14 th Americas School of Mines. Basics of Mining Accounting Marcus Cardoso Vânia Pereira

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1 Basics of Mining Accounting Marcus Cardoso Vânia Pereira

2 Agenda Key accounting principles and issues for a mining company GAAP differences Non-GAAP measures

3 1. Exploration and Evaluation Accounting policy (expense v. capitalize) Cut off between phases 2. Development Stages of ore reserves and resources Joint Ventures Capitalization of costs 3. Production PP&E, depreciation and deferred stripping Inventory and production Functional currency 4. Closure and Reclamation Page 3

4 Exploration and Evaluation Exploration (search for) and evaluation of mineral resources suitable for commercial exploitation include the following activities: Exploratory drilling, trenching and sampling Determining ore grade and volume of deposit Feasibility study preparation Key accounting principle determination: expense x capitalize? Slide 4

5 Exploration and Evaluation US GAAP prohibits capitalization of exploration and evaluation costs until bankable feasibility study completed and permits are in place IFRS: IFRS 6 provides option on conversion to avoid IASB framework and capitalize E&E asset depending on prior accounting policy Slide 5

6 Exploration and Evaluation Financial Statements in the exploration stage: Costs incurred on E&E Stock option costs G&A Issues to consider: Impairment triggering events and implication Rights to explore have or about to expire No further expenditures planned Not deemed commercially viable Going concern disclosure considerations Slide 6

7 Exploration and Evaluation Cut-off between E&E and development key: Technical feasibility and commercial viability Usually on completion of Bankable Feasibility Study Decision to develop made by the board of directors Treatment of costs: Transfer of E&E asset costs into development asset US GAAP: expensed so n/a IFRS: intangible / tangible split Slide 7

8 Development Reserves Stages of ore reserves and resources: Resources are identified mineral occurrences with reasonable prospects for eventual economic extraction Reserves are the part of a resource that, based upon appropriate assessments, demonstrate that economic extraction could reasonably be justified Categorized by degree of certainty with which quantities can be estimated: Inferred Measured and Indicated Probable Proven (developed or undeveloped) Slide 8

9 Development Reserves Ore Reserves the fisherman s view : Inferred Measured and indicated Probable Probable undeveloped Probable developed There is lake in the distance You saw something disturb the surface of the lake it looked like a fish There are fish in the lake you have had some bites, have seen them jumping and heard of others catching them, but have not caught any yet The fish is on the hook and you can see it but it is still in the water, where they always look bigger The fish is in the boat you have eighed it and will keep it for dinner. Slide 9

10 Development Reserves Difference in reserve standards: US GAAP: SEC Industry Guide 7 only allows proven and probable reserves to be disclosed (unless required by foreign law e.g ) IFRS currently no global standard Implication: reserves form the basis for depletion and amortization calculations Based on most current information change in estimate (prospective), usually annually for producing mines Slide 10

11 Development JV s Joint Ventures are common in the mining industry due to: The high capital requirements associated with new projects Increasing number of projects in high-risk developing countries Companies looking for a strategic investment Contractual arrangements whereby two or more parties undertake an economic activity which is subject to joint control Joint Control contractually agreed sharing of the continuing power to determine the entities strategic operating, financing and investing activities (regardless of ownership interest) Slide 11

12 Development JV s Joint Ventures usually fall into one of two groups Jointly control entities Jointly controlled assets / operations Jointly controlled assets / operations provide for an undivided interest in a percentage of all balances, including production US GAAP proportionate accounting by each party (allowed for extractive industries under ASC /EITF 00-01) IFRS Proportionate accounting Slide 12

13 Development JV s Jointly controlled entities involve the establishment of a legal entity which can enter contractual arrangements in its own right US GAAP equity accounting by each party IFRS at present choice under review But Slide 13

14 Development JV s US (ASC )FIN 46, such joint venture relationships must be evaluated under the Variable Interest Entity (VIE) rules first to determine if the joint venture is a variable interest entity, and whether one investor, or another enterprise with variable interest in the entity, is the primary beneficiary and may be required to consolidate the joint venture Slide 14

15 Development JV s Accounting considerations: Accounting policies JV financial information should be adjusted to conform to the policies of the venturer which is incorporating the information in their own accounts JV financial statements should be adjusted to eliminate any material balances existing between JV and investor JV year end needs to be within 3 months of venturer s, but still need to consider material events in intervening period Slide 15

16 Development Cost Capitalization Cost capitalization Purchase price of the area of interest and construction costs (inc. community infrastructure costs, roads) Costs to bring the asset to location and condition for intended use (e.g. removal of overburden, shaft sinking) Borrowing / interest costs (ASC /FAS 34, IAS 23) Present value of initial estimate of future costs of dismantling and removing and restoring the site Allocation of directly attributable costs (inc. salaries and stock options) Amortization of assets used in development of mine Slide 16

17 Development Start up Costs Current GAAP (ASC ) (FAS 7 -SOP 98-5) Pre-operating costs should be expensed as incurred Other costs should be assessed for capitalization or expense depending on the nature (i.e. PP&E purchase) Expense once start production (US model) Amortize when ready for productive use 2011 model under IFRS? Slide 17

18 Production Moving from development to production: Impact: cease capitalizing, expense operations Assets must be ready for productive use Historically mining industry accepted that this is when commercial production levels are achieved Nominated percentage of designed capacity for the mill Continuous production or output Consideration of geological footprint as to when ready Slide 18

19 Production Production PP&E Stripping is the removal of overburden or waste to access mineralized material. Capitalize prior to production. Deferred stripping in the production phase: US GAAP: (ASC ) EITF Expense costs IFRS: IASB framework for definition of an asset use of strip ratio to defer costs (effect of smoothing) permitted Slide 19

20 Production - Production PP&E PP&E is depreciated over its useful economic life Each part of an item of PP&E with a cost that is significant to the total cost of the item shall be depreciated separately (IAS 16). Period over which it is expected to be used; or Units of production expected to be obtained from or processed by the asset Stop depreciating when Asset held for sale / Discontinuing Operation Asset is derecognized (end of LOM a moving target) Slide 20

21 Production Production PP&E What should be taken into account when calculating depreciation charges? Proven and probable; or Resources not yet designated as reserves (and future costs to develop resources) (not allowed in US GAAP) Mixed practices in the mining industry Factors to consider : Track record in converting resources into reserves Time frame for carrying out the work to convert resources Further development expenditure would be needed to access the resource Slide 21

22 Production PP&E Impairment Not an annual test, but based on triggering events: Changes to commodity prices, political and regulatory circumstances Increased production costs including ARO estimate Decrease in reserves US GAAP: FAS144 (ASC ) An impairment loss should be recognized if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value IFRS: IAS 36 An asset is impaired if its carrying amount is greater than its recoverable amount which is the higher of the value-in-use and fair value less costs to sell Slide 22

23 Production PP&E Impairment US GAAP 2 step test IFRS 1 step test Gross cash flows over the LOM v. carrying value of the mines assets If less, step 2 requires determining fair value of the mining property (discounted cash flow model) Value-in-use: based only on existing factors Mining context fair value more appropriate Implication more frequent impairments as go to FV straight away but reversals of impairments required Slide 23

24 Production Inventory and Production Components of inventory Stockpiles Leach pad material Concentrate and in-circuit Processed metals Supplies Inventory costs Labor (standard and contract) Consumable material (fuel, reagents, and chemicals) Overhead elements directly and indirectly attributable to production based on normal capacity Slide 24

25 Production Inventory and Production Stockpiles measurement based on quantities and perpetual inventory systems. Grade determined through assays. Highly inaccurate science Long term stock piles generally lower grade to be processed later IAS 2 requires that inventory be valued at the lower of cost and net realizable value If inventory costs plus costs to complete will not be recovered by sales proceeds, inventories should be written down to net realizable value Fair value write downs may be reversed if NRV recovers Slide 25

26 Production Inventory and Production Supplied include materials utilized in production process Reagents and chemicals, grinding balls, safety supplies, other consumables Capital spares and insurance spares commencing 2008 included in PP&E (IAS 16) Expense costs of routine maintenance and repairs Major cyclical maintenance projects treatment? Perpetual method of inventory with cycle counts performed on a regular basis (most common method utilized) Usually accounted for using the average cost method easiest to apply Slide 26

27 Production Inventory and Production Joint/Co-product v By-product accounting Joint Products: metals or minerals within an ore body which each have significant relative sales values record their own costs, and revenues separately By-products: metals or minerals within an ore body which have minor sales values revenue included as net expense in P&L Slide 27

28 Production Functional Currency US: FAS 52 (ASC ) Self sustaining v. Integrated operations Impact on recording of foreign transactions in P&L v CTA In determining classification of foreign operation: Sales price for minerals Labor, material and other costs Financing currency Day-to-day relationship and intercompany transactions significant Change in functional currency done prospectively Slide 28

29 Production Functional Currency IFRS 21: Concept of influences on primary and secondary indicators Presentation currency An entity may elect to present its financial statements in a currency which differs from its functional currency Slide 29

30 Closure and Reclamation Asset Retirement Obligations (FAS 143/ASC ): Unavoidable existing legal obligations associated with retiring the mine / reclaiming the land Not obligations that result from on-going, or improper, operation of an asset, e.g., clean-up / remediation Examples of closure activities: removal of infrastructure, pit in-fill, tailings pond, on-going water treatment Referred to as: Reclamation, Environmental Remediation, Decommissioning, Restoration, Rehabilitation Slide 30

31 Closure and Reclamation Measured at fair value The present value of the expected future cash flows based on closure activities performed by a third party Requires recognition for a closure obligation when an obligation is incurred Assumptions required to determine measurement Timing of future cash flows Real Discount rate (credit-adjusted risk-free rate) Third party costs Accounting on day 1 to set up asset and liability at fair value; thereafter amortize the asset in PP&E, and accrete up the liability to the amount of cash to pay on final closure Slide 31

32 Closure and Reclamation Need to consider: changes in estimates, timing and assumptions significant area of estimates Recognize as an increase or decrease in a) carrying amount of the ARO and b) the related asset retirement cost capitalized as part of the carrying amount of the related long-lived asset Slide 32

33 Closure and Reclamation IAS 37 Present obligation both legal or constructive Use management best estimate Use current discount rate each balance sheet date Accretion as interest expense not operating cost Slide 33

34 Non-GAAP measures Not in the financial statements but the MD&A Main measure is cash costs per unit of production Provides information on the efficiency of the mine Used by investors to make decisions but outside the scope of our opinion Benchmarking Comparability of information across the industry No fixed standard of what has to be included although the Gold Standard has a voluntary standard Slide 34

35 Questions? Accounting Basics in Mining Slide 35

CONDENSED INTERIM FINANCIAL STATEMENTS. For the Three Months Ended February 28, (unaudited)

CONDENSED INTERIM FINANCIAL STATEMENTS For the Three Months Ended February 28, 2013 Notice of No Auditor Review of Condensed Interim Financial Statements For the three months ended February 28, 2013 The