Viewpoints: Applying IFRSs in the Mining Industry

Transcription

1 Viewpoints: Applying IFRSs in the Mining Industry a series published by the mining industry task force on ifrss Compliments of: David Danziger, CPA, CA MNP LLP international financial Reporting standards mining industry

2 Copyright 2014 Chartered Professional Accountants of Canada and Prospectors and Developers Association of Canada. All rights reserved. This publication is protected by copyright and written permission is required to reproduce, store in a retrieval system or transmit in any form or by any means (electronic, mechanical, photocopying, recording, or otherwise). For information regarding permission, please contact permissions@cpacanada.ca

3 Table of Contents The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors and Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to mining companies. Capitalization of borrowing costs (February 2014) Accounting for share purchase warrants issued (February 2014) Recognition of Corporate Social Responsibility provisions under IAS 37 (July 2013) Redevelopment costs of an inactive mine by an existing owner (May 2013) Impairment of exploration and evaluation assets (April 2013) Asset acquisition versus business combination (October 2012) Depletion of a mine in the production phase: useful life of the mine (August 2011) Commencement of commercial production (July 2011) Flow-through shares (May 2011) Exploration and evaluation expenditures (May 2011) Farm-out arrangements in the exploration and evaluation phase (May 2011) Functional currency (April 2011) Background on different phases of activities in a mining entity (May 2011) Available for free download and PDAC.ca/public-affairs/ifrs

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5 MInInG InduSTRy TASk FoRCe on IFRSS Letter from the Chair March 14, 2014 Dear Colleagues, The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors and Developers Association of Canada (PDAC) have created the Mining Industry Task Force on IFRSs ( Task Force ) to share views on International Financial Reporting Standards (IFRSs) application issues of relevance to mining companies. IFRSs create unique challenges for mining companies. Financial reporting in the sector is atypical due to significant differences in characteristics between mining companies and other types of companies. To address these challenges, the Task Force meets regularly to discuss and share views on IFRS application issues. The Task Force views are provided in a series of papers entitled Viewpoints: Appling IFRS in the Mining Industry that are available for free download on the CPA Canada and PDAC websites. These views are of particular interest to Chief Financial Officers, Controllers and Auditors. All our current Viewpoints published as of March 2014 are included in this publication. I hope you find them useful! To learn more about the Task Force visit the CPA Canada website at If you have any comments or suggestions for future Viewpoints, please feel free to contact myself or Alex Fisher, Principal, at CPA Canada at afisher@cpacanada.ca. Best regards, Ron Gagel, CPA, CA Chair, Mining Industry Task Force on IFRSs Board of Directors, Prospectors & Developers Association of Canada

6 JANUARY 2014 CAPITALIZATION OF BORROWING COSTS VIEWPOINTS: Applying IFRSs in the Mining Industry BACKGROUND Mining companies may need to borrow substantial amounts of external debt to fund either their exploration or development activities. Subsequent to the commencement of commercial production, mining companies may continue to incur borrowing costs and capital expenditures related to assets that take a substantial period of time to get ready for their intended use, such as the further development or extension of ore bodies. Borrowing costs are interest and other costs that a company incurs in connection with borrowing funds. Borrowing costs may include interest expense calculated using the effective interest method, finance charges in respect of finance leases, and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. IAS 23 Borrowing Costs provides specific guidance on the accounting for borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset. ISSUE What factors should a mining company consider in determining whether borrowing costs should be capitalized? VIEWPOINTS Under IAS 23, a mining company capitalizes borrowing costs when it first meets all of the following conditions: it incurs expenditures which relate to a qualifying asset; it incurs borrowing costs; and it undertakes activities that are necessary to prepare the asset for its intended use or sale. The activities necessary to prepare an asset for its intended use encompass more than the physical construction of the asset. Mining Industry Task Force on IFRSs International Financial Reporting Standards (IFRSs) create unique challenges for mineral resource companies. Financial reporting in the sector is atypical due to significant differences in characteristics between mineral resource companies and other types of companies. The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors & Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to mineral resource companies. The task force views are provided in a series of papers that are available through free download. These views are of particular interest to Chief Financial Officers, Controllers and Auditors. The views expressed in this series are non-authoritative and have not been formally endorsed by CPA Canada, PDAC or the organizations represented by the task force members.

7 CAPITALIZATION OF BORROWING COSTS Activities may include technical and administrative work prior to the commencement of physical construction, such as those associated with obtaining permits. In determining an appropriate way to account for borrowing costs, some factors to consider include, but are not limited to: Definition of a qualifying asset Assessment of probable future economic benefit Consistency between accounting policy decisions Costs not eligible for capitalization Suspension and cessation of capitalization. Definition of a qualifying asset Care should be taken to determine what constitutes a qualifying asset. A qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale. IAS 23 does not provide guidance on what constitutes a substantial period of time. Company specific facts and circumstances must be considered in making this determination. Qualifying assets may include inventories, processing plants, power facilities, intangible assets and mining projects that are in the exploration and evaluation, development or construction stages. Certain items will not meet the definition of a qualifying asset if they are already available for use in the condition purchased or if they do not take a substantial period of time to get ready for use. For example, the acquisition of equipment that is available to be used immediately in the mining process would not be considered eligible for interest capitalization. In some views, an exploration license would not meet the definition of a qualifying asset as it is available for use in the condition in which it is purchased and does not take a substantial period of time to get ready for use. Financial assets are not considered qualifying assets. As a result of the adoption of IFRS 11 Joint Arrangements, some mining companies may have an increased number of equity accounted investments. An equity accounted investment is specifically not considered a qualifying asset under IAS 23, even if it is undergoing development activities. In contrast, when a company recognizes its share of the assets and liabilities of a joint operation under IFRS 11, capitalization of related borrowing costs is required to the extent that any of those assets are qualifying assets, provided the other requirements of IAS 23 are met. Assessment of probable future economic benefit IAS 23 requires capitalization of borrowing costs as part of the cost of qualifying assets. Such borrowing costs are capitalized as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably. However, it is unclear how the requirements in IAS 23 regarding probable future economic benefit interact with the guidance in IFRS 6, Exploration for and Evaluation of Mineral Resources. For example, if a company incurs borrowing costs in the E&E phase that do not meet the probability criteria under IAS 23, differing views exist on how to account for such costs. View 1: Account for borrowing costs under IFRS 6 In some views, E&E expenditures may include borrowing costs, if such borrowing costs are incurred by the company in connection with its E&E activities. Under IFRS 6, a company determines an accounting policy specifying which expenditures are recognized as exploration and evaluation assets and applies such policy JANUARY

8 CAPITALIZATION OF BORROWING COSTS consistently. In making this determination, the company would need to consider the degree to which the expenditure can be associated with finding specific mineral resources. 1 View 2: Account for borrowing costs under IAS 23 In others views, E&E expenditures do not include borrowing costs. Accordingly, these costs are accounted for under IAS 23. Under IAS 23, it must be considered whether the capitalization of borrowing costs would meet the criteria that probable future economic benefits be expected to flow to the mining company. From this perspective, if in the E&E phase a company incurs borrowing costs that do not meet the probability criteria under IAS 23, such costs are expensed as incurred. Consistency between accounting policy decisions E&E Expenditures IFRS 6 requires a company to develop an accounting policy specifying which type of expenditures are recognized as exploration and evaluation (E&E) assets and to apply the policy consistently. Such an accounting policy considers the degree to which expenditures can be associated with finding specific mineral resources. As discussed above, in some views, E&E expenditures may include borrowing costs, if such borrowing costs are incurred by the company in connection with its E&E activities. Judgment should be exercised to ensure that the accounting for borrowing costs is logical given the mining company s policy with respect to other E&E expenditures. For example, it may appear inconsistent if a mining company adopts an accounting policy which expenses incurred E&E expenditures yet capitalizes borrowing costs (incurred on those expenditures). From this perspective, if a company has a policy to expense E&E expenditures as incurred, capitalizing borrowing costs on those E&E expenditures may not be appropriate. However, if a mining company recognizes E&E assets acquired through a business combination, while having an accounting policy of expensing all incurred E&E costs, capitalizing borrowing costs on the acquired E&E costs would not be inconsistent. Non-E&E Expenditures Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset, outside of the E&E phase, must be capitalized. Costs not eligible for capitalization IAS 23 does not deal with the actual or imputed cost of equity including preferred capital not classified as a liability. These costs are therefore excluded from borrowing costs. In addition, notional borrowing costs cannot be capitalized. Costs common to mining companies such as those in respect to the unwinding of a discount rate (i.e., accretion) related to environmental restoration and closure provisions cannot be capitalized as a borrowing cost under IAS Suspension and cessation of capitalization 3 A company should suspend capitalization of borrowing costs during extended periods in which it suspends active development of a qualifying asset. IAS 23 does not provide guidance on what length of time is considered an extended period, and therefore judgment is required in making this determination. Cessation of borrowing cost capitalization occurs when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete. JANUARY

9 CAPITALIZATION OF BORROWING COSTS In the mining industry, however, it is common for the development of a mine site or a mining area to be completed in phases. This would mean that as each phase of mining activity is completed, the company removes the cumulative cost of such phase from its qualifying asset value and continues capitalizing borrowing costs for items remaining in the development phases which still meet the definition of a qualifying asset. Capitalization of borrowing costs to each phase would be over that phase s development period. As such, it is possible to have a mine in commercial production but continue to have qualifying assets which are eligible for the capitalization of borrowing costs as these assets have not been advanced to the stage where they are ready for their intended use. Accounting for borrowing costs can be complex and requires the exercise of significant judgment in arriving at an appropriate conclusion. Mining companies should consider consulting their accounting advisors and their auditors when undertaking such analysis. (Endnotes) 1. From this view, the requirements of IAS 23 do not override the exception in IFRS 6 that allows a company a choice of either expensing or capitalizing each type of E&E expenditure; this is because IFRS 6 defines E&E expenditure as expenditure incurred in connection with E&E activities, which in some views is broad enough to cover the related financing of such activities. Accordingly, from this perspective, a company may choose to either expense or capitalize borrowing costs related to E&E assets. 2. Refer to paragraph 8 of IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities. 3. Refer to paragraphs of IAS 23 for additional guidance. JANUARY

10 CAPITALIZATION OF BORROWING COSTS The Mining Industry Task Force on IFRSs Members Ronald P. Gagel, CPA, CA (Chair) Prospectors and Developers Association of Canada Susan Bennett, CPA, CA Deloitte & Touche LLP Sean Cable, CPA, CA PricewaterhouseCoopers LLP John S. Cochrane, CPA, CA Raymond Chabot Grant Thornton LLP Montreal, Quebec Craig Cross BDO Canada LLP David Danziger, CPA, CA MNP LLP Etobicoke, Ontario Blake Langill, CPA, CA Ernst & Young LLP Michael Lepore, CPA, CA Barrick Gold Corporation Ken McKay, CPA, CA KPMG LLP Keith McKay, CPA, CA Dalradian Resources Inc. Staff Alex Fisher, CPA, CA CPA Canada Chris Hicks, CPA, CA CPA Canada Comments on this Viewpoint, or suggestions for future Viewpoints should be sent to: Alex Fisher, CPA, CA Principal, International Financial Reporting Standards Research, Guidance and Support Chartered Professional Accountants of Canada 277 Wellington St. West M5V 3H2 For more information on IFRSs visit: JANUARY

11 FEBRUARY 2014 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED VIEWPOINTS: Applying IFRSs in the Mining Industry BACKGROUND A common feature of certain transactions entered into by mining entities, in particular exploration stage companies, is the issuance of units which comprise share capital ( shares ) and share purchase warrants ( warrants ) as elements of consideration for the transaction. For example, a mining company (the issuer) may enter into a financing arrangement requiring the issuance of warrants to investors (the holder(s)) as part of the transaction, making the financing arrangement more attractive to the investors. At the same time, warrants may also be issued to brokers or underwriters as consideration for services provided. It is also common for warrants to be issued in connection with other transactions, comprising part of the consideration for specified services, such as investor relations work. In general terms, a warrant is an instrument that entitles the holder to buy an underlying security (e.g., share) of the issuing company at an exercise price within a certain time frame. ISSUE How should a mining company (the issuer) account for share purchase warrants issued, both at the time of issuance and subsequently? VIEWPOINTS To determine the appropriate accounting for warrants by an issuer, it is critical to obtain a complete understanding of the nature of the transaction giving rise to the issuance as well as the specific terms and conditions of the warrants. The nature of the transaction will determine whether the warrants issued are accounted for in accordance with: IFRS 2 Share-based Payment Warrants issued in exchange for goods or services provided to the mining company are Mining Industry Task Force on IFRSs International Financial Reporting Standards (IFRSs) create unique challenges for mineral resource companies. Financial reporting in the sector is atypical due to significant differences in characteristics between mineral resource companies and other types of companies. The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors & Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to mineral resource companies. The task force views are provided in a series of papers that are available through free download. These views are of particular interest to Chief Financial Officers, Controllers and Auditors. The views expressed in this series are non-authoritative and have not been formally endorsed by CPA Canada, PDAC or the organizations represented by the task force members.

12 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED generally within the scope of IFRS 2. IFRS 2 applies to share-based payment transactions with some exceptions. 1 IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement Warrants not issued in exchange for goods or services are generally within the scope of IAS 32/IAS 39. The accounting guidance for instruments within each of these standards is different. For example, if the warrants are accounted for in accordance with: IFRS 2, a company determines if the warrants are i) an equity-settled award, or ii) a cash-settled award. 2 Following this determination, the company applies the specific recognition and measurement guidance in IFRS 2. IAS 32, a company determines if the warrants are i) equity, or ii) a financial liability. Following this determination, the company applies the specific measurement guidance in IFRS applicable to each classification. Determining the nature of the transaction is especially important in situations where warrants, with the same terms and conditions, are issued concurrently to different parties. For example, in a public or private financing arrangement, identical warrants may be issued concurrently to investors as part of the financing transaction, as well as to brokers and underwriters (i.e., commonly referred to as broker warrants ) as compensation for their services provided. WARRANTS FOR SERVICES PROVIDED Mining companies commonly issue warrants to external service providers such as brokers, underwriters or investor relation agencies. Generally, such warrants are accounted for in accordance with IFRS 2 as they are issued for services provided to the mining company and typically would not meet the scope exemptions in IFRS 2. 3 Under IFRS 2, transactions in which external services are received as consideration for equity instruments of the company should be measured at the fair value of the goods or services received. Only if the fair value of the services cannot be measured reliably would the fair value of the equity instruments granted be used. Illustrative Example: Warrants Issued for Services Mine X Co. engages a broker to provide services relating to a public offering of units in Mine X Co. Each unit comprises one common share and one warrant entitling the holder to purchase one common share at a fixed price by a future date. The warrants are required to be settled by the delivery of a fixed number of equity shares for a fixed price. No cash or net settlement options exist. As compensation for the broker s services, Mine X Co. issues warrants to the broker. The fair value of the broker s services provided is $100,000. This transaction with the broker is considered an equity-settled share-based payment transaction because Mine X Co. receives services as consideration for its own equity instruments. These warrants are considered equity-settled instruments and are accounted for under IFRS 2. FEBRUARY

13 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED Illustrative Example: Warrants Issued for Services Continued... The following journal entries are recorded by Mine X Co. (excluding tax consequences, if any): Initial recognition & measurement Dr. Equity (Share Issuance Cost) $100,000 Cr. Equity (Warrant Reserve or Contributed Surplus) $100,000 This transaction with brokers is in relation to a share issuance. As a result, the services provided relate to share issuance and share issuance expenses are included within equity. Subsequent measurement Under IFRS 2, equity-settled instruments are not subsequently re-measured (i.e., subsequent changes in fair value are not recognized). Note: If warrants are accounted for in accordance with IFRS 2 Share-based Payment, the company determines if the warrants are i) an equity-settled award, or ii) a cash-settled award. As such, classification guidance under IAS 32 is not relevant (see below for further discussion). WARRANTS WITHOUT SERVICES PROVIDED As part of a financing arrangement, Canadian mining companies commonly issue shares and warrants together as units to lenders or investors (e.g., in a public or private equity placement or as part of a convertible debenture financing arrangement). Warrants not issued in exchange for goods or services are generally within the scope of IAS 32 and IAS 39. To determine the appropriate accounting under IAS 32, a mining company must carefully review the terms and conditions of the warrants to understand whether the warrants have characteristics of: a derivative financial liability ( financial liability ) that is measured at fair value, with changes in value recorded in profit or loss; or an equity instrument. Although warrants are often settled by the issuance of equity shares, the warrants themselves may not necessarily be classified as an equity instrument. Under IAS 32, equity classification applies to instruments where a fixed amount of cash (or liability), denominated in the issuer s functional currency, is exchanged for a fixed number of shares (often referred to as the fixed for fixed criteria). Warrants issued by mining entities that fail to meet equity classification often contain terms that breach the fixed for fixed criteria in IAS 32. The classification process is complex. However, some of the common features of warrants observed in Canada that may result in financial liability classification include, but are not limited to: Feature warrants with an exercise price based on the issuer s market share price at the date of exercise warrants where the number of shares to be issued on exercise varies warrants with an exercise price that is in a currency that is different from the functional currency of the issuer Example Company A (the issuer) issues warrants with an exercise price dependent on Company A s market share price at the date of exercise. Company B issues warrants where the number of shares to be issued is based on the lowest five-day Volume Weighted Average Price in the last 30 days prior to exercise. Company C (the issuer) has a U.S. dollar 4 functional currency and issues warrants that have an exercise price denominated in Canadian dollars. FEBRUARY

14 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED The above list is not exhaustive. Other terms and conditions of warrants may exist, that may also result in financial liability classification. The analysis is very complex and involves professional judgment. The classification of a warrant as an equity instrument or a financial liability can significantly affect a company s financial statements. For example, if a warrant is classified as a financial liability, it is subsequently measured at fair value with changes in value recorded in profit or loss, resulting in potential volatility within the financial statements (e.g., equity and profit or loss). Consideration received on the sale of a share and share purchase warrant classified as equity is allocated, within equity, to their respective equity accounts on a reasonable basis. Two commonly accepted allocation approaches are the residual method and the relative fair value method. 5 The allocation of consideration received on the sale of a unit comprising a common share and a share purchase warrant with the share purchase warrant classified as a financial liability can be more complicated. Please refer to the IFRS Discussion Group website for further discussion on this topic and page 7 for a listing of some other relevant IFRS Discussion Group topics. Illustrative Example: Warrants Classified as Equity To finance exploration activities, ABC Ltd. (the issuer), entered into a $1,000,000 private placement of units. Each unit comprises one common share and one share purchase warrant in ABC Ltd. Each share purchase warrant has a fixed exercise price denominated in Canadian dollars and is convertible into a fixed number of shares. ABC Ltd. has a Canadian dollar functional currency. The fair value for the shares at the date of issue is $800,000. The share purchase warrants are classified as equity instruments because a fixed amount of cash is exchanged for a fixed amount of equity. In this example, no other features exist that would result in financial liability classification. Applying a residual approach, the following journal entries are recorded by ABC Ltd. (excluding tax consequences, if any): Initial recognition & measurement Dr. Cash $1,000,000 Cr. Equity (Warrant Reserve or Contributed Surplus) $200,000 Cr. Equity (Share Capital) $800,000 Subsequent measurement Warrants classified as equity instruments are not subsequently re-measured (i.e., subsequent changes in fair value are not recognized). FEBRUARY

15 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED Illustrative Example: Warrants Classified as Financial Liabilities To finance exploration activities, XYZ Ltd. entered into a $1,000,000 private placement of units. Each unit is comprised of one common share and one share purchase warrant in XYZ Ltd. Each share purchase warrant has a fixed exercise price denominated in U.S. dollars and is convertible into a fixed number of shares. XYZ Ltd. has a Canadian dollar functional currency. At the date of issue, the share purchase warrants have a fair value of $400,000 Canadian dollars. The share purchase warrants are classified as a financial liability. Although the conversion amount in foreign currency may be fixed, when converted back to XYZ Ltd. s Canadian functional currency, it results in a variable amount of Canadian dollar denominated cash (that is, a variable carrying amount for the financial liability that arises from changes in exchange rates), and hence the instrument fails the fixed for fixed criteria for equity classification. The following journal entries are recorded by XYZ Ltd. (excluding tax consequences, if any): Initial recognition & measurement: Dr. Cash $1,000,000 Cr. Financial Liability $400,000 Cr. Equity (Share Capital) $600,000 Subsequent measurement (assuming an increase in value of warrants) Dr. Expense - Fair Value Movement $XXX Cr. Financial Liability $XXX MEASUREMENT OF WARRANTS The measurement or valuation of a warrant, which is analogous to a call option issued by a company, is frequently calculated using an option pricing model. A commonly used model is the Black-Scholes model. Mining companies, however, should exercise caution in automatically assuming that the Black-Scholes model is always appropriate and is the only valuation method that can be applied. For example, where a breach of the fixed for fixed requirement exists (as discussed above) and the warrants are classified as a financial liability, the use of different valuation models, possibly more complex in nature, may be appropriate. A common issue highlighted by users of the Black-Scholes model relates to the model s underlying assumption that warrants can only be exercised at expiration, which may not always be the case with certain warrants. In addition, a key input into the Black-Scholes model is the implied volatility of the company s shares. For some junior mining companies, basing the expected volatility on actual historical volatility may result in an unexpected (e.g., high) valuation. For example, some junior mining entities may have low trading volumes. These companies may be more susceptible to a wide range of trading prices which in turn may create a high historical volatility number, contributing to a high warrant valuation (assuming all other factors remain constant). Another valuation issue occurs when the valuation of the total unit, or in some cases simply the warrants, is greater than the transaction value. In these situations entities need to consider the restrictions on the recognition of day one gains or losses set out in IAS 39 and IFRS 13 Fair Value Measurement. 6 MODIFICATION OF WARRANTS Subsequent to the initial recognition of warrants, there may be instances where the original terms of the warrants are amended prior to, or near, maturity. For example, the amendment may take the form of an extension of the expiry date, a change in the exercise price or a combination of both. 7 FEBRUARY

16 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED The accounting for a subsequent modification of the terms of the warrants depends on the initial classification of the warrants. Assuming there is no evidence of any services being received on the subsequent re-pricing of the warrants the following accounting guidance should be applied: Initial Classification of Warrants IFRS 2 Within the scope of IFRS 2 IAS 32 and IAS 39 Within the scope of IAS 32 and IAS 39 Equity Settled Liability Settled Equity Presentation Liability Presentation Guidance Apply IFRS 2 guidance on modifications to equity settled share-based payment arrangements. Recognize an expense for any increase in the fair value of the equity instruments granted measured immediately before and after the modification. Any decrease in value is not taken into account. Re-measure the fair value of the liability at the end of each reporting period, with any changes in fair value recognized in profit or loss for the period. The modification could be viewed as the cancellation of the old warrants followed by the issuance of new warrants. Subject to a company s accounting policy, a re-measurement adjustment, as a result of the amendments, may or may not be recognized within equity. Note a change within equity may also result in an earnings per share adjustment. Re-measure the financial liability based on the new terms of the warrants with any gain or loss recorded in the profit or loss. EXERCISE OF WARRANTS If a warrant holder exercises the option to convert the warrants into common shares of a company, the accounting for the exercise will depend on the classification of the warrant: Initial Classification of Warrants Equity Presentation Liability Presentation Guidance Amounts for warrants classified as equity instruments are transferred to another account within equity at the date the warrants are exercised. Amounts for warrants classified as a financial liability are revalued immediately prior to settlement. Any change in fair value is recognized in profit or loss. EXPIRY OF WARRANTS When shares prices are low, many warrants may expire unexercised. The accounting for unexercised warrants will depend on the initial classification of the warrant: Initial Classification of Warrants Equity Presentation Liability Presentation Guidance Amounts for warrants classified as equity instruments are generally transferred to another account within equity (e.g., Contributed Surplus) at the date the warrants expire. Amounts for warrants classified as a financial liability are revalued immediately prior to expiry and derecognized. Any change in fair value is recognized in profit or loss. FEBRUARY

17 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED The expiration of warrants, however, may have tax consequences. A discussion of such tax consequences is outside the scope of this Viewpoint, but readers are encouraged to consult with their professional tax advisor. OTHER SOURCES OF INFORMATION To learn more about accounting for share purchase warrants, mining companies may want to refer to the following IFRS Discussion Group reports, published on the Financial Reporting and Assurances Standards Canada website: IAS 39: Measurement of a Unit Comprised of Common Shares and Warrants September 5, 2013 The report considers the measurement of a unit comprised of common shares and warrants. Modification of Share Purchase Warrants July 19, 2012 The report considers the accounting treatment for a modification to the terms of warrants issued for proceeds including any effect on earnings per share. Recognition of Share Purchase Warrants January 12, 2012 The report considers which standard applies when warrants are issued to brokers or underwriters as consideration for the services provided in conjunction with an issuance of warrants or other securities. Accounting for warrants can be complex and requires the exercise of judgment in arriving at an appropriate conclusion. Mining companies should consider consulting their professional accounting advisors and auditors when undertaking such analysis. (Endnotes) 1. Exceptions noted in IFRS 2 paragraphs 3A A cash-settled share-based payment transaction is a share-based payment transaction in which the entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity. An equity-settled share-based payment transaction is a sharebased payment transaction in which the entity receives goods or services a) as consideration for its own equity instruments (including shares or share options), or b) has no obligation to settle the transaction with the supplier. For cash-settled share-based payment transactions, the goods or services acquired and the liability incurred are measured at the fair value of the liability. Until the liability is settled, the liability is remeasured at fair value at each reporting date (and the settlement date). Any changes in fair value are recognized in profit or loss for the period. 3. Exceptions noted in IFRS 2 paragraphs 3A Although the issue and repayment amount in foreign currency may be fixed, when converted back to the entity s functional currency, it results in a variable amount of cash (that is, a variable carrying amount for the financial liability that arises from changes in exchange rates), and hence fails the fixed-for-fixed criteria for equity classification. 5. Under the residual method, one component is measured first and the residual amount is allocated to the remaining component. In contrast, under the relative fair value method the total proceeds of the instrument is allocated to the components in proportion to their relative fair values. 6. Refer to IAS 39.AG76-78, IFRS and IFRS 13.BC Often, an extension in the term and/or change in exercise price are made as a result of a decline in the entity s quoted share price below the warrant exercise price, which results in the exercise of the warrants being uneconomic to the holder. As a consequence of the modification, the fair value of the warrants will typically increase in comparison with the fair value immediately prior to the modification. The alternative to modification would be to allow the warrants to lapse, with the entity then attempting to raise new capital from investors. FEBRUARY

18 ACCOUNTING FOR SHARE PURCHASE WARRANTS ISSUED The Mining Industry Task Force on IFRSs Members Ronald P. Gagel, CPA, CA (Chair) Prospectors and Developers Association of Canada Susan Bennett, CPA, CA Deloitte & Touche LLP Sean Cable, CPA, CA PricewaterhouseCoopers LLP John S. Cochrane, CPA, CA Raymond Chabot Grant Thornton LLP Montreal, Quebec Craig Cross BDO Canada LLP David Danziger, CPA, CA MNP LLP Etobicoke, Ontario Blake Langill, CPA, CA Ernst & Young LLP Michael Lepore, CPA, CA Barrick Gold Corporation Ken McKay, CPA, CA KPMG LLP Keith McKay, CPA, CA Dalradian Resources Inc. Staff Alex Fisher, CPA, CA CPA Canada Chris Hicks, CPA, CA CPA Canada Comments on this Viewpoint, or suggestions for future Viewpoints should be sent to: Alex Fisher, CPA, CA Principal, International Financial Reporting Standards Research, Guidance and Support Chartered Professional Accountants of Canada 277 Wellington St. West M5V 3H2 For more information on IFRSs visit: FEBRUARY

19 JULY 2013 VIEWPOINTS: RECOGNITION OF CORPORATE SOCIAL RESPONSIBILITY PROVISIONS UNDER IAS 37 Applying IFRSs in the Mining Industry BACKGROUND Mining entities often enter into agreements with local communities to undertake certain activities, such as improving the infrastructure of the local community, building new towns or residences, providing water supply and educating people from the communities. These commitments are often termed Corporate Social Responsibility (CSR) obligations and are generally considered by mining entities to be part of the process of obtaining and maintaining their social licence to operate. IFRS provides specific guidance on the accounting for provisions and asset retirement obligations within IAS 37 Provisions, Contingent Liabilities and Contingent Assets. This Viewpoint discusses how CSR obligations should be considered under IAS 37. ISSUE When and how should a company recognize a Corporate Social Responsibility (CSR) obligation? VIEWPOINTS IAS 37 requires a provision to be recognized when all of the following criteria are met: an entity has a present obligation (legal or constructive) as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation. A legal obligation is an obligation that derives from a contract (through its explicit or implicit terms), legislation or other operation of law. Mining Industry Task Force on IFRSs International Financial Reporting Standards (IFRSs) create unique challenges for junior mining companies. Financial reporting in the sector is atypical due to significant differences in characteristics between junior mining companies and other types of companies. The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors and Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to junior mining companies. The task force views are provided in a series of papers that are available through free download. These views are of particular interest to Chief Financial Officers, Controllers and Auditors. The views expressed in this series are non-authoritative and have not been formally endorsed by CPA Canada, PDAC or the organizations represented by the task force members.

20 RECOGNITION OF CORPORATE SOCIAL RESPONSIBILITY PROVISIONS UNDER IAS 37 A constructive obligation is an obligation that derives from an enterprise s actions whereby in an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities and, as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. In determining whether and when to recognize a provision for a CSR obligation, judgment will need to be applied to determine whether an obligating event has occurred that gives rise to a legal or a constructive obligation. The process for making such a determination and the resulting accounting implications will be based on individual facts and circumstances. To illustrate the judgment that may be required, consider the following example: Under each of the following two independent scenarios, assume that Mine Co. has a long established history of completing construction and commencing operations of its mines. On May 1, 2013, the budget and mine plan received approval from Mine Co. s Board of Directors and mine site construction commenced on May 15, Scenario A The budget approved by the board designates that $10 million will be spent on the construction of a local hospital. The commitment to construct the hospital is outlined within the mining concession arrangement with the host community, which was also signed on May 1, Scenario B In accordance with Mine Co. s Corporate Social Responsibility Charter, Mine Co. commits to spending $10 million on improvements within the host community. The budget approved by the board designates that the $10 million will be spent on the construction of a local hospital; however, the obligation is not specifically listed in the mining concession arrangement with the host community. Analysis: Scenario A Within scenario A, the obligation to spend $10 million on the hospital is outlined within the mining concession arrangement with the host community. Based on the guidance of IAS 37, Mine Co. should recognize a provision for its CSR obligation to construct a hospital on May 15, 2013, because: Mine Co. has a present obligation as a result of a past event: As the obligation is specified in the contract with the host community, the obligation is considered a legal obligation. Commencement of the construction of the mine site on May 15, 2013 is the obligating event that requires the provision to be recognized. Probable outflow of economic resources: As Mine Co. has a long-established history of completing construction and commencing operations of its mines, it is probable that there will be an outflow of economic resources. Reliable estimate: In formulating the budget, Mine Co. has determined a reliable estimate. In determining its best estimate of the provision, Mine Co. should consider the uncertainties and time value of money in accordance with IAS Scenario B Similar to scenario A, the commencement of construction of the mine site is considered the past event that may give rise to either a constructive or a legal obligation. As the obligation to spend $10 million on the hospital is not outlined within the mining concession arrangement with the host community, it is not considered a legal obligation. In order to determine if a constructive obligation exists, judgment will have to be applied. july

21 RECOGNITION OF CORPORATE SOCIAL RESPONSIBILITY PROVISIONS UNDER IAS 37 In assessing if board approval of the $10 million expenditure creates a constructive obligation, paragraph 20 of IAS 37 provides some further guidance:... because an obligation always involves a commitment to another party, it follows that a management or board decision does not give rise to a constructive obligation at the end of the reporting period unless the decision has been communicated before the end of reporting period to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will discharge its responsibilities. As Board approval in and of itself is not sufficient, determining when a constructive obligation exists will require judgment and consideration of both of the following: Does Mine Co. have an established pattern of past practice of fulfilling such CSR obligations? Has Mine Co. s communication with the host community created a valid expectation that the commitment will be fulfilled? If Mine Co. has a demonstrated pattern of fulfilling its CSR obligations and the host community has been informed prior to May 15, 2013, of the Company s intention to spend $10 million, then it might be concluded that a constructive obligation exists as of May 15, Conversely, if Mine Co. does not have a history of executing on its CSR commitments and the plan to spend $10 million on a hospital has not been communicated to the host community, then it might be concluded that a constructive obligation does not exist as at May 15, What is the other side of the entry? If it is concluded that a provision should be recorded under IAS 37, a mining entity will need to determine whether the provision should be capitalized (for example, as part of the cost of the mineral property) or recorded as an expense for the period. Judgment will be required in determining the appropriate accounting treatment. If the obligating event to record the CSR obligation occurs during the pre-production phase of a mine (such as in scenario A above), then a mining entity would need to consider the IFRS criteria for capitalization (IAS 16, IAS 38 or IFRS 6) to determine if capitalizing the expenditure as part of the cost of the mine is appropriate. A mining entity might conclude that the CSR obligation is a part of the overall cost to develop the mine and, therefore, will capitalize the obligation as part of the mine asset. Alternatively, if the obligating event for the CSR obligation arises during the production phase, then the obligating event is more likely to be considered an operating expense for the period, though this would need to be determined based on the individual facts and circumstances of the specific situation. Analyzing CSR obligations is complex and requires the exercise of judgment in arriving at a conclusion. Mining entities should consider consulting their accounting advisers and their auditors when undertaking such analysis. (Endnotes) 1. The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity should consider other possible outcomes. Where other possible outcomes are either mostly higher or mostly lower than the most likely outcome, the best estimate should be adjusted accordingly (i.e., higher or lower). Once the cash flows associated with the obligation have been estimated, it is then necessary to consider whether or not the time value of money has a material effect on the amount of the provision. Where the effect of time value of money is material, discounting amounts to be paid is necessary the provision should then be the present value of the expenditures required to settle the obligation. The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The discount rate should not reflect risks for which future cash flow estimates have been adjusted. july

22 RECOGNITION OF CORPORATE SOCIAL RESPONSIBILITY PROVISIONS UNDER IAS 37 The Mining Industry Task Force on IFRSs Members Ronald P. Gagel, CPA, CA (Chair) Prospectors and Developers Association of Canada Susan Bennett, CPA, CA Deloitte & Touche LLP Sean Cable, CPA, CA PricewaterhouseCoopers LLP John S. Cochrane, CPA, CA Raymond Chabot Grant Thornton LLP Montreal, Quebec Craig Cross BDO Canada LLP Blake Langill, CPA, CA Ernst & Young LLP Michael Lepore, CPA, CA Barrick Gold Corporation Ken McKay, CPA, CA KPMG LLP Staff Alex Fisher, CPA, CA CPA Canada Chris Hicks, CPA, CA CPA Canada Comments on this Viewpoint, or suggestions for future Viewpoints should be sent to: Alex Fisher, CPA, CA Principal, International Financial Reporting Standards Research, Guidance and Support Chartered Professional Accountants of Canada 277 Wellington St. West M5V 3H2 For more information on IFRSs visit: JULY

23 May 2013 Viewpoints: REDEVELOPMENT OF AN INACTIVE MINE BY AN EXISTING OWNER Applying IFRSs in the Mining Industry Background When interest in continuing production at a mine ceases, mining activity stops and the mine typically becomes inactive. Inactivity can range from full and permanent abandonment to temporary inactivation during which incidental maintenance activity may occur, but the extent of such maintenance activity can vary. Interest in continuing production at a mine typically ceases because a change in circumstances such as lack of sales contracts, depressed commodity prices, significantly increased costs and/or changes in exchange rates has made production uneconomical. If interest in recommencing production arises at a later date, redevelopment work begins. Depending on the situation, redevelopment costs could be incurred by a new owner or by an existing owner. This Viewpoint addresses the accounting for the costs incurred by an existing owner in redeveloping an inactive mine. The nature and extent of redevelopment work can vary. Examples of redevelopment activities may include: exploration and evaluation; mine development; refurbishment, replacement and/or relocation of plant and equipment; mobilization and training of staff; repairs and maintenance; and other operational-type activities. ISSUE What is the accounting for costs associated with the redevelopment of an inactive mine by an existing owner? VIEWPOINTS The accounting treatment for costs associated with the redevelopment of an inactive mine would depend on the specific facts and circumstances of a particular mine, including for example: Accounting entries recorded at the time of inactivation: o Were impairment losses recognized when the mine became inactive? o Was the useful life and residual value of depreciable assets adjusted when the mine became inactive? Mining Industry Task Force on IFRSs International Financial Reporting Standards (IFRSs) create unique challenges for junior mining companies. Financial reporting in the sector is atypical due to significant differences in characteristics between junior mining companies and other types of companies. The Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors and Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to junior mining companies. The task force views are provided in a series of papers that are available through free download. These views are of particular interest to Chief Financial Officers, Controllers and Auditors. The views expressed in this series are non-authoritative and have not been formally endorsed by CPA Canada, PDAC or the organizations represented by the task force members.

24 REDEVELOPMENT OF AN INACTIVE MINE BY AN EXISTING OWNER o o Were assets derecognized as a result of the mine becoming inactive? Were provisions, such as decommissioning liabilities, adjusted as a result of the inactivation? Condition of the mine and associated property, plant and equipment at the time of reactivation: o How long has the mine been inactive? o Does the property still have the characteristics of a mine? o To what extent were property, plant and equipment maintained during the period of inactivity? Nature of redevelopment costs incurred: o To what extent are costs related to asset improvements and enhancements rather than asset repair, relocation and/or reactivation? o Are costs incurred to develop new areas within the mine? o Are costs incurred to develop a new or different mineral within the mine? o What activity are the costs associated with exploration and evaluation, development, or production? The above list is not exhaustive and, therefore, consideration of other factors may also be helpful. When a redevelopment decision is made, management needs to revisit the treatment of the historical costs of the mine to determine if any adjustments are necessary (e.g., reversal of a prior period impairment). 1 Subsequent expenditures, associated with redevelopment of an inactive mine by an existing owner, may qualify for capitalization if, and only if, such costs satisfy the asset recognition principles of the applicable IFRSs (e.g., IAS 16 and/or IAS 38). Analyzing factors such as the condition of the mine and the associated property, plant and equipment, the length of time the mine has been inactive, and the level of maintenance undertaken during the period of inactivity may provide insight into the future economic benefit expected from the redevelopment expenditures. Consider the following: Subsequent expenditures incurred to return an asset back to its historical level, or a portion of its historical level, of production (and/or economic benefit) would often be considered maintenance in nature and expensed as incurred. Similarly, subsequent expenditures incurred to maintain, repair, and/or regularly service an asset throughout the period of inactivity or at the time of activation (as a catch-up maintenance compensating for maintenance that should have occurred during the period of inactivity) would generally also be expensed as incurred. Subsequent expenditures that can be demonstrated to improve or enhance an asset s potential to deliver additional future economic benefits and/or production beyond its historical level, or a portion of its historical level, may qualify for capitalization, depending on the recognition principles of the applicable IFRSs (e.g., IAS 16 2 ). Improvements or enhancements may be evidenced in several ways, for example: o Extending the mine s useful life (e.g., expenditures incurred to deepen an underground mine to access additional reserves); o Increasing a mining-related asset s service capacity (e.g., expenditures to expand a processing plant so it can process greater volumes); o Substantially improving the quality of output (e.g., expenditures to improve purification); and o Reducing future operating costs. Generally, it would be difficult to demonstrate that redevelopment costs relating directly to reactivating a previously producing mine that was only temporarily inactive, where the inactivity resulted in limited deterioration of the infrastructure, results in the creation of a new asset or in a significant improvement of an existing asset. Conversely, if a mine was inactive for a substantial period of time, with all associated assets either fully depreciated, derecognized, and/or impaired, the property may have deteriorated to such an extent that it no longer resembles a mine (e.g., landslides may have closed a surface mine, an underground mine may have been allowed to flood) and therefore costs incurred to redevelop the mine may result in significant improvements (including access and/or functionality) which may meet the asset recognition principles of the applicable IFRSs, depending on the nature of costs incurred. MAY

25 REDEVELOPMENT OF AN INACTIVE MINE BY AN EXISTING OWNER If applying the recognition principles of IAS 16, an entity should also consider the following: Replacement parts If the cost of replacing a part of plant and equipment is capitalized into the carrying amount of an asset, then the carrying amount of the replaced part must be derecognized. 3 Safety or environmental equipment Items of plant and equipment acquired for safety or environmental reasons (e.g., detection and warning systems) would qualify for capitalization if the incurrence of such costs was necessary to obtain future economic benefits from mining operations in excess of what could have been derived had these items not been acquired. In most cases, the purchase of mining safety or environmental equipment is a requirement of the mining permit and therefore a necessary cost of obtaining benefit from the mining operation as a whole. Relocation costs The costs of moving, relocating, or redeploying existing items of plant and equipment would typically not qualify for capitalization because such costs are generally viewed to provide no incremental future economic benefit to an asset 4. Staff mobilization and training The costs incurred on mobilization and training of staff needed to operate the redeveloped mine would generally not be capitalized. General overheads Overhead costs (e.g., corporate overhead or head office salaries) that are not directly attributable to redevelopment, would generally not be capitalized. Day-to-day servicing costs Costs of salaries, consumables and small parts that would have otherwise been incurred in the day-to-day servicing of the mine, including activities such as the normal course pumping of water, would generally not be capitalized. To understand the nature of costs incurred, it may also be helpful to consider the nature of the activity that influenced the incurrence of those costs. While redeveloping an inactive mine, work may also focus on exploring, evaluating and/or developing a new and/or previously unexplored area of the mine. Accordingly, the entity would apply its existing accounting policy to such costs (e.g., costs incurred to determine technical feasibility and commercial viability of extracting mineral resources from the new area of the mine would be recognized in line with the entity s current accounting policy for such costs in accordance with IFRS 6). During redevelopment, production may commence on part of the mine. As a result, expenditures of an operating nature, associated with the producing area, generally cease to be capitalized as part of the mine (even if the mine is operated at less than full planned capacity). Instead, these expenditures either form part of the cost of inventory or are expensed. 5 (Endnotes) 1. Accounting entries recorded at the time the mine became inactive need to be considered when redevelopment of the mine commences. For example, if impairment losses on tangible or intangible assets were recognized as a result of the mine becoming inactive, the reactivation of the mine may indicate that the recoverable amount of those assets has improved and that the previously recognized impairment losses may no longer exist or may have decreased, requiring those previously recognized impairment losses to be reversed (except impairment losses recognized for goodwill). In addition, the useful life, depreciation method, and/or residual values of all mine assets would need to be reviewed and possibly adjusted (even if no impairment losses were reversed) based on new circumstances; however, if upon inactivation/closure of the mine a loss was incurred as a result of one or more assets being derecognized, reversing the derecognition transactions and the related losses is not permitted. 2. An entity evaluates under the IAS 16 recognition principles all its property, plant and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it. 3. The carrying amount of the replaced part is derecognized regardless of whether it had been identified as a component and depreciated separately. Where it is not practical to determine the carrying amount of the replaced part, the cost of the replacement, suitably depreciated, can be used as a proxy for the carrying amount of the replaced part. 4. IAS 38.69(d) and IAS list relocation expenditures as an example of a cost that should be expensed as incurred. 5. The Viewpoint: Commencement of Commercial Production provides views on how a mining entity determines when commercial production commences. MAY

26 REDEVELOPMENT OF AN INACTIVE MINE BY AN EXISTING OWNER The Mining Industry Task Force on IFRSs Members Ronald P. Gagel, CPA, CA (Chair) Prospectors and Developers Association of Canada Susan Bennett, CPA, CA Deloitte & Touche LLP Sean Cable, CPA, CA PricewaterhouseCoopers LLP John S. Cochrane, CPA, CA Raymond Chabot Grant Thornton LLP Montreal, Quebec Craig Cross BDO Canada LLP John Gingell, CA Teck Resources Limited Vancouver, British Columbia Blake Langill, CPA, CA Ernst & Young LLP Michael Lepore, CPA, CA Barrick Gold Corporation Ken McKay, CPA, CA KPMG LLP Staff Alex Fisher, CPA, CA CPA Canada Chris Hicks, CPA, CA CPA Canada MAY

27 reissued April 2013 VIEWPOINTS: IMPAIRMENT OF EXPLORATION AND EVALUATION ASSETS Applying IFRSs in the Mining Industry BACKGROUND IAS 36, Impairment of Assets, applies to the accounting for the impairment of all assets, including exploration and evaluation (E&E) assets 1. IAS 36 prescribes the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount, which is the higher of the amount to be recovered through use of the asset and the amount to be recovered through sale of the asset. Carrying amount Exceeds Amount to be recovered through use (Value in use) If an asset is carried at more than its recoverable amount, the asset is impaired and IAS 36 requires an entity to recognize an impairment loss. IAS 36 also specifies when an entity should reverse an impairment loss. It is important to note that although IAS 36 applies to the accounting for the impairment of E&E assets, IFRS 6, Exploration for and Evaluation of Mineral Resources, modifies the requirements in IAS 36 with respect to: the indications of impairment; and the level at which impairment is tested. Recoverable amount Higher of Amount to be recovered through sale (Fair value less costs to sell) 1 For more information, download the paper on Exploration and Evaluation Expenditures from Mining Industry Task Force on IFRSs Canada s move to International Financial Reporting Standards (IFRSs) creates unique challenges for junior mining companies. Financial reporting in the sector is atypical due to significant differences in characteristics between junior mining companies and other types of companies. Chartered Professional Accountants of Canada (CPA Canada) and the Prospectors and Developers Association of Canada (PDAC) created the Mining Industry Task Force on IFRSs to share views on IFRS application issues of relevance to junior mining companies. The task force s views are provided in a series of papers that are available through free download. These views are of particular interest to chief financial officers, controllers and auditors. The views expressed in this series are non-authoritative and have not been formally endorsed by CPA Canada, PDAC or the organizations represented by the task force members.