costs of disposal. [IAS 36.6]. FVLCD is less restrictive in its application than VIU and can
be easier to work with, which may be why some entities choose to use this approach
for impairment testing purposes. While IAS 36 does not impose any restrictions on how
an entity determines the FVLCD, there are specific requirements in IFRS 13 as to how
to determine fair value. IFRS 13 is discussed in more detail in Chapter 14.
The concept of fair value in IFRS 13 is explicitly an exit price notion. FVLCD, like fair
value, is not an entity-specific measurement, but is focused on market participants’
assumptions for a particular asset or liability. Under IFRS 13, for non-financial assets,
entities have to consider the highest and best use (from a market participant
perspective) to which the asset could be put. However, it is generally presumed that an
entity’s current use of those mining or oil and gas assets or CGUs would be its highest
and best use (unless market or other factors suggest that a different use by market
participants would maximise the value of the asset).
IFRS 13 does not limit or prioritise the valuation technique(s) an entity might use to
measure fair value. An entity may use any valuation technique, or multiple techniques,
as long as it is consistent with one of three valuation approaches: market approach,
income approach and cost approach and is appropriate for the type of asset/CGU being
measured at fair value. However, IFRS 13 does focus on the type of inputs to be used
and requires an entity to maximise the use of relevant observable inputs and minimise
the use of the unobservable inputs.
Extractive
industries
3295
Historically, many mining companies and oil and gas companies have calculated FVLCD
using a discounted cash flow (DCF) valuation technique. This approach differs from VIU in a
number of ways. One of the key differences is that FVLCD would require an entity to use
assumptions that a market participant would be likely to take into account rather than entity-
specific assumptions. For example, as mining sector and oil and gas sector market
participants invest for the longer term, they would not restrict themselves to a limited project
time horizon. Therefore, the cash flow forecasts included in a FVLCD calculation may cover
a longer period than may be used in a VIU calculation. Moreover, market participants would
also likely take into account future expansionary capital expenditure related to subsequent
phases in the development of a mining property in a FVLCD calculation, whereas this is not
permitted in a VIU calculation. Having said this, some of the issues discussed above for a VIU
calculation also need to be considered for a FVLCD calculation which uses a DCF model (we
discuss some of these further below). As illustrated in Extract 39.18 at 11.1 above, BHP uses
this approach in determining the FVLCD for its mineral assets.
11.5.1
Projections of cash flows
As required by IFRS 13, the assumptions and other inputs used in a FVLCD DCF model
is required to maximise the use of observable market inputs. These should be both
realistic and consistent with what a typical market participant would assume.
11.5.2
Commodity price assumptions
Similar to a VIU calculation, commodity price is a key assumption in calculating the
FVLCD of any mine or oil field when using a DCF model, and therefore similar issues as
those discussed for a VIU calculation (see 11.4.3 above) apply. On the same basis, while the
specific disclosure requirements relating to price assumptions in IAS 36 technically only
apply in the context of impairment testing of CGUs to which goodwill and indefinite life
intangible assets are allocated, because there can be considerable differences between
entities in their estimates of future commodity prices, we recommend additional
disclosures be provided. Regardless of the specific requirements of IAS 36, an entity is
also required to consider the disclosure requirements relating to significant judgements or
estimates and hence the requirements of IAS 1. [IAS 1.122, 125]. For example, an entity may
wish to disclose the actual commodity prices used in calculating the FVLCD of any mine
or oil field, as these would generally be considered a significant judgement or estimate and
hence would require disclosure under IAS 1. [IAS 1.122, 125].
11.5.3
Future capital expenditure
There are no restrictions similar to those applicable to a VIU calculation when
determining FVLCD provided that it can be demonstrated that a market participant would
be willing to attribute some value to the future enhancement and that the requirements of
IFRS 13 have been complied with. IFRS 13 is discussed in more detail in Chapter 14.
The treatment of future capital expenditure in an impairment test is discussed in more
detail in Chapter 20 at 7.1.2.
11.5.4
Foreign currency cash flows
For FVLCD calculations, the requirements relating to foreign currency cash flows are
not specified other than they must reflect what a market participant would use when
valuing the asset or CGU. In practice, entities that use a DCF analysis when calculating
3296 Chapter 39
FVLCD will incorporate a forecast for exchange rates into their calculations rather than
using the spot rate. A key issue in any forecast is the assumed timeframe over which the
exchange rate may return to lower levels. This assumption is generally best analysed in
conjunction with commodity prices in order to ensure consistency in the parameters
used, i.e. a rise in prices will usually be accompanied by a rise in currency.
11.6 Low mine or field profitability near end of life
While mining companies and oil and gas companies would like to achieve steady
profitability and returns over the life of a project, it is not uncommon to see profitability
declining over the life of a mine or field. From an economic perspective, a mining
company or oil and gas company will generally continue to extract minerals as long as
the cash inflows from the sale of minerals exceed the cash cost of production.
From a mining perspective, most mine plans aim to maximise the net present value of
mineral reserves by first extracting the highest grade ore with the lowest production
costs. Consequently, in most mining operations, the grade of the ore mined steadily
declines over the life of the mine which results in a declining annual production, while
the production costs (including depreciation/amortisation) per volume of ore, e.g. tonne,
gradually increases as it becomes more difficult to extract the ore. From an oil and gas
perspective, both oil and gas may be produced from the same wells but ordinarily oil
generates greater revenue per barrel of oil equivalent sold relative to gas. As the oil is
often produced in greater quantities first, this means that the oil and gas operation is
often more profitable in the earlier years relative to later years.
Consequently, where there is a positive net cash flow, a mining company or oil and gas
company will continue to extract minerals even if it does not fully recover the
depreciation of its property, plant and equipment and mineral reserves, as is likely to
occur towards the
end of the mine or field life. In part, this is the result of the
depreciation methods applied:
• the straight-line method of depreciation allocates a relatively high depreciation
charge to periods with a low annual production;
• a units of production method based on the quantity of ore extracted allocates a
relatively high depreciation charge to production of lower grade ore;
• a units of production method based upon the quantity of petroleum product
produced in total terms allocates an even depreciation charge per barrel of oil
equivalent, whereas the revenue earned varies; and
• a units of production method based on the quantity of minerals produced
allocates a relatively high depreciation charge to production of minerals that are
difficult to recover.
Each of these situations is most likely to occur towards the end of the life of a mine or field.
It is possible the methods of depreciation most commonly used in each of the sectors do
not allocate a sufficiently high depreciation charge to the early life of a project when
production is generally most profitable. An entity should therefore be mindful of the fact
that relatively small changes in facts and circumstances can lead to an impairment of assets.
Following on from this, the impairment tests in the early years of the life of a mine or
field will often reveal that the project is cash flow positive and is able to produce a
Extractive
industries
3297
recoverable amount that is sufficient to recoup the carrying value of the project, i.e. the
project is not impaired. However, when the impairment tests are conducted in later
years, while the mine or field may still be cash flow positive, i.e. the expected cash
proceeds from the future sale of minerals still exceed the expected future cash costs of
production and hence management will continue with the mining or oil and gas
operations, as margins generally reduce towards the end of mine or field life, the
impairment tests may not produce a recoverable amount sufficient to recoup the
remaining carrying value of the mine or field. Therefore, it will need to be impaired.
It is possible, when preparing the impairment models for a mine or field, for an entity to
identify when (in the future) the remaining net cash inflows may no longer be sufficient
to recoup the remaining carrying value, that is, when compared to the way in which the
assets are expected to be depreciated over the remaining useful life. However, provided
the recoverable amount as at the date of the impairment test exceeds the carrying
amount of the mine or field, there is no requirement to recognise any possible future
impairment. It is only when the recoverable amount actually falls below the carrying
amount that an impairment must be recognised.
12 REVENUE
RECOGNITION
The sub-sections below consider some of the specific revenue recognition issues faced
by mining companies and oil and gas companies under the requirements as set out in
IFRS 15 (see Chapter 28 for more details) or where they may earn other revenue (or
other income) in the scope of other standards.
12.1 Revenue in the development phase
Under IAS 16, the cost of an item of property, plant and equipment includes any costs
directly attributable to bringing the asset to the location and condition necessary for it
to be capable of operating in the manner intended by management. [IAS 16.16(b)]. During
the development/construction of an asset, an entity may generate some revenue. The
current treatment of such revenue depends on whether it is considered incidental or
integral to bringing the asset itself into the location and condition necessary for it to be
capable of operating in the manner intended by management.
If the asset is already in the location and condition necessary for it to be capable of being
used in the manner intended by management, then IAS 16 requires capitalisation to
cease and depreciation to start. [IAS 16.20]. In these circumstances, all income earned
from using the asset must be recognised as revenue in profit or loss and the related costs
of the activity should include an element of depreciation of the asset.
12.1.1 Incidental
revenue
During the construction of an asset, an entity may enter into incidental operations that
are not, in themselves, necessary to bring the asset itself into the location and condition
necessary for it to be capable of operating in the manner intended by management. The
standard gives the example of income earned by using a building site as a car park prior
to starting construction. An extractives example may be income earned from leasing out
the land surrounding the mine site or an onshore gas field to a local farmer to run his
sheep on. Because incidental operations such as these are not necessary to bring an item
3298 Chapter 39
to the location and condition necessary for it to be capable of operating in the manner
intended by management, the income and related expenses of incidental operations are
recognised in profit or loss and included in their respective classifications of income and
expense. [IAS 16.21]. Such incidental income is not offset against the cost of the asset.
12.1.2
Integral to development
The directly attributable costs of an item of property, plant and equipment include the
costs of testing whether the asset is functioning properly, after deducting the net proceeds
from selling any items produced while bringing the asset to that location and condition.
[IAS 16.17(e)]. The standard gives the example of samples produced when testing equipment.
There are other situations in which income may be generated wholly and necessarily as
a result of the process of bringing the asset to the location and condition for its intended
use. The extractive industries are highly capital intensive and there are many instances
where income may be generated prior to the commencement of production.
Some mining examples include:
• During the evaluation phase, i.e. when the technical feasibility and commercial
viability are being determined, an entity may ‘trial mine’, to determine which
development method would be the most profitable and efficient in the
circumstances, and which metallurgical process is the most efficient. Ore mined
through trial mining may be processed and sold during the evaluation phase.
• As part of the process of constructing a deep underground mine, the mining
operation may extract some saleable ‘product’ during the construction of the mine
e.g. sinking shafts to the depth where the main ore-bearing rock is located.
• At the other end of the spectrum, income may be earned from the sale of product
from ‘ramping up’ the mine to production at commercial levels.
Some oil and gas examples include:
• Onshore wells are frequently placed on long-term production test as part of the
process of appraisal and formulation of a field development plan. Test production
may be sold during this time.
Some interpret IAS 16’s requirement quite narrowly as only applying to income earned
from actually ‘testing’ the asset, while others interpret it more broadly to include other
types of pre-commission
ing or production testing revenue.
We have noted in practice that some income may be generated wholly and necessarily
as a result of activities that are part of the process of bringing the asset into the location
and condition for its intended use, i.e. the activities are integral to the construction or
development of the mine or field. Some consider that as IAS 16 makes it clear that
income generated from incidental operations is to be taken to revenue, [IAS 16.21], but
does not explicitly specify the treatment of integral revenue, it could be interpreted that
income earned from activities that are integral to the development of the mine or field
should be credited to the cost of the mine or field. This is because the main purpose of
the activities is the development of the mine or field, not the production of ore or
hydrocarbons. The income earned from production is an unintended benefit.
In our experience, practice in accounting for pre-commissioning or test production
revenue varies. These various treatments have evolved as a result of the way in which
Extractive
industries
3299
the relatively limited guidance in IFRS has been interpreted and applied. In some
instances, this has also been influenced by approaches that originated in previous and
other GAAPs, where guidance was/is somewhat clearer.
The key challenge with this issue is usually not how to measure the revenue but how
entities view this revenue and, more significantly, how to distinguish those costs that
are directly attributable to developing the operating capability of the mine or field from
those that represent the cost of producing saleable material. It can be extremely difficult
to apportion these costs. Consequently, there is a risk of misstatement of gross profits if
these amounts are recorded as revenue and the amount of costs included in profit or
loss as cost of goods sold is too low or too high.
Other GAAPs have either previously provided or continue to provide further guidance
that has influenced some of the approaches adopted under IFRS. For example, the now
superseded Australian GAAP (AGAAP) standard on extractive industries108 and the
former OIAC SORP109 provided more specific guidance. The former clearly required,
and the latter recommended, that any proceeds earned from the sale of product
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 652