Extracting value - Issue 7
The naked truth about accounting for stripping costs by resources companies
In our final edition of Extracting Value for 2009, we explore the global debate on the treatment of ‘stripping costs’ (overburden and waste removal). IFRIC has decided to develop an Interpretation in this area which may result in more profit volatility for mining companies and also have consequential impacts on accounting for various similar costs in mining and oil and gas operations.
Topics discussed below are:
- Methods that are currently used
- The ‘unit of account’ dilemma
- Potential inconsistency with the IASB extractives project
- Other mining and oil and gas activities are conceptually similar.
You can download a PDF version of this document at the bottom of the page.
The November meeting of the International Financial Reporting Interpretations Committee (IFRIC) saw a decision to add a project on accounting for stripping costs. Stripping costs include the costs of removal of waste material and overburden and arise in open pit mining operations.
The IFRIC project is only considering how stripping costs arising in the production phase are accounted for – there is an implicit acknowledgement that stripping costs in the development phase are an asset that is generally capitalised.
The IFRIC’s intention is to develop an Interpretation that would prescribe accounting for deferred stripping costs and eliminate the diversity of practice that currently exists around the globe.
The table below is an overview summary of some of the accounting approaches currently used to account for stripping costs:
|Expense||All stripping costs incurred during the production phase of a mine are expensed as incurred||
Introduces significant volatility in profit or loss if the mine plan has periods where proportionately more or less waste material is removed.
Accordingly, this approach is commonly adopted where large scale stripping does not occur in advance of related production.
|Inventory cost||Stripping costs are treated as a variable period inventory cost||This is the prescribed approach in the United States and can result in significant volatility in reported profits from year to year as mine plans change - ore produced in years of greater stripping activities will have a higher cost of production.|
|Capitalise if a ‘betterment’ to the mining asset||Stripping costs are capitalised if they result in a ‘betterment’ of the mining asset, otherwise treated as a variable period inventory cost||
This is the prescribed approach under Canadian GAAP.
Costs related to future production are capitalised if they relate to future reserves, and amortised over those future reserves.
|Stripping ratio||Stripping costs are allocated to all production on the basis of the ratio of waste material to ore||This generally results in an ‘averaging’ of the cost of waste removal over all the reserves. Variants of the model may anticipate future waste removal costs or applying different stripping ratios to parts of the overall mining operation.|
The fundamental reason the issue of accounting for stripping costs is so problematic is due to the question of ‘unit of account’, i.e. how is a mining operation componentised and recognised for accounting purposes?
From a commercial perspective, the decision to proceed to development is made by reference to the ‘mine as a whole’. In other words, the mine plan is optimised for the whole of the life of the mine and overburden and waste removal planning will form an integral part of this assessment. It may be that when the overburden costs are significantly large that it is only economic to proceed to development when considering all the reserves to be mined over the life of the mine. The total development cost, including overburden and waste removal, will be scheduled to maximise cash flows from the mine, i.e. these costs will be deferred wherever possible to balance production and ongoing development activities. The cost of mining ore will explicitly or implicitly consider the total expected cost of overburden and waste removal.
The ‘unit of account’ from a commercial perspective may in many cases therefore appear to be the mine in its entirety. However, from an accounting perspective, the methods developed under United States and Canadian GAAP are effectively using a much more granular ‘unit of account’, i.e. almost looking at the individual tonnes of overburden or waste. When considered from this perspective, the ability to delineate and measure an ‘asset’ is more problematic.
When considered from its commercial reality, the optimal accounting would in many cases be to spread the total costs of overburden and waste removal, both past and future, over all the reserves. (In other cases, particular activities may be separately tracked and accounted for where they allow access to specific and distinct reserves.) Including future costs in the depreciable amount is sometimes adopted for amortisation of development costs in their entirety, although is much less common under IFRS than under pre-IFRS Australian Accounting Standards. We expect that this particular aspect (i.e. inclusion of future costs) may be a high hurdle for IFRIC to overcome. An alternate approach might be the use of an average of actual past costs only, with no regard to future costs, when calculating amounts to defer (a fairly common existing practice).
In addition, the scheduling of waste and overburden removal is dependent on the nature of the ore body. In some cases, disproportionately higher stripping costs are expected in the future as compared to the past. The additional question of whether a credit balance (effectively an accrual for future expected stripping costs) can be recognised in these circumstances may prove to be an even higher hurdle for IFRIC to overcome. .
It will be interesting to monitor how IFRIC’s assessment of these issues develops.
|Any move towards the United States or Canadian approaches may result in significant volatility in reported profits and costs of production compared to the ‘stripping ratio’ approach commonly used in Australia. Initial discussions at the IFRIC meeting appeared to favour the Canadian approach, with some sympathy for the stripping ratio approach. However, there was some resistance to retaining the stripping ratio approach as some IFRIC members considered it inconsistent with the Framework.|
The IFRIC agenda papers acknowledge that the treatment of stripping costs would clearly fall within the scope of the IASB possible project on extractive activities. Nevertheless, IFRIC decided to add this matter to its agenda as the extractive activities project is effectively ‘on hold’ pending other projects, particularly the IASB’s response to the global financial crisis.
The draft Discussion Paper is very clear that many of the issues arising in accounting for extractive activities is due to the ubiquitous use of ‘phase accounting’, i.e. considering a particular project to be in ‘exploration’, ‘development’, ‘production’ and so on. The fact that ‘development’ type activities continue after production has started is a good example of this issue.
The draft Discussion Paper argues that there is effectively only one asset and that phase accounting is inappropriate, although presentation of the asset may be based on the predominant phase that a project is currently in (i.e. producing projects would be presented separately from exploration and development projects). Accordingly, all costs would be capitalised into the single ‘mining asset’ or ‘oil and gas asset’. (See Extracting Value Issue 6 for our initial analysis of the proposals in the draft Discussion Paper Extractive Activities made available by the IASB in August.)
IFRIC’s current project is exclusively focussed on stripping costs incurred in the production phase. The IFRIC Agenda paper considered at the November meeting, perhaps incorrectly, states that “once commercial production begins, development costs cease to be capitalised” – certainly not our experience in practice.
By focussing on this issue from a ‘mining phase’ perspective, IFRIC potentially risks being too narrow in its focus in how these costs should be treated. We hope that IFRIC considers the draft Discussion Paper and its conclusions when formulating its own views on this issue.
|The key question for IFRIC is whether it is appropriate to mandate a particular approach under existing IFRS which may well be changed by any IASB project on extractive activities. IFRIC decided that because the IASB’s project is likely to be three to five years away from completion that a project is justified. This is not necessarily consistent with IFRIC’s approach taken in other areas, e.g. consider IFRIC’s reluctance to opine on any income tax accounting issues for a number of years.|
IFRIC is focussing on ‘stripping costs’, i.e. the removal of overburden and waste in an open pit mining operation. However, IFRIC’s eventual Interpretation on this matter may potentially have a much wider application to other aspects of mining due to the ‘hierarchy’ under IFRS.
Costs akin to stripping costs are routinely incurred in many mining and oil and gas operations, e.g.:
- Underground mining operations often involve the extension of the shaft or decline after mining production has commenced
- Underground mines also routinely incur costs of development drives to reach areas of ore (sometimes referred to as ‘advanced operating development’)
- Coal mining operations often involve a degree of ‘de-watering’ and ‘benching’ progressively throughout the mining operation
- Oil and gas operations can also incur similar costs, e.g. deeper drilling past the producing horizon, ‘de-watering’ costs (particularly in coal seam gas fields), salt water disposal, injection well treatments, ‘well work over’ costs and ‘location preparation’ costs.
|In some cases, these types of costs are incurred on a non-lineal basis over the life of the mine or field, therefore giving rise to the same issues as for stripping costs. Accordingly, all resources companies should carefully monitor the IFRIC developments to ensure that the outcome is palatable and commercially realistic. If IFRIC releases a draft Interpretation on this matter, both directly and indirectly affected resources companies should comment on the proposals so that IFRIC appreciates the true breadth of the issue they are discussing.|
- Deloitte observer notes from the November IFRIC meeting
- IFRIC Agenda Paper 2A: Accounting for Production of Stripping Costs – preliminary discussions (PDF 99kb)
- IFRIC Agenda Paper 2B: Accounting for Production of Stripping Costs – tentative agenda decision (PDF 73kb)
Other developments from the November IFRIC meeting
At its November meeting, the IFRIC considered a request to add to its agenda a project to clarify unit of account for forward contracts with volumetric optionality. The IFRIC discussed the forward contracts to buy and sell a fixed quantity of a specified commodity at a fixed price over the term of a contract that grants the buyer the flexibility to purchase quantities of the same commodity also at this fixed price. These types of arrangements are quite commonly used by resources companies. IFRIC explored a number of possible treatments and is to consider the matter further at its next meeting in January. More information on the issue can be found in the IFRIC Agenda Paper (PDF 93kb).
Spotlight on common financial reporting issues
In assisting our clients to meet their goals, our resources experts continually encounter numerous matters across a diverse spectrum of issues arising under IFRS. Examples of some common issues in recent times include the following:
We’d be happy to explore these, or any other, issue with you. Feel free to contact your local Deloitte contact or the people profiled at the back of this publication for more information.