The scope of IFRS 6 Exploration for and Evaluation of Mineral Resources is limited to the recognition, measurement and disclosure of expenditure incurred in the phase covering the Exploration for and Evaluation (E&E) of mineral resources. Although the term used is ‘mineral resources’, the definitions in IFRS 6 clarify that this extends to cover minerals, oil, natural gas and other similar nonregenerative resources meaning that it applies across the extractives industry sector.
The limitation of scope to cover the exploration and evaluation phase means that IFRS 6 does not apply to expenditure incurred:
- In the previous prospecting phase;
- In all phases after the E&E phase has been completed, including development, production, closure and rehabilitation.
As a result other IFRS standards have to be applied outside the E&E phases.
CAPITALISE OR EXPENSE E&E EXPENDITURE?
After determining which types of expenditure meet the definition of E&E expenditure, an entity has a choice of either capitalising or expensing each of these types of expenditure during the E&E phase. This is an accounting policy choice, to be applied consistently. Consequently, there is a choice of capitalising no E&E expenditure, only some E&E expenditure, or almost all E&E expenditure.
IFRS 6 Exploration for and Evaluation of Mineral Resources identifies a number of different types of expenditure that might be considered for capitalisation:
- Acquisition of rights to explore;
- Topographical, geological, geochemical and geophysical studies;
- Exploratory drilling;
- Activities in relation to evaluating the technical feasibility and commercial viability of extracting a mineral resource.
The range of types of expenditure that are permitted to be capitalised as E&E assets are broad, including items such as depreciation of property, plant and equipment, and consumables, with (depending on the unit of account used for an E&E area) even costs of failed test results being eligible to be capitalised.
CHANGES IN ACCOUNTING POLICY
IFRS 6 Exploration for and Evaluation of Mineral Resources includes guidance for changes in the accounting policy applied to E&E expenditure. A change in an entity’s accounting policy for E&E expenditure is permitted if this change makes the financial statements ‘more relevant to the decision making needs of users and no less reliable, or more reliable and no less relevant’ and brings the financial statements ‘closer to meeting the criteria in IAS 8’. The reference to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors is relevant because IFRS 6 grants a temporary exemption from certain requirements of IAS 8, including a requirement to consider the definition of an asset in the Conceptual Framework.
This implies that a change in policy from capitalising all eligible E&E expenditure to successful efforts would be acceptable, as would a change from capitalising E&E expenditure to expensing all expenditure as incurred. This is because it is normally difficult to demonstrate that the costs result in an item that meets the definition of an asset.
CLASSIFICATION OF E&E EXPENDITURE
If an entity chooses an accounting policy to capitalise E&E expenditure, a question which then follows is whether that expenditure should be classified as a tangible or intangible asset, or as both tangible and intangible.
IFRS 6 Exploration for and Evaluation of Mineral Resources Paragraph 15 notes that E&E assets are classified as either tangible or intangible, according to the nature of the assets acquired, and that this classification is applied consistently.
Certain E&E assets will clearly be tangible (such as vehicles and equipment), while other expenditure will be less easy to classify. An appropriate approach to follow would be to consider whether the costs incurred relate to a physical asset, or are related more to enhancing knowledge about where and how development activities should be carried out. For example, exploratory drilling activity is likely only to provide additional knowledge about the potential mineral reserves, and would be classified as an intangible E&E asset.
To the extent that a tangible asset is depreciated during E&E activities, with that depreciation reflecting the extent to which the tangible asset has been consumed, that deprecation would be added to the intangible E&E asset balance. However, IFRS 6.16 is explicit in stating that using a tangible asset to develop an intangible asset does not change a tangible asset into an intangible asset.
CLASSIFICATION OF CASH FLOWS
The classification of cash flows relating to E&E activities depends on whether the expenditure is capitalised as an E&E asset. To the extent that it is capitalised, the cash flows are classified as relating to investing activities as they have resulted in a recognised asset (IAS 7 Statement of Cash Flows Paragraph 16). To the extent that the expenditure is expensed as incurred, the cash flows are classified as relating to operating activities.
MEASUREMENT OF E&E EXPENDITURE
If an entity chooses an accounting policy of capitalising E&E expenditure, this will be recorded at cost on initial recognition. For subsequent measurement there is a choice between the cost model and the revaluation model for an entity’s tangible and intangible E&E assets.
The cost model
Under the cost model, tangible assets used for E&E activities (such as vehicles and equipment) will be depreciated to their residual value over their useful economic lives. During the E&E phase, to the extent that these depreciation charges relate to the use of the assets for E&E activities, the charges are added to the cost of the intangible E&E asset itself.
Depreciation or amortisation of each tangible and intangible asset commences when the asset is ready for use. IAS 16 Property, Plant and Equipment Paragraph 55 and IAS 38 Intangible Assets Paragraph 97 both note that this is when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. For items such as vehicles and equipment, this will normally be straightforward (although it should be noted that depreciation will still be recorded, even if E&E activities are suspended for a period).
The revaluation model
Under the revaluation model, the approach followed is consistent with the guidance set out in IAS 16 for tangible assets and IAS 38 for intangible assets. IFRS 6 Exploration for and Evaluation of Mineral Resources Paragraph 25 notes that E&E assets are regarded as being a separate class of assets for the purposes of revaluation. An entity may have E&E assets classified as both tangible and intangible, and each of these can be considered separately for revaluation (that is, an entity could choose to apply the revaluation model to its tangible E&E assets and the cost model to its intangible E&E assets).
IAS 38 permits the revaluation model to be applied to intangible assets only where there is an active market for the related intangible asset. An active market exists only where all of the following conditions apply:
- The items traded within the market are homogeneous;
- Willing buyers and sellers can normally be found at any time;
- Prices are available to the public.
It is unlikely that these conditions will apply to intangible E&E assets.
Due to their often specialised nature, it will often be difficult to determine the fair value of tangible E&E assets.
Consequently, in practice most entities use the cost model.
In addition, because an E&E asset will ultimately be consumed in production or sold, even if an asset was eligible to be revalued it is unlikely that this policy would be adopted. This is because it would result in reduced (possibly significantly reduced, or even nil) profits during the production phase.
E&E assets are required to be assessed for impairment (IFRS 6 Exploration for and Evaluation of Mineral Resources Paragraph 18), with an impairment test being required when facts and circumstances suggest that the carrying amount of capitalised E&E expenditure exceeds its recoverable amount. However, the impairment requirements contained in IFRS 6 differ from, and are considerably less strict, than the requirements of IAS 36 Impairment of Assets Paragraphs 8-17. In particular, IFRS 6.20 sets out specific circumstances in which E&E assets are required to be tested for possible impairment.
These reliefs from the full requirements of IAS 36 are significant, and mean that the determination of whether a project is in its E&E phase, or has reached the development or preproduction phase, is very important.
IFRS 6.21-22 set out guidance for the allocation of E&E assets to cash generating units (CGUs) or groups of CGUs for the purpose of impairment testing. Care is required when determining an entity’s CGUs and in the allocation of E&E assets to those CGUs (see below).
Triggers for an impairment test Exploration for and Evaluation of Mineral Resources
When identifying whether an E&E asset is required to be tested for impairment, IFRS 6.20 sets out the following indicators, while also noting that this is not an exhaustive list:
- 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;
- Substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned;
- Exploration for and evaluation of mineral resources in the specific areas 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;
- Sufficient data exists 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 sale.
If any of the above conditions, or other similar conditions, exists then the E&E asset is required to be tested for impairment in accordance with IAS 36. Other conditions that give rise to an impairment test may include significant adverse changes in commodity prices, and changes in tax or regulatory requirements.
In its original exposure draft (the ED), the IASB proposed that IAS 36 should be applied in full, including the criteria for a trigger event for an impairment test. However, respondents to the ED noted that in some cases, and in particular for exploration only entities, exploration and evaluation assets do not generate cash flows and there is insufficient information about the mineral resources in a specific area to make reasonable estimates of exploration and evaluation assets’ recoverable amounts. This is because information sufficient to estimate future cash flows would typically not be available, meaning that it would not be possible to estimate the two measures of recoverable amount in IAS 36 (fair value less costs to sell, or value in use). Consequently, the application of the requirements for trigger events that give rise to an impairment test in IAS 36 would result in an immediate write off of E&E assets in many cases. In order to address this point, the IASB concluded that an impairment test of E&E assets should be triggered by changes in facts and circumstances.
The level at which impairment is assessed Exploration for and Evaluation of Mineral Resources
IFRS 6 permits the aggregation of CGUs for the purposes of impairment tests. IFRS 6.21 requires an accounting policy to be developed for the allocation of E&E assets to CGUs (or groups of CGUs) for the purposes of an assessment for impairment. However, each CGU (or group of CGUs) is not permitted to be smaller than an operating segment as determined in accordance with IFRS 8 Operating Segments.
There is an important distinction to be drawn between an operating segment, and a reportable segment. Although reportable segments are included in the segment disclosures to financial statements, these can be made up of a number of operating segments which have been combined. Consequently care is required if CGUs are grouped for the purposes of impairment, as it is not possible simply to look to the segmental disclosures in an entity’s financial statements when considering whether a particular aggregation is acceptable.
Once the accounting policy for the allocation of E&E assets to CGUs (or groups of CGUs) has been determined, this approach is required to be applied consistently from one reporting period to the next. A change in accounting policy is only permitted if the criteria in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors for a change are met.
Note: Exploration for and Evaluation of Mineral Resources
Although it might appear attractive to allocate E&E assets to a group of CGUs (to the extent permitted by the constraint placed on this by IFRS 8 – see above) for the purposes of impairment, this can give rise to practical issues. In particular, it might well increase the frequency with which the group of CGUs needs to be tested for impairment and could result in larger charges for impairment. There are two scenarios which illustrate this point:
1) Grouping projects that are close to commercial development with start-up projects
When an E&E asset moves into the development phase, IFRS 6.17 requires an impairment test to be carried out. Consequently, as each project moves to its commercial development phase, an impairment test of the entire CGU in which the asset is included will be required.
2) Grouping projects that have a higher risk of being unsuccessful with ongoing E&E projects
Each time a project is found to be unsuccessful, IFRS 6.20 requires an impairment test to be carried out. Consequently, each time a higher risk E&E project does not lead to the discovery of commercially viable quantities of mineral resources, an impairment test of the entire CGU in which the asset arising from the project is included will be required.
Example, possible scenarios and questions Exploration for and Evaluation of Mineral Resources
Company A is exploring for oil in a known oil basin in West Africa. The oil basin stretches across the borders of countries X and Y. Company A is carrying out E&E activities in both countries and, out of 40 specified exploration areas, has the rights to areas 1, 2, 20, 26, 27 and 40. Areas 1, 2 and 20 are located in country X, and areas 26, 27 and 40 are located in country Y.
Areas 1 and 2 are adjacent to each other, as are areas 26 and 27, and 20 and 40.
Scenario 1 Exploration for and Evaluation of Mineral Resources
Company A has started to drill a planned total of 1,000 test wells in area 26. Five wells have been completed, with only water having been found. Company A intends to continue with its test drilling.
Question Exploration for and Evaluation of Mineral Resources
Does the failure of the first five test wells to find oil represent an impairment trigger under the requirements of IFRS 6.20?
Answer Exploration for and Evaluation of Mineral Resources
This question will typically arise when an entity follows a policy of capitalising all eligible E&E expenditure. Under this approach, the unit of account for the purposes of accounting for E&E assets could be determined as being the area over which Company A has a right to explore. Because Company A intends to continue its E&E activities in area 26, this indicates that an impairment trigger has not occurred. The costs associated with the five test wells are carried forward as an E&E asset, on the basis that the results of drilling provide useful information about the licence area as a whole.
Company A has completed drilling its planned 1,000 test wells in area 20. Although the results indicate the presence of hydrocarbon reserves, Company A concludes that it will not actively bring area 20 into production due to an unfavourable tax and regulatory regime that has been implemented in country X. However, Company A does intend to continue E&E activities in the adjacent area 40, which is located in country Y. The decision to continue E&E activities in area 40 is partly based on the results of test drilling in area 20.
Question Exploration for and Evaluation of Mineral Resources
Is Company A’s decision not to continue to production in area 20 a trigger for an impairment test? (A linked and relevant question, which needs to be answered first, is whether areas 20 and 40 can be viewed as being a single unit of account, despite the fact that they are in different countries).
Answer Exploration for and Evaluation of Mineral Resources
Determination of the unit of account is not defined in IFRS 6, and constitutes a key judgement. Many entities view the unit of account to be the area of interest (and so will apply either area-of-interest or full cost accounting for the purposes of their E&E assets). An area of interest can be based on a geological feature that lends itself to a unified exploration and development effort, and can be made up from a number of adjacent geographic areas that have separate licences attached to them. Consequently, it could be argued that areas 20 and 40 constitute one combined area of interest, and that there has been no trigger for an impairment test.
REVERSAL OF IMPAIRMENT Exploration for and Evaluation of Mineral Resources
After a charge for impairment has been made, this is reversed for assets other than goodwill (that is, capitalised E&E assets and property, plant and equipment) if there is a subsequent increase in the recoverable amount calculated in accordance with IAS 36 Impairment of Assets.
Example 1 Exploration for and Evaluation of Mineral Resources
Company B is carrying out E&E activities in country X. A requirement of the licence to carry out E&E activities is that Company B incurs a specified minimum amount of exploration expenditure in each year. Due to a collapse in investor confidence, Company B determines the end of its financial year that it is unlikely that it will be able to raise sufficient funds to meet the minimum spending requirement. Consequently, a charge for impairment of its E&E asset is included in its financial statements.
Shortly after the financial statements have been approved, the government of country X grants a three year exemption from the minimum spend requirement. Exploration for and Evaluation of Mineral Resources
In this case, the reason for the original charge for impairment has been eliminated. Provided Company B now expects to continue to carry out E&E activities and there are no other indicators of impairment that need to be considered, the original charge for impairment is reversed.
However, the ability to reverse an impairment loss is dependent on the original asset not having been derecognised. In some circumstances, E&E activities may not result in the discovery of mineral reserves and E&E activities are abandoned. In these circumstances, the E&E assets are derecognised and any subsequent developments, such as the discovery of mineral reserves due to improved technology, will not result in a reversal of the impairment charge for the previous E&E assets that have been derecognised.
E&E assets are also derecognised if, for example, an entity loses the right to explore in a specific area.
Company A is carrying out E&E activities in country Z. Due to a change of government, all existing licences for E&E and mining activities are cancelled and the State takes control of all projects. Consequently, Company A abandons its E&E projects in country Z, and impairs and derecognises the related E&E assets.
Five years later, following another change in government, Company A secures new rights to carry out E&E and mining activities. Although future E&E expenditure is eligible for capitalisation (assuming that this is Company A’s accounting policy), the impairment of the original E&E asset cannot be reversed, even if the area being explored is the same, as the original E&E asset was derecognised.
DISCLOSURE Exploration for and Evaluation of Mineral Resources
IFRS 6 Exploration for and Evaluation of Mineral Resources Paragraphs 23-25 set out a number of specific disclosure requirements. The overall requirement is for an entity: Exploration for and Evaluation of Mineral Resources
‘…to disclose information that identifies and explains the amounts recognised in its financial statements arising from the exploration for and evaluation of mineral resources.’ Exploration for and Evaluation of Mineral Resources
In order to comply with this requirement, both the following disclosures need to be made:
- Accounting policies for exploration and evaluation expenditures, including the recognition of exploration and evaluation assets;
- The amounts of assets, liabilities income and expense and operating and investing cash flows arising from the exploration and evaluation of mineral resources.
E&E assets are treated as separate classes of assets, with the disclosures required by IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets being made consistently with the classification of E&E assets.
In addition, IAS 1 Presentation of Financial Statements Paragraphs 122 and 125 are likely to require additional disclosures relating to E&E activities. IAS 1.122 requires disclosures relating to significant judgements (apart from those involving estimations) that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on amounts recognised in the financial statements. IAS 1.125 requires information to be disclosed about the assumptions that have been made about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
FARM IN ARRANGEMENTS Exploration for and Evaluation of Mineral Resources
It is common for entities involved in the E&E phase (and other phases) of extractive activities to enter into ‘farm in’ arrangements with third parties. Under a farm in arrangement, an entity engaged in E&E activities (the farmor) gives up the right to future reserves in exchange for a reduction in future funding obligations which will be met by another party (the farmee). In addition to costs being shared among entities, one of the drivers for these arrangements is to share the risks associated with the extractive project with one or more other parties.
The arrangements result in the transfer of a proportion of a property in exchange for a commitment from the farmee to fund certain obligations. Consequently, from the farmor’s perspective, a farm in arrangement represents the complete disposal of a proportion of a property.
IFRS 6 Exploration for and Evaluation of Mineral Resources Paragraph 4 notes that:
‘The IFRS does not address other aspects of accounting by entities engagement in the exploration for and evaluation of mineral resources.’
This brings the question of whether farm in arrangements fall within the scope of IFRS 6. However, because these arrangements result in the recognition by the farmee of E&E activities and (potentially) a disposal of part of an E&E asset by the farmor, we consider that IFRS 6 is not precluded from being applied to these arrangements.
The approach followed in practice is often based on the approach that many entities previously applied under their own national GAAPs. In summary:
- The farmor will not record any expenditure (whether this would otherwise have been capitalised or expensed immediately) that is settled by the farmee;
- The farmor does not recognise a gain or loss on the basis of the partial disposal of any E&E asset that has already been capitalised. Instead, any proceeds received that are not attributable to future expenditure are simply credited against the carrying amount of any existing E&E asset;
- To the extent that the proceeds received from the farmee exceed the carrying amount of any E&E asset that has already been capitalised by the farmor, this excess is recognised as a gain in profit or loss.
Company A owns 100% of the rights to explore and mine area Z, and has spent and capitalised Currency Units (CU)1,000 to date. Company A (the farmor) enters into an agreement under which it sells 25% of the property to Company B (the farmee) for CU1,000.
The proceeds are set against the carrying value of the E&E asset:
|Cr E&E asset||CU1,000|
Company A owns 100% of the rights to explore and mine area Z, and has spent CU1,000 to date, of which CU500 has been capitalised as an E&E asset. Company A (the farmor) enters into an agreement under which it sells 25% of the property to Company B (the farmee) for CU1,000.
The proceeds are set against the carrying value of the E&E asset to the extent of its carrying amount, with the excess being credited to profit or loss:
|Cr E&E asset||CU500|
|Cr Other income||CU500|