provide a realistic value of reserves? Reasons for not recognising expected fair values of resources Uncertainty regarding the value of reserves Extractive companies subject to high levels of political scrutiny Revaluation credit cannot go to income

35. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–35 Research on accounting regulation of preproduction costs US proposal to permit only successful-efforts method when previously it also allowed the use of full-cost method would have been likely to affect cash flows of firm, and impacted on covenants in contractual agreements Share price of firms using full-cost method fell following issue of exposure draft (continues)

36. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–36 Research on accounting regulation of preproduction costs (cont.) Great number lobbied against ED Suggested that, in Australia, considerations of political costs influence how firms account for preproduction costs

37. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–37 Other developments in extractive industry reporting Many mineral and energy companies presently making disclosures about their environmental performance Public environmental performance reporting subject to limited statutory regulation Guidance documents released by international industry associations Australian Minerals Code for Environmental Management released in 1997 (Minerals Council) – Revised and reissued in 2000

38. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–38 Comparison with IFRS AASB 6 is an equivalent standard to IFRS 6

39. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–39 Differences with AASB 6 and AASB 1022 The primary difference between this Standard and the AASB Standard that it supersedes, AASB 1022 Accounting for the Extractive Industries, is that the scope of this Standard is restricted to the treatment of exploration and evaluation expenditures whereas AASB 1022 also dealt with the: a. treatment of development, construction, and restoration costs; b. amortisation of those costs; c. treatment of inventories; and d. revenue recognition.

40. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan 19–40 Tutorial questions: modified from published list of questions Deegan Chapter 19: 1 9 11 12 14 (area of interest method only) 16 – New question: For exploration and evaluation assets in a particular area of interest, what factors would you consider as indicators of possible impairment. Read and discuss Australian Financial Review article ‘Norgold overstates its operating losses’, on pp.716-17