customers, to contain volume flexibility features. For example, a supplier might enter
into a contract requiring it to deliver, say, 100,000 units at a given price as well as giving
the counterparty the option to purchase a further 20,000 units at the same price. Often
such a supply contract will be readily convertible to cash as parties to the contract can
settle the contract on a net basis, as discussed at 13.1 above. For example, precious
metals or base metals quoted on the London Metal Exchange or oil contracts are
considered to be readily convertible to cash, whereas bulk materials without spot prices
(e.g. coal and iron) are generally not considered to be readily convertible to cash.
However, with increasing levels of liquidity in certain commodities, this view may need
to be reconfirmed/rechallenged before concluding that this remains the case.
If the customer has access to markets for the non-financial item and, following the
guidance of the Interpretations Committee the supplier might consider such a contract
to be within the scope of IFRS 9 as it contains a written option (see Chapter 41 at 4.2.3).
However, some would say that the supplier could split the contract into two separate
components for accounting purposes: a forward contract to supply 100,000 units (which
may qualify as a normal sale and so meet the recognition exemption) and a written
option to supply 20,000 units (which would not). Arguments put forward include:
• the parties could easily have entered into two separate contracts, a forward
contract and a written option; and
• it is appropriate to analogise to the requirements for embedded derivatives and
separate a written option from the normal forward sale or purchase contract
because it is not closely related.
Some contracts, however, contain operational volume tolerances such as, in the case of
certain oil purchase and sale contracts, a volume that is plus or minus a certain (often
quite small) percentage of the stated quantity. These tolerances relate to physical
changes in the volume during transportation caused by, for example, evaporation. The
optionality within the contract typically cannot be monetised by either party but,
instead is a practical requirement of the contract. In such cases, the optionality would
not be considered a separate derivative within the scope if IFRS 9. In other cases,
however, the volume tolerance may be greater than that which is required for practical
reasons. This optionality may give one party the ability to benefit from changing
underlying prices and could be considered a separate derivative. Judgement is required
in assessing the nature of these volume tolerances.
This issue is discussed in more detail in Chapter 41 at 4.2.4 and 4.2.5.
13.4 Hedging sales of metal concentrate (mining)
In the mining sector certain commodities are often sold in the form of a concentrate that
comprises two or more metals and impurities. These concentrates are the output of mines
and are sold and shipped to smelters for treatment and refining in order to extract the
metals in their pure form from the concentrate (or, alternatively, the concentrate may be
sold to traders who will subsequently sell and ship to smelters). The metal content of
concentrate varies depending on the mine and grade of ore being mined. The sales
proceeds of concentrate are typically determined as the total of the payments for the
3330 Chapter 39
actual content of each of the metals contained in a given concentrate shipment and they
reflect the condition in which the metal is sold (i.e. unrefined, still being dissolved in
concentrate). Typical pricing formulas are based on the price for dissolved metal off the
quoted price for refined metal (e.g. the London Metal Exchange (LME)), with deductions
for amounts that reflect the fact that the metal sold is not treated and/or refined. Actual
deductions may vary by contract but typically comprise treatment and refining charges,
price participation clauses, transportation, impurity penalties, etc.
Under IFRS 9, an entity is permitted to designate a risk component of a non-financial
item as the hedged item in a hedging relationship, provided the risk component is
separately identifiable and reliably measurable. See Chapter 49 at 3.7 for more
information on the IFRS 9 hedge accounting requirements and hedging of risk
components. These considerations also apply from the perspective of an entity that
purchases metals in the form of a concentrate.
14 INVENTORIES
Inventories should be measured at the lower of cost and net realisable value under
IAS 2. However, IAS 2 does not apply to the measurement of minerals and mineral
products, to the extent that they are measured at net realisable value in accordance with
well-established practices in those industries. [IAS 2.3(a)]. There is also an exception for
commodity broker traders who measure their inventories at fair value less costs to sell.
When such inventories are measured at fair value less costs to sell, changes in fair value
less costs to sell are recognised in profit or loss in the period of the change. [IAS 2.3(b)].
This is discussed further at 14.4 below.
Various cost methods are acceptable under IFRS and include specific identification,
weighted average costs, or first-in first-out (FIFO). Last-in first-out (LIFO) is not
permitted under IFRS.
Issues that mining companies and oil and gas companies commonly face in relation to
inventory include:
• point of recognition (14.1 below);
• cost absorption in the measurement of inventory;
• method of allocating costs to inventory, e.g. FIFO or weighted average;
• determination of joint and by-products and measurement consequences
(see 14.2 below);
• accounting for core inventories (see 14.3 below); and
• measuring inventory at fair value (see 14.4 below).
Additional issues relating to inventory for mining companies include:
• accounting for stockpiles of long-term, low grade ore (see 14.5 below); and
• heap leaching (see 14.6 below).
14.1 Recognition of work in progress
Determining when to start recognising inventory is more of an issue for mining
companies than oil and gas companies. Inventory is recognised when it is probable that
Extractive
industries
3331
future economic benefits will flow to the entity and the asset has a cost or value than
can be reliably measured.
Oil and gas companies often do not separately report work-in-progress inventories of
either oil or gas. As is noted in the IASC Issues Paper ‘the main reason is that, at the
point of their removal from the earth, oil and gas frequently do not require processing
and they may be sold or may be transferred to the enterprise’s downstream operations
in the form existing at the time of removal, that is, they are immediately recognised as
finished goods. Even if the oil and gas removed from the earth require additional
processing to make them saleable or transportable, the time required for processing is
typically minimal and the amount of raw products involved in the processing at any one
time is likely to be immaterial’.119 However, if more than an insignificant quantity of
> product is undergoing processing at any given point in time then an entity may need to
disclose work-in-progress under IAS 2. [IAS 2.8, 37].
For mining companies, it has become accepted practice to recognise work-in-progress
at the point at which ore is broken and the entity can make a reasonable assessment of
quantity, recovery and cost.120
Extract 39.24 from the financial statements of Harmony Gold Mining illustrates the need
for judgement in determining when work-in-progress can be recognised.
Extract 39.24: Harmony Gold Mining Company Limited (2017)
NOTES TO THE GROUP FINANCIAL STATEMENTS [extract]
for the years ended 30 June 2017
23 INVENTORIES [extract]
ACCOUNTING POLICY
Inventories, which include bullion on hand, gold-in-process, gold in lock-up, ore stockpiles and consumables, are
measured at the lower of cost and net realisable value. Net realisable value is assessed at each reporting date and
is determined with reference to relevant market prices.
The cost of bullion, gold-in-process and gold in lock-up is determined by reference to production cost, including
amortisation and depreciation at the relevant stage of production. Ore stockpiles are valued at average production
cost. Stockpiles and gold in lock-up are classified as non-current assets where the stockpile exceeds current
processing capacity and where a portion of static gold in lock-up is expected to be recovered more than 12 months
after balance sheet date.
Gold in-process inventories represent materials that are currently in the process of being converted to a saleable
product. In-process material is measured based on assays of the material fed to process and the projected
recoveries at the respective plants. In-process inventories are valued at the average cost of the material fed to
process attributable to the source material coming from the mine or stockpile plus the in-process conversion costs,
including the applicable depreciation relating to the process facility, incurred to that point in the process. Gold in-
process includes gold in lock-up which is generally measured from the plants onwards. Gold in lock-up is expected
to be extracted when plants are demolished at the end of their useful lives, which is largely dependent on the
estimated useful life of the operations feeding the plants. Where mechanised mining is used in underground
operations, in-progress material is accounted for at the earliest stage of production when reliable estimates of
quantities and costs are capable of being made. At the group’s open pit operations, gold in-process represents
production in broken ore form.
Consumables are valued at weighted average cost value after appropriate allowances for slow moving and
redundant items.
3332 Chapter 39
Measurement issues can arise in relation to work-in-progress for concentrators, smelters
and refineries, where significant volumes of product can be located in pipes or vessels,
with no uniformity of grade. Work-in-progress inventories may also be in stockpiles, for
example underground, where it is more difficult to measure quantities.
Processing varies in extent, duration and complexity depending on the type of mineral
and different production and processing techniques that are used. Therefore, measuring
work-in-progress, as it moves through the various stages of processing, is difficult and
determining the quantities of work-in-progress may require a significant degree of
estimation. Practice varies in this area, which is a reflection of the genuine differences
mining companies face in their ability to assess mineral content and predict production
and processing costs.
Extract 39.25 below from the financial statements of Anglo American Platinum
illustrates the complexity involved in making such estimates.
Extract 39.25: Anglo American Platinum Limited (2017)
SIGNIFICANT ACCOUNTING PRINCIPLES [extract]
for the year ended 31 December 2017
CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS [extract]
Metal inventory
Work-in-progress metal inventory is valued at the lower of net realisable value (NRV) and the average cost of
production or purchase less net revenue from sales of other metals, in the ratio of the contribution of these metals to
gross sales revenue. Production costs are allocated to platinum, palladium, rhodium and nickel (joint products) by
dividing the mine output into total mine production costs, determined on a 12-month rolling average basis.
Concentrate purchased from third parties is determined on a 12-month rolling average basis. The quantity of ounces
of joint products in work in progress is calculated based on the following factors:
• The theoretical inventory at that point in time, which is calculated by adding the inputs to the
previous physical inventory and then deducting the outputs for the inventory period.
• The inputs and outputs include estimates due to the delay in finalising analytical values.
• The estimates are subsequently trued up to the final metal accounting quantities when available.
• The theoretical inventory is then converted to a refined equivalent inventory by applying appropriate
recoveries depending on where the material is within the production pipeline. The recoveries are based
on actual results as determined by the inventory count and are in line with industry standards.
• Unrealised profits and losses are excluded from the inventory valuation before determining the
lower of NRV and cost calculation.
Other than at the precious metal refinery, an annual physical count of work in progress is done, usually around
February of each year. The precious metal refinery is subject to a physical count usually every three years, but this
could occur more frequently by exception. The annual physical count is limited to once per annum due to the
dislocation of production required to perform the physical inventory count and the in-process inventories being
contained in tanks, pipes and other vessels. Once the results of the physical count are finalised, the variance between
the theoretical count and actual count is investigated and recorded. Thereafter the physical quantity forms the opening
balance for the theoretical inventory calculation. Consequently, the estimates are refined based on actual results over
time. The nature of the production process inherently limits the ability to precisely measure recoverability levels. As
a result, the metallurgical balancing process is constantly monitored and the variables used in the process are refined
based on actual results over time.
Ore in circuit for a mining company at the end of a reporting period can be very difficult
to measure as it is generally not easily accessible. The value of materials being processed
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industries
3333
should therefore be estimated based on inputs, throughput time and ore grade. The
significance of the value of ore in circuit will depend on the type of commodity being
processed. For example, precious metals producers may have a material value in
process at reporting period end.
14.2 Sale of by-products and joint products
In the extractive industries it is common for more than one product to be extracted
from the same reserves, e.g. copper is often found together with gold and silver and
oil, gas and gas liquids are commonly found together. Products p
roduced at the same
time are classified as joint products or by-products and are usually driven by the
importance of the different products to the viability of the mine or field. The same
commodity may be treated differently based on differing grades and quantities of
products. In most cases where more than one product is produced there is a clear
distinction between the main product and the by-products. In other cases the
distinction may not be as clear.
The decision as to whether these are joint products or whether one is a by-product, is
important, as it impacts the way in which costs are allocated. This decision may also
affect the classification of sales of the various products.
14.2.1 By-products
A by-product is a secondary product obtained during the course of production or
processing, having relatively small importance when compared with the principal
product or products.
IAS 2 prescribes the following accounting for by-products:
‘...When the costs of conversion of each product are not separately identifiable,
they are allocated between the products on a rational and consistent basis. The
allocation may be based, for example, on the relative sales value of each product
either at the stage in the production process when the products become
separately identifiable, or at the completion of production. Most by-products, by
their nature, are immaterial. When this is the case, they are often measured at
net realisable value and this value is deducted from the cost of the main product.
As a result, the carrying amount of the main product is not materially different
from its cost.’ [IAS 2.14].
By-products that are significant in value should be accounted for as joint products as
discussed at 14.2.2 below. However, there are some entities that treat such by-product
sales as a negative cost, i.e. by crediting these against cost of goods sold of the main
product. This treatment would likely only be acceptable on the basis of materiality. It is
important to note that the negative cost approach discussed in IAS 2, [IAS 2.14], only
relates to the allocation of the costs of conversion between the main product and by-
product and does not allow the revenue from a sale of by-products as a reduction of
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 659