FASB Emerging Issues Task Force. Issue No Accounting for Post-Production Stripping Costs in the Mining Industry

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1 EITF Issue No FASB Emerging Issues Task Force Issue No Title: Accounting for Post-Production Stripping Costs in the Mining Industry Document: Issue Summary No. 1 Date prepared: June 17, 2004 FASB Staff: Larson (ext. 229)/ Westerlund (ext. 212) Date previously discussed: None Previously distributed EITF materials: None References: FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (FAS 3) FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies (FAS 19) FASB Statement No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (FAS 86) FASB Concepts Statement No. 6, Elements of Financial Statements (CON 6) APB Opinion No. 20, Accounting Changes (Opinion 20) AICPA Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, Chapter 4, "Inventory Pricing" (ARB 43) AICPA Accounting Research Bulletin No. 45, Long-Term Construction-Type Contracts (ARB 45) AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use Securities Act Industry Guide 7, Description of Property by Issuers Engaged or to be Engaged in Significant Mining Operations (Industry Guide 7) The alternative views presented in this Issue Summary are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination and it is ratified by the Board. EITF Issue No Issue Summary No. 1, p. 1

2 IAS ED 6, Exploration and Evaluation of Mineral Resources (IAS ED 6) International Accounting Standards Committee, An Issues Paper Issued for Comment by the IASC Steering Committee on Extractive Industries (IASC Issues Paper) EITF Issue No. 90-8, "Capitalization of Costs to Treat Environmental Contamination" (Issue 90-8) EITF Abstracts, Topic No. D-1, "Implications and Implementation of an EITF Consensus" (Topic D-1) EITF Issue No Issue Summary No. 1, p. 2

3 Background 1. In June 2003, the EITF Agenda Committee considered an issue on the accounting for stripping costs (costs of removing waste materials from a mine) in the mining industry. The Agenda Committee acknowledged that other issues that are unique to the mining industry exist and requested that the FASB staff form a working group to identify and deliberate mining industry issues. The Working Group met in September 2003 to consider the stripping cost issue, as well as other issues encountered in the mining industry. The Working Group believes that existing authoritative literature does not specifically address the accounting for stripping costs in the mining industry and, as a result, diversity in practice exists. Accordingly, the Working Group requested that the EITF provide guidance on this Issue and, based upon the recommendation of the Working Group, the Agenda Committee added this Issue to the EITF agenda at its November 5, 2003 meeting. 2. The Working Group discussed this Issue and generally believes that the stripping cost issue is complex due to (a) the diversity in the types of mines, including both underground and above ground operations and (b) the types of costs that are incurred in the development and production phases of the mine. For example, an entity that mines coal in an above ground operation may defer stripping costs as inventory/work-in-process for several months based on its cycle for removing overburden. In contrast, an entity that mines precious or base metals may defer stripping costs for years based on the long-term benefits that the removal of the waste is deemed to provide given the long term duration of these mines (both above ground and underground operations). That is, stripping costs are deferred for different periods based on the nature of the stripping program required by the mine plan The Working Group believes that the fundamental issue underlying the stripping cost question is how to determine whether costs that increase the future capacity or production of the mine can be capitalized when such costs are incurred during the production phase of the mine. Therefore, many members of the Working Group believe that the issue is broader than stripping costs and includes all costs incurred during the development and production phases of a mine 1 A mine plan is a term used in the mining industry for a plan filed with a regulatory body that details an entity s work plan for a particular ore body. EITF Issue No Issue Summary No. 1, p. 3

4 that may benefit future periods. For example, if an entity that operates an underground mine constructs a tunnel before the mine is in production, the costs are capitalized. If that entity constructs a tunnel while the mine is in production and the tunnel will benefit production both in the current period and in the future, how should the entity determine whether to capitalize or expense the related costs? Current practice is diverse. Similarly, mining entities drill to define an ore body and to determine the best alternative to gain access to that ore body. Diversity in practice exists as to whether the related costs should be expensed as exploration costs or capitalized as development costs. 4. The lack of authoritative accounting guidance for the mining industry contributes to the diverse accounting. There is no mining-specific authoritative literature to assist a mining entity in its assessment of whether a cost should be expensed or capitalized. In contrast, the FASB has provided guidance to oil and gas entities in FAS 19. Industry practice that has developed in the mining industry is based roughly by analogy to the guidance in FAS The Working Group believes that an effective approach to address the stripping cost issue is to develop a broad framework for analyzing all costs incurred in a mining operation. A framework to address these costs could be similar to other existing authoritative guidance including FAS 19 and FAS 86. The Working Group recommends that the EITF define and provide guidance for the following types of costs: Exploration Evaluation Development Production Closure. 6. Some members of the Working Group worked together to provide Exhibit 04-6A of this Issue Summary to assist the Task Force in understanding the life cycle of a mine and its various phases. The exhibit reflects the efforts of those Working Group members and does not represent an industry-standard set of definitions and descriptions. EITF Issue No Issue Summary No. 1, p. 4

5 7. The Working Group believes that developing a framework for these activities is the first step in developing comprehensive guidance for the mining industry. However, some members of the Working Group and the FASB staff question whether developing comprehensive guidance for the mining industry, including this first step, is outside the charter of the EITF. If the Task Force does not address the broader issue of cost capitalization throughout the life of the mine, some members of the Working Group believe that the EITF should, at a minimum, address the accounting for stripping costs incurred during the production phase of the mine. Other members of the Working Group believe that addressing the accounting for stripping costs without the benefit of a more comprehensive cost accounting framework for the mining industry may result in the Task Force reaching an inappropriate answer. Scope of This Issue Summary 8. After further study, the FASB staff believes that developing a broad framework for cost accounting in the mining industry, while preferred by the majority of the Working Group, is beyond the charter of the EITF. Therefore, the staff recommends that the Task Force not address the broad issue of accounting for costs in the mining industry. However, the FASB staff believes that the Task Force should address the accounting for post-production stripping costs (that is, after production commences) as that is an area in which diversity in practice exists and for which the Working Group and others believe further guidance is needed. Accordingly, this Issue Summary addresses the specific practice issue associated with the accounting for post-production stripping costs in the mining industry. 9. The FASB staff acknowledges that stripping costs are not the only types of costs in the mining industry that have elements of both production and development (refer to paragraph 3 for examples). However, the staff has limited the scope of this Issue to post-production stripping costs because it believes that the primary practice issue is deferred stripping costs. 10. At the June 30 July 1, 2004 EITF meeting, the FASB staff will ask Task Force members whether they agree with the scope of this Issue. If the Task Force disagrees with the scope, the FASB staff will ask for additional direction for example, whether the Issue should develop a EITF Issue No Issue Summary No. 1, p. 5

6 framework for the accounting for costs in the mining industry or address the accounting for costs with elements of both production and development. If the Task Force believes that the scope of this Issue should be broader to include other costs in addition to deferred stripping costs, the FASB staff recommends that the Task Force initially discuss the post-production stripping costs issue because the FASB staff believes that the discussion of that issue will help in the development of the broader issue. In that case, the FASB staff, utilizing the input of the Working Group, will then draft an Issue Supplement for discussion at the September 29 30, 2004 EITF meeting to address the broader issue. Issue Introduction 11. In the mining industry, companies may be required to remove overburden and other mine waste materials while accessing mineral deposits. The costs of removing overburden and waste materials are referred to as 'stripping costs.' During the development of a mine (before production begins) it is generally accepted in practice that stripping costs are capitalized as part of the depreciable cost of building, developing, and constructing the mine. These capitalized costs are typically amortized over the productive life of the mine using the units of production method. A mining company may continue to remove overburden and waste materials, and therefore incur stripping costs, during the production stage of the mine. It is the accounting for stripping costs incurred during production that has resulted in questions being raised as to the appropriate accounting for those costs, and now diversity in practice exists. 12. The question of accounting for stripping costs is a difficult issue to address because postproduction stripping costs may benefit both future periods (that is, the nature of the cost is the same or similar to stripping costs incurred in the development phase) and current period production. Until the last unit of reserves is extracted from a mine, some believe that all stripping costs incurred in a mining operation have an element of future benefit, as the removal of the overburden and waste material allows the entity to gain access to additional reserves. 13. In practice, many mining companies estimate the total material to be mined throughout the mine's productive life. Those companies, using a long-term mine plan, then develop a "life of mine stripping ratio," or a "stripping ratio," which is calculated as the estimated total post- EITF Issue No Issue Summary No. 1, p. 6

7 production waste material tons mined divided by the estimated total proven and probable reserves contained within the mine (that is, recoverable ore in a unit of measure, for example, pounds of copper or ounces of gold). 14. Because the physical concentration of mineral deposits is not uniform throughout a mine, a company generally is mining a ratio of waste material to mineral deposits that is different from the life-of-mine stripping ratio. Refer to Exhibit 04-6B for an illustration of a cross section of a mine and a calculation of a deferred stripping ratio. For each period, the actual stripping ratio is compared to the life-of-mine stripping ratio. If the actual stripping ratio exceeds the life-of-mine stripping ratio (that is, more waste is removed than the estimated average), the excess stripping cost that was incurred is recognized as a deferred stripping asset. Alternatively, if the actual stripping ratio is less than the life-of-mine stripping ratio (that is, less waste is removed than the estimated average), the shortfall is recognized as a reduction in the deferred stripping asset. In certain limited cases, the shortfall is recognized as a deferred credit on the balance sheet (when the deferred stripping asset, if any, does not absorb the amount of the shortfall). Changes in the average life of-mine stripping ratio are accounted for prospectively as changes in estimates. This method of accounting for post-production stripping costs may be used in practice in circumstances in which the stripping ratio is expected to vary substantially over the life of the mine. Other entities may expense stripping costs as incurred when the stripping ratio over the life of a mine is expected to be relatively stable. Scope of This Issue 15. This Issue applies only to mining entities that use a method of accounting similar to the successful efforts method that is described in FAS 19. Mining entities include entities involved in finding and removing non-renewable wasting natural resources, other than oil and gas producing entities that are within the scope of FAS 19. Definition of the Production Phase 16. This Issue applies to the accounting for stripping costs incurred in the production phase of a mining operation. It is often difficult to determine when development or construction of the mine has ended and the production phase has begun. Industry Guide 7 defines the production EITF Issue No Issue Summary No. 1, p. 7

8 stage as the stage that "includes all issuers engaged in the exploitation of a mineral deposit (reserve)." For purposes of defining the scope of this Issue, a further definition of the production phase of a mine is warranted. That definition is as follows: The production phase of a mine is deemed to have begun when mine development has been completed, operations have commenced, and revenue is realized from the sale of minerals, irrespective of the level of production. Accounting Issues and Alternatives Issue 1: Accounting for post-production stripping costs. View A: Post-production stripping costs should be expensed as incurred. 17. Proponents of View A believe that once a mine begins production, all subsequent costs to remove materials from the mine are costs of current production. These proponents hold the view that post-production stripping costs are costs incurred to maintain current production and, while a necessary cost of extracting the unrefined product from the mine, provide little future economic benefit to be obtained or controlled by an entity. Accordingly, View A proponents believe that costs incurred to conduct post production stripping activities do not meet the definition of an asset as contemplated by CON 6 and therefore must be expensed as incurred. 18. Some proponents of View A believe that post-production stripping costs primarily benefit current production, but also acknowledge that these activities could provide benefits to future periods. However, because it is difficult to accurately allocate these costs between those that benefit current production and those that benefit future periods, as a practical expedient, these proponents believe immediate recognition as an expense is appropriate. This view is consistent with other areas within U.S. GAAP, such as paragraph 25 of SOP 98-1, when an entity cannot distinguish whether a cost should be capitalized or expensed as incurred; the default treatment is for the cost to be expensed as incurred. EITF Issue No Issue Summary No. 1, p. 8

9 19. Proponents of View A point out that it is often the case that the occurrence of mineral deposits is not uniform throughout a mine. In those cases, it is expected that there will be periods in which more minerals or fewer minerals are produced. View A proponents believe that the inconsistency in stripping costs associated with the amount of reserves being mined during a period should be recognized in the operating results of the mining entity. 20. Proponents of View A are concerned that deferring post-production stripping costs and recognizing the stripping costs at a uniform rate over the life of the mine (refer to View B) results in smoothing of earnings such that the financial statements do not accurately reflect economic reality. If costs are incurred unevenly, then the financial statements should reflect that economic reality, rather than being smoothed through the use of an artificial matching methodology. View B: Post-production stripping costs should be deferred and recognized in earnings using a life-of-mine stripping ratio, subject to not recognizing a liability in periods when the actual stripping ratio is less than the life-of-mine stripping ratio. 21. Proponents of View B believe that stripping costs should be capitalized over the life of the mine regardless of whether they are incurred during the mine development or production phase. View B proponents believe that in addressing the accounting for post production stripping costs, the unit of account should be the mine. Using that as a basis, proponents of View B believe that applying a life-of-mine stripping ratio to recognize stripping costs ratably over the life of the mine results in a practical and reasonable allocation of those costs to the associated revenue from the minerals extracted from the mine. 22. Proponents of View B note that post-production stripping costs are necessary costs that will be continually incurred over the life of the mine. They believe that post-production stripping activities represent the continuous development of the mine as they allow access to additional sources of proven and probable reserves as minerals are mined. For that reason, View B proponents see no difference between pre-production and post-production stripping activities EITF Issue No Issue Summary No. 1, p. 9

10 and, therefore, hold the view that all stripping costs should be accounted for on a comparable basis (that is, recognized in the income statement ratably over the life of the mine). 23. For periods in which actual waste material removed exceeds the estimated average waste, proponents of View B believe it is appropriate to recognize an asset (that is, deferred stripping costs) as the costs for the excess material moved represent a probable future economic benefit to be realized by the extraction of ore in subsequent periods. To further support the recognition of an asset, View B proponents highlight that the fair value of a partially developed ore body, where waste material has already been removed, would be greater than a comparable ore body where no or less waste material had been removed (that is, the ore body is more valuable as a result of the removal of waste because access to future reserves becomes easier and less costly). 24. Proponents of View B believe that stripping costs deferred on the balance sheet as an asset meet the characteristics of an asset as defined by CON 6. They point to paragraph 26 of CON 6, which defines the essential characteristics of assets as: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others' access to it, and (c) the transaction or other event giving rise to the entity's right to or control of the benefit has already occurred. Since removal of waste material is required to allow the entity to gain access to additional probable reserves that are economically recoverable in the future, View B proponents believe that the cost to remove the waste material embodies a probable future benefit that, in combination with the other assets of the mine, contributes directly to the future net cash inflows of the enterprise. Further, with regard to characteristic (b), View B proponents hold the view that the mining enterprise has valid rights to access and mine the reserves in a specified area and, therefore, control the benefit (and others' access to it) obtained from the stripping activity. The costs incurred to undertake the stripping activity that results in the recognition of an asset have "already occurred." Therefore, View B proponents believe that characteristic (c) has also been satisfied. EITF Issue No Issue Summary No. 1, p. 10

11 25. In contrast, for periods in which actual waste material tons moved is below the normalized waste material tons moved determined by applying the life of-mine stripping ratio, View B proponents do not believe it is appropriate to recognize a deferred stripping cost liability. Paragraph 35 of CON 6 states that "liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events" (footnote references omitted). View B proponents believe that under no circumstance would the accounting for stripping costs under this method create an obligation of the entity to transfer assets or provide services in the future. Therefore, an entity accounting for stripping costs under this method would not incur a liability as defined under CON 6. In that circumstance, proponents of View B believe that stripping costs recognized for a given period should reflect the lesser of the actual stripping costs incurred or the stripping costs that would be recognized in the period through application of the life-of-mine stripping ratio concept. It is important to note that certain entities that currently use a stripping cost ratio recognize liabilities under those same circumstances. The FASB staff included this limitation in View B as it believes there is no conceptual basis for recording a liability under this scenario (see View B' for an alternative view). 26. Proponents of View B further believe that expensing all stripping costs once production has begun results in unnecessary volatility in reported production costs and earnings as the products being mined are produced from sections of the mine where ore concentrations may be more or less than the expected average over the life of the mine. They believe investors would be confused by widely varying production costs from period to period and that comparability of operating results between companies would be impaired if stripping costs were not deferred after production began. Proponents of View B note that deferral of post production stripping costs is a long-standing industry practice, and they believe it more appropriately portrays the long-run cost structure of producing the minerals. 27. In contrast, opponents to View B note that the determination of the production stripping ratio is subject to significant subjectivity. This subjectivity arises from the need to estimate both stripping costs and proven and probable reserves over potentially long periods of time (that is, EITF Issue No Issue Summary No. 1, p. 11

12 the life of the mine). Because the ratio needs to be adjusted as additional data becomes available, the use of the life of-mine stripping ratio also creates opportunities for manipulation of earnings that could cause investors and others to call into question the reliability of financial reporting in this industry. Supporters of View B disagree with this argument as they contend that the legal and regulatory requirements in the mining industry require an entity to obtain very precise estimates of both reserve levels and estimated life of mine waste material before substantive mining operations can begin. Those estimates are subject to revision on a prospective basis as more information is obtained and operations commence. Supporters of View B argue that significant effort is put into determining and updating these estimates, such that opportunities for earnings manipulation are mitigated, since significant adjustment to initial estimates would be thoroughly scrutinized. Supporters of View B also note that the estimates of waste materials to be removed over the life of the mine are similar to other estimates that are required to be made throughout the life of the mine (for example, estimates of recoverable reserves). 28. Opponents to View B also believe the need to estimate the waste-to-ore ratio over the life of the mine introduces an unnecessary and subjective element into the financial accounting and reporting process. To support that claim, they point to paragraph 211 of FAS 19 in which the Board rejected the use of estimated future development costs in determining amortization of capitalized costs for oil and gas companies, a notion that is similar to the concept of recognizing post-production stripping costs using a life of-mine stripping ratio. These opponents note that the "matching" of revenues and expenses is no longer a consideration in determining the timing of expense recognition in financial statements and believe that the variability in stripping costs from period to period can be adequately disclosed in the financial statements and related documents, including the Management Discussion and Analysis section for an SEC registrant. View B': Post-production stripping costs should be deferred and recognized in earnings using a life of-mine stripping ratio. 29. Proponents to View B' put forth the same arguments as those proponents of View B, with the exception of eliminating the prohibition on liability recognition. Consistent with supporters EITF Issue No Issue Summary No. 1, p. 12

13 of View B, View B' proponents also believe that the accounting for stripping costs should be analyzed by considering the entire mine as the unit of account. They further support the idea that recognition of a normalized amount of stripping costs in the income statement over the productive life of the mine is the desired outcome of employing a deferred stripping accounting model. 30. Proponents of View B' believe that the costs associated with removing waste material from the mine should be recognized on a ratable basis over the life of the mine using a life-of-mine stripping ratio as it is not practical to distinguish the portion of the stripping costs in a period that relates to current production from the portion that relates to future (or past) production. Therefore, View B' proponents believe that recognizing stripping costs on a basis other than a normalized basis, provides a punitive answer to those enterprises that have a stripping ratio that is expected to vary substantially over the life of the mine. Supporters of View B' agree with the conceptual basis for recognition of an asset under View B, but disregard the argument that there is no conceptual basis for the recognition of a liability as they believe the benefits of reporting consistent operating results over the life of the mine outweigh the "costs" of the conceptual inaccuracies that arise in recording a liability for stripping costs under this View. View C: Post-production stripping costs are a variable production cost that should be considered a component of mineral inventory cost subject to the provisions ARB Proponents of View C believe that after a mine begins production; all subsequent costs to remove materials from the mine are costs of current production and therefore represent a component of the inventory cost of the minerals being extracted. Statement 3 of ARB 43 states that "the primary basis of accounting for inventories is cost. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location." View C proponents believe that the costs incurred to remove waste material are a direct cost incurred to bring the mineral reserves to a condition and location that provides the future value to the entity. EITF Issue No Issue Summary No. 1, p. 13

14 32. View C proponents hold the view that the unit of account to be considered in determining the appropriate accounting for post-production stripping costs, is the minerals extracted in a given period and not the total minerals extracted over the life of the mine (the view point of View B and View B' proponents). Consistent with that notion, stripping costs incurred in a given period should be associated with the activities of that period, including the mineral inventory extracted, giving no consideration to the benefits that may be provided to the future activities of the mine. 33. View C proponents point out that since entities engaged in mining activities are not exempt from the provisions of ARB 43, all costs of producing the reserves should, therefore, be considered costs of the extracted minerals under a full absorption costing system and recognized as a component of costs of sales in the same period as the related revenue from the sale of the minerals. 34. View C proponents highlight that the discussion in Statement 3 of ARB 43 states that " under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges rather than as a portion of the inventory cost." View C proponents believe that mining entities should consider this guidance in determining whether stripping costs in a reporting period are so abnormal as to require treatment as a period charge and not a component of the cost of the minerals extracted. 35. View C proponents believe that the same methods should be used for accounting for production costs in the mining industry as are used in other industries where inventories are produced and sold for a profit. As such, production costs for a period should be attributable to the inventory produced during that period. 36. Opponents to View C believe that it is inaccurate to attribute all of the costs to remove waste material for a given period to the mineral inventory extracted for the period, as the removal of the waste material clearly has an element of future benefit. These opponents believe that a portion of the stripping cost in a given period does relate to current production, but in some cases EITF Issue No Issue Summary No. 1, p. 14

15 (depending upon the geological structure of the mine), the majority of the cost to remove the waste may be akin to a development cost as its primary purpose is to allow the entity to access additional probable reserves. These opponents believe that associating all of the stripping costs to production in the current period would not be representationally faithful as it does not capture the true economics of the reserves extracted in the current period (that is, if the mining entity was only concerned with extracting the reserves in the current period, it may choose not to produce the reserves extracted in that period or that stage of the mine may not be economically recoverable). View D: Post-production stripping costs are presumed to be a cost of current production; however, this presumption may be overcome if it can be clearly demonstrated that the stripping cost incurred does not benefit the current period's production but, rather, solely benefits future production of the mine. 37. Proponents of View D believe that most post-production stripping costs relate to the current production, but acknowledge some post-production stripping costs may benefit future periods, not current production. That is, some post-production stripping costs may be akin to stripping costs incurred during the development of a mine. View D proponents believe certain stripping costs must be incurred solely to enable the enterprise to access additional reserves without benefit to current or near-term production. Proponents of View D believe that it is inappropriate to determine the accounting for post-production stripping costs based solely on the phase of the mine. Rather, they believe the nature of the underlying cost and whether it benefits a future period must be considered in determining whether a stripping cost should be capitalized or treated as a current cost of production. 38. Proponents of View D note that it is accepted in practice that stripping costs incurred in the development phase of a mine are capitalized and amortized over the life the mine. That position is accepted because an entity cannot obtain access to the first unit of reserves until the initial layer of waste (overburden) is removed. Therefore, it is clearly understood how the stripping cost incurred in mine development benefits the future production of the mine. In certain mining operations, the removal of the initial layer of overburden (at the surface level) is required to be EITF Issue No Issue Summary No. 1, p. 15

16 completed in stages. In that case, the first phase of waste removal is completed while the mine is in the development phase. However, once the production phase commences, an entity may be required to remove additional surface level overburden (for example widening the access point in the same manner as the overburden removed in the development phase). View D proponents believe that the nature of the stripping costs to remove the overburden in the production phase is no different from the nature of the costs incurred to remove the overburden in the development phase and, therefore, these costs should be evaluated to determine whether they benefit a future period. 39. Proponents of View D acknowledge that it is difficult to discern whether a stripping cost that is incurred during production benefits current production and/or future production. Further, if an entity determines that a stripping cost benefits both the current production and a future period, allocating the cost between the current production and the future period is extremely difficult. Accordingly, View D proponents believe that if any of the stripping cost benefits current production, the entire cost should be allocated to current production. That is, an entity should not allocate a stripping cost to current production and a future benefit. View D proponents believe that the cost allocation prohibition is a practical solution that will improve consistency among mining entities. 40. View D proponents believe that if the Task Force supports View D, criteria should be provided to assist in determining whether the presumption that post-production stripping costs are production costs is overcome. They believe that the presumption should be overcome, and the costs should be capitalized (and treated as a component of the entity's investment in the mine), if the costs are recoverable, in the context of the entity's recoverability of its overall investment in the mine, and also meet all of the following additional criteria: a. The stripping costs increase the productive capacity or extend the productive life of the mine (that is, allows further access to extractable reserves). b. Incurrence of the stripping costs was contemplated as part of the entity's documented plan for production of the mine and it was determined in the planning phase that the stripping costs were necessary to enable access to an additional section(s) of reserves within the mine. EITF Issue No Issue Summary No. 1, p. 16

17 c. Current period production would not have been affected if the stripping costs had not been incurred. 41. Proponents of View D point to the consensus reached by the Task Force in Issue 90-8 as a model for the treatment of stripping costs in the mining industry. In that consensus the Task Force indicated that, in general, environmental contamination treatment costs should be charged to expense. The consensus further provided that those treatment costs may be capitalized if recoverable, provided that specific additional criteria are met. The additional criteria were designed to ensure that the expenditure provided future benefits to the entity and, therefore, was capital in nature. View D proponents believe a similar model may be effective for determining the appropriate accounting for post-production stripping costs. 42. Opponents to View D believe that the theory underpinning View D is sound; however, in practice that approach is difficult to implement given the judgment involved in determining when the nature of the stripping costs overcomes the presumption that the costs are a cost of current production. Furthermore, for the same reasons, these opponents believe a View D approach raises additional concerns around auditability. For those reasons, opponents to View D believe that all post-production stripping costs should be treated in a consistent manner (that is, under an approach like the ones presented in View A, View B, and View C). Other View D opponents believe that the criterion in Item 3 of paragraph 39 is too stringent and, accordingly, believe that this criterion should be changed to permit an acceptable level of production that would not preclude capitalization. Issue 2: If the Task Force reaches a consensus on View D of Issue 1, the appropriate accounting for post-production stripping costs that are determined to be costs of current production. View A (View A under Issue 1): incurred. Post-production stripping costs should be expensed as EITF Issue No Issue Summary No. 1, p. 17

18 View B (View C under Issue 1): Post-production stripping costs are a variable production cost that should be considered a component of mineral inventory cost subject to the provisions of ARB Further discussion of each of these views is put forth above under Issue 1. Transition 44. Current practice on the accounting for post-production stripping costs is diverse. It is apparent that there are a number of entities applying the accounting under variations of the Views put forth above. Given the significant costs associated with performing stripping activities in a mining entity, reaching a consensus on any of the views in this Issue Summary may result in a significant change in accounting for a subset of entities in the mining industry. Accordingly, if a consensus is reached on this Issue, the FASB staff believes that the Task Force should provide a transition alternative to the standard Topic D-1 transition guidance for an EITF consensus. The alternative transition provisions to be considered are as follows: View A: The guidance in this consensus shall be effective for financial statements issued for fiscal years beginning after December 15, 2004, with early adoption permitted. An entity shall recognize the cumulative effect of initially applying this consensus in accordance with the provisions of APB 20. Entities that elect to early adopt the guidance in this consensus during an interim period, shall report the effects of this change in interim financial statements in accordance with the provisions of FAS Proponents of View A believe that the change in financial reporting resulting from a consensus on this Issue will have significant effects on the financial statements of certain entities. Accordingly, these proponents believe that reporting the effect of a significant change in accounting principle is most effectively accomplished through the reporting of a cumulative effect adjustment, with pro-forma disclosures to highlight the effects of retroactive application of the consensus on previously issued financial statements. An effective date of fiscal periods beginning after December 15, 2004, is proposed to allow entities adequate time to prepare for the adoption of the consensus guidance in this Issue. EITF Issue No Issue Summary No. 1, p. 18

19 View B: The guidance in this consensus shall be applied for fiscal periods beginning after December 15, 2004, with earlier application permitted. The effects of applying this guidance shall be reported by retroactive restatement of prior period financial statements in accordance with paragraphs 27 and 28 of APB Proponents of View B agree with proponents of View A and believe that the change in accounting resulting from this consensus will be a significant change in practice for certain mining entities. However, View B proponents believe the advantages of restating prior periods (that is, comparability in financial reporting amongst entities in the mining industry) outweigh the disadvantages, and, therefore, mandatory restatement of prior period financial statements would be the preferable transition alternative. View C: The guidance in this consensus shall be effective for stripping costs incurred in fiscal periods beginning after the date of Board ratification of the consensus. Recognition of a cumulative effect in accordance with the provisions of APB 20 or FAS 3 would not be permitted. Restatement of financial statements previously issued would also not be permitted (standard transition under Topic D-1 for an EITF consensus). 47. Proponents of View C believe that standard Topic D-1 transition is acceptable for a change of this nature. However, they believe that this is a viable transition alternative only if the Task Force reaches a consensus on View B of Issue 1, as a consensus on View A, View C, or View D would have the effect of prolonging the deferral of significant amounts of stripping costs over extended periods (thereby, prolonging the diversity in practice that currently exists). 48. Opponents of View C believe that prospective transition is not an acceptable alternative for a change in practice of this magnitude. Given the significant amount of stripping costs incurred in the mining industry, as well as the long life of operating mines associated with certain minerals, these opponents believe that providing a prospective transition approach will prolong the diversity in practice that currently exists, rather than eliminate it. Given the broad diversity EITF Issue No Issue Summary No. 1, p. 19

20 in practice, these opponents strongly believe that a transition method in line with View A or View B is the only acceptable alternative. EITF Issue No Issue Summary No. 1, p. 20

21 EXHIBIT 04-6A LIFE CYCLE OF A MINE The six common terms used to describe the different phases of the life cycle of a mine are; exploration, evaluation, development, construction, production, and closure. The points at which one phase ends and another begins are important when accounting for the costs of each phase. The phases often overlap, and sometimes several phases occur simultaneously. Accordingly, judgment is required to determine the cut-off points for costs among the various phases based upon an assessment of the geologic and other technical data that is obtained over a period of time as discussed below. Phase 1 Exploration Exploration is the search for resources suitable for commercial exploitation. It includes: Researching and analyzing an area's historic exploration data Conducting topographical, geological, geochemical, and geophysical studies Exploratory drilling, trenching, and sampling. Exploration costs are expensed as incurred. Phase 2 Evaluation Evaluation is defined as the determination of the technical feasibility and commercial viability of a mineral resource. It includes: Determining volume and grade of deposits Examining and testing extraction methods and metallurgical or treatment processes Surveying transportation and infrastructure requirements Conducting market and finance studies. The Evaluation phase will require a feasibility study to identify proved or probable reserves and, subsequently, may lead to the decision to develop the mine. The feasibility study identifies the: Commercial viability of the project Availability of financing Existence of markets or long-term contracts for the product Plan to develop, construct, operate, and close the mine. To summarize, the costs of exploration are incurred for discovering mineral resources, while the costs of evaluation are incurred for proving the technical feasibility and commercial viability of EITF Issue No Issue Summary No. 1, p. 21

22 any resources found. Currently, in accordance with SEC interpretations, evaluation costs are expensed as incurred. Phase 3 Development Development is defined as establishing access to the mineral reserve, and other preparations for commercial production. Costs incurred during the development of the mine are capitalized and subsequently charged to operations through the units-of-production method as the mineral is extracted, processed, and sold. Development costs may include: Sinking shafts and underground drifts (for example, passageways for personnel or equipment) Permanent excavations (for example, underground areas for maintenance, warehousing, or fueling) Roads and tunnels Additional drilling to further define the ore body Advance removal of overburden (top soil and waste material removed prior to initial mining of the ore body) and waste material (non-economic material that is intermingled with the ore body). The development phase is reached when, under all the known facts and circumstances, it is determined that some portion of the mineral deposit can be mined and processed economically. At that point, the company declares that proven and probable reserves have been identified based upon the evaluation of technical data, including a feasibility study. The cut-off between evaluation and development is often a critical accounting issue, and the decision to develop the mine is based on the information obtained upon the completion of the feasibility study. The primary costs of the evaluation stage relate to planning and feasibility studies, while development costs relate to gaining access to the mineral reserves after the decision has been made to develop the mine. Once a company has decided to proceed with a mine, costs are capitalized as development costs. Capitalization of those costs will occur only for drilling in areas that are presently in a reserve or resource area. Once capitalized, those costs are amortized when the project commences production. Step-out-drilling outside of a reserve or resource area is generally expensed as incurred. Stripping costs (to remove overburden and waste material) incurred prior to the production phase of an open pit mine are capitalized. Stripping costs are defined as pre-production stripping or development costs. Stripping costs can also be incurred after the mine is in production and are referred to as postproduction stripping costs. In those cases, development continues through the removal of overburden and waste material in portions of the mine to reach deeper ore that will be extracted in later periods. Accounting for those subsequent stripping costs varies among companies. Since those extraction costs can benefit both current and future periods, mining companies can EITF Issue No Issue Summary No. 1, p. 22

23 allocate a portion of those costs to current operations and defer the remaining costs as a "deferred stripping asset" for recognition in future periods when the deeper ore is extracted, processed, and sold. In summary, stripping costs are incurred during two phases of a mine's life and can be categorized as follows: the pre-production stripping costs that benefit future periods and the postproduction stripping costs that benefit both current and future periods. Underground development costs may also be incurred in a mine after production has begun. For example, the extensions of underground shafts or haulage ways after production has commenced benefit both current and future production. Further, costs may be incurred to develop additional points of access to the ore body at various levels below the ground. Those points of access are developed from the shaft system. Additional infrastructure may be required to establish a new shaft as well as hoisting capacity and other support systems. Phase 4 Construction Construction is defined as establishing and commissioning facilities to extract, treat, and transport production from the mineral reserve. Those facilities include infrastructure, buildings, machinery, and equipment. Development and construction costs differ in the following ways: Development involves access costs such as shaft sinking and removing overburden and waste material in advance of production Construction involves tangible assets such as housing, buildings, machinery, and plant and equipment. Tangible assets have a measurable life and start to depreciate as soon as they are used. Some consider that the distinction between development and construction costs is not important, because all expenditures will eventually be expensed over the life of the mine. This view does not consider that the period for amortizing development costs may differ from the period for construction expenditure, because some construction assets have a shorter or longer life than that of the mine. Accordingly, these assets will be depreciated or amortized over their useful lives using different depreciation methods. Phase 5 Production Production is defined as the day-to-day activities of obtaining a saleable product from the mineral reserve. It includes extraction and any processing before sale. Some of those processes include blasting, loading, hauling, conveying, crushing, grinding, floatation, leaching, heap leach, milling, smelting, refining, and electrowinning. In general, a mining company ceases the mine development phase of a mine and commences the production phase when the development has been completed and the mining operations have EITF Issue No Issue Summary No. 1, p. 23

24 commenced for the sale of the mineral, irrespective of the level of production at the mine. Furthermore, development often continues after production has begun. For example: Drilling in a reserve or resource area during the operation phase will be capitalized if the purpose is to increase the reserve rather than to plan production. (See discussion under the Development section.) Stripping costs where removal of overburden and waste material benefit future production, can be capitalized. (See discussion under the Development section.) Phase 6 Closure Closure occurs after mining operations have ceased and includes restoration of the site. A mine's operational life is considered to end either when the ore body is depleted or when the mine is closed for other reasons and the normal ore feed to the plant stops or production ceases. Closure costs may be incurred prior to the end of mining operations as portions of the operating site are restored. EITF Issue No Issue Summary No. 1, p. 24

25 EXHIBIT 04-6B CROSS SECTION OF A MINE AND CALCULATION OF A DEFERRED STRIPPING COST RATIO Waste/Ore Stripping Ratio Year 1 - Initial stripping-all waste material (capitalized) Year 2 6:1 Stripping ratio is high as waste material is removed to reach lower portions of the ore body Year 3 3:1 Stripping ratio is slightly lower as the ore body is being accessed Year 4 2:1 Stripping ratio is low as most waste was removed in prior phases Life-of-Mine 3:1 EITF Issue No Issue Summary No. 1, p. 25