New on the Horizon: Production stripping costs. International Financial Reporting Standards September 2010

Transcription

1 New on the Horizon: Production stripping costs International Financial Reporting Standards

2 Foreword In Draft Interpretation DI/2010/1 Stripping Costs in the Production Phase of a Surface Mine the IFRS Interpretations Committee in effect proposes component accounting for production phase stripping costs. Stripping activity can be a significant part of the cost base for many open pit mines. Allocating the cost of this activity between development and cost of sales has long been a matter of debate. In 2005 the US Financial Accounting Standards Board came down on the side of allocating all production stripping costs to inventory produced during the period in which the costs are incurred (essentially expense as you go); this was despite the long-standing practice of many mining companies of equalising the costs over production, usually using average stripping ratios. This approach was controversial as many commentators believed that it did not reflect their view of the economics of the decision to mine, and created inappropriate volatility in the income statements of many mining companies. In 2006 the Canadian accounting standard setter issued specific guidance allowing stripping costs to be capitalised in certain circumstances. The IFRS Interpretations Committee has now decided to address this issue. The proposals recognise that some production stripping activities will benefit future periods production and propose capitalising those costs and allocating them to the cost of producing the incremental ore exposed by the stripping campaign. The proposed approach of identifying the costs of a stripping campaign against specific portions of the ore body and charging the cost to the production of the ore in those areas differs significantly from the currently popular average strip ratio approach. Application will require significant judgement in practice, which may limit the degree of consistency achieved by the proposals, although this may not be much different from the treatment of certain underground development costs. We hope that this publication will assist you in gaining a greater understanding of the proposals in DI/2010/1. We encourage you to join in the debate and to provide the IFRS Interpretations Committee with your comments by the deadline of 30 November Jimmy Daboo Global Audit Lead, Energy & Natural Resources KPMG in the UK Lee Hodgkinson Global Director of Mining KPMG in Canada

3 About this publication This publication has been produced by the KPMG International Standards Group (part of KPMG IFRG Limited). We would like to acknowledge the efforts of the principal authors of this publication. Those authors include Julie Santoro of the KPMG International Standards Group, Nicole Perry of KPMG in Australia, and Jimmy Daboo of KPMG in the UK. Content Our New on the Horizon publications generally are prepared upon the release of a new proposed IFRS or proposed amendment(s) to the requirements of existing IFRSs. They include a discussion of the key elements of the new proposals and highlight areas that may result in a change of practice. This edition of New on the Horizon considers the proposed requirements of Draft Interpretation DI/2010/01 Stripping Costs in the Production Phase of a Surface Mine, which was published by the IASB on 26 August The text of this publication is referenced to the draft interpretation by way of references in the left-hand margin. Further analysis and interpretation will be needed in order for an entity to consider the potential impact of this draft interpretation in light of its own facts, circumstances and individual transactions. The information contained in this publication is based on initial observations developed by the KPMG International Standards Group, and these observations may change. Other KPMG publications A more detailed discussion of the general accounting issues that arise from the application of IFRSs can be found in our publication Insights into IFRS. In addition to Insights into IFRS, we have a range of publications that can assist you further, including: The Application of IFRS: Mining New on the Horizon publications, which discuss consultation papers such as Discussion Paper DP/2010/1: Extractive Activities IFRS compared to US GAAP Illustrative financial statements for interim and annual periods IFRS Handbooks, which include extensive interpretative guidance and illustrative examples to elaborate or clarify the practical application of a standard New on the Horizon publications, which discuss consultation papers Newsletters, which highlight recent developments IFRS Practice Issue publications, which discuss specific requirements and pronouncements First Impressions publications, which discuss new pronouncements Disclosure checklist. IFRS-related technical information also is available at For access to an extensive range of accounting, auditing and financial reporting guidance and literature, visit KPMG s Accounting Research Online. This web-based subscription service can be a valuable tool for anyone who wants to stay informed in today s dynamic environment. For a free 15-day trial, go to and register today.

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5 Contents 1. Overview of proposals 5 2. Background 6 3. Scope and approach 7 4. Recognition 8 5. Measurement Initial measurement Subsequent measurement 9 6. Disclosure Effective date and transition 12 Country contacts 13 Global contacts 14

6 5 New on the Horizon: Production stripping costs 1. Overview of proposals The draft interpretation deals with waste removal costs (stripping costs) that are incurred in surface mining activity during the production phase of a mine. Production stripping costs incurred as part of a stripping campaign would be capitalised as a component of an existing asset when the definition of an asset is met; a stripping campaign is a systematic process to gain access to a specific section of the ore body. The stripping campaign component would be classified as tangible or intangible, consistent with the classification of the larger asset to which the component relates. The component would be recognised initially based on the costs incurred, including an allocation of directly attributable costs. Subsequent to initial recognition, the stripping campaign component would be recognised at cost less depreciation/amortisation and less any impairment losses. The period of depreciation/amortisation would be based on the expected useful life of the specific section of the ore body that becomes directly accessible as a result of the stripping campaign. Routine production stripping costs, i.e. costs that are not part of a stripping campaign, would be included in current period production costs. The draft interpretation does not include a proposed effective date, but proposes that early adoption of the final interpretation be permitted. The final interpretation would be applied to production stripping costs incurred on or after the beginning of the earliest period presented following adoption of the final interpretation. Existing asset balances upon adoption of the final interpretation would be allocated to the relevant section of the ore body, or recognised in profit or loss at the beginning of the earliest period presented if allocation is not possible; existing liability balances would be recognised in profit or loss at the beginning of the earliest period presented. First-time adopters of IFRSs would be allowed to adopt the transition requirements for existing users of IFRSs, based on the later of the effective date of the final interpretation and the date of transition to IFRSs.

7 New on the Horizon: Production stripping costs 6 2. Background The IFRS Interpretations Committee (Interpretations Committee) added a project to its agenda on the accounting for production stripping costs in the mining industry in November When mining entities perform significant operations as part of surface mining that involve the removal of waste materials, this activity usually is undertaken to allow and facilitate access to the underlying ore. This waste removal process is particularly important in open pit mining, but an analogous range of processes also exists in underground mining development. There is no existing guidance in IFRSs related specifically to the accounting for production stripping costs. In our publication The Application of IFRS: Mining 1 we reported that generally the entities in our survey captalised production stripping costs; the majority of these entities stated that they capitalised costs to the extent that actual stripping ratios exceeded average life-of-mine stripping ratios. In practice, stripping costs generally are recognised in profit or loss over the remaining life of the mine as a whole. In our experience, this approach can also result in a provision being recognised when stripping ratios increase towards the end of the mine s life, particularly when recognition is based on the mineral content of the ore. Some entities follow the US GAAP treatment, which involves expensing all stripping costs incurred as a production cost of the period. Therefore, it appears that the proposals, if implemented in their current form, would improve consistency amongst entities in the industry that apply IFRSs, although there could continue to be a significant difference from US GAAP. In addition, if the proposals are implemented in their current form, there is likely to be a change in accounting for many entities as they move away from using stripping ratios and life-of-mine calculations. Stripping costs would be depreciated/amortised over shorter periods under these proposals than if an entity was using a life-of-mine basis. In addition, some stripping costs that are capitalised currently would not qualify for capitalisation under these proposals because the costs cannot be related to a specific section of the ore body. 1 Published in September 2009; executive summary available at kpmg.com/ifrs

8 7 New on the Horizon: Production stripping costs 3. Scope and approach DI 5, 9 DI 4 DI BC6 DI BC7 The scope of the draft interpretation is restricted to waste removal costs that are incurred in surface mining activities during the production phase of a mine. While the main focus of the proposals is stripping costs incurred as part of a stripping campaign, other production stripping costs also are dealt with in the proposals. A stripping campaign is a systematic process undertaken to gain access to a specific section of the ore body. The proposals note that a stripping campaign is a more aggressive process than routine waste clearing activities. A stripping campaign is planned in advance, has a defined start date and forms part of the mine plan; the campaign ends when the entity has completed the waste removal activity necessary to access the ore with which the campaign is associated. The draft interpretation focuses on surface mining activities, i.e. activities that will most commonly apply to open pit mines. The Interpretations Committee notes its understanding that stripping activities occur mainly in surface mining activities, rather than in underground mining or waste removal activities in the oil and gas industry. However, the draft interpretation does not rule out application by analogy to those other activities. Stripping costs incurred during the development phase of a mine are excluded from the scope of the proposals based on the Interpretations Committee s understanding that there is no diversity in practice. In our experience, pre-production stripping costs generally are capitalised and amortised over the productive life of the mine using the unit-of-production method. In our experience, there are many different types of surface mines and the ways in which stripping activity occurs in practice are very diverse; this means that in some cases it may not be easy to distinguish between pre-production stripping and production stripping. Mines vary from simple single pits with a reasonably contained ore body (such as in the illustrative example included in the draft interpretation), to complex multi-pit mines in which each campaign is pre-production for the pit but not for the mine as a whole, to large single pits in which the ore body is accessed in phases and the initial pre-production stripping activity (or at least some part of it) provides access only to a part of the ore body. To determine what constitutes pre-production stripping versus production stripping may require considerable judgement. Entities should therefore consider whether it would be more appropriate for the final interpretation to cover all stripping costs that provide access to part, rather than the whole, of an ore body instead of requiring a judgemental distinction to be made between preproduction and production stripping activities. Entities should consider whether the definition of a stripping campaign reflects the process and information that is used operationally. For example, some entities may undertake stripping activities that broadly meet the above definition; however, they may not have a defined start date. It is unclear whether the features of a stripping campaign as described above are intended to form part of the definition of a stripping campaign. As current practice often involves recognising production stripping costs in profit or loss on some form of life-of-mine basis, the proposals would likely result in a less uniform recognition of the cost of production through the life of the mine than has been the case in the past.

9 New on the Horizon: Production stripping costs 8 4. Recognition DI 7 The draft interpretation notes that stripping activity gives rise to a benefit, being improved access to the underlying ore that will be mined. However, in order to conclude that the costs incurred should be capitalised as part of an asset, it would be necessary to demonstrate: control of the benefit created, through ownership of either the land or the rights to mine the land; the existence of a past event from which benefits arise, which would be the stripping activity; and future economic benefits through improved access to economically recoverable reserves. DI 8, 9 The draft interpretation envisages these tests being met when stripping costs are incurred as part of a stripping campaign, noting that the costs then become a component of an existing asset; this may be the mine asset, for example. However, routine production stripping costs that are not incurred as part of a stripping campaign would be recognised as a current cost of production in accordance with IAS 2 Inventories. Routine production stripping costs that are not incurred as part of a stripping campaign, but which may provide a benefit in future periods, would not be permitted to be recognised as an asset despite potentially meeting the above criteria for capitalisation. DI 10 The draft interpretation proposes that an entity capitalise production stripping costs that meet the recognition criteria as part of the larger asset to which the costs relate. This means that the component would be classified as a tangible or intangible asset component, based on the classification of the related asset. In our publication The Application of IFRS: Mining we reported diversity in the classification of capitalised stripping costs. For those entities whose classification was apparent from the financial statements, the majority classified capitalised stripping costs as property, plant and equipment; other classifications were as a separate non-current asset and as a separate current asset. Although the component accounting proposed in the draft interpretation is an integral part of the accounting under IAS 16 Property, Plant and Equipment, it is not mentioned explicitly in IAS 38 Intangible Assets. However, in our experience component accounting is applied to intangible assets in a manner similar to property, plant and equipment in appropriate circumstances. DI 11 The draft interpretation proposes that the stripping campaign component be specifically associated with, i.e. allocated to, the section of ore that becomes directly accessible as a result of the stripping activity. Entities should consider how their existing systems track specific ore extraction when compared to stripping campaigns. There may be systems alterations required to amend system data and mapping to implement these proposals.

10 9 New on the Horizon: Production stripping costs 5. Measurement 5.1 Initial measurement DI 12, 14, 15 The stripping campaign component would be measured initially at cost, i.e. as an accumulation of the costs incurred as the stripping campaign is undertaken. This would include an allocation of directly attributable costs. However, any costs incurred in relation to incidental operations, i.e. operations not necessary for the stripping campaign to continue as planned, would be expensed as incurred. This approach is consistent with the initial measurement principles in IAS 16 for property, plant and equipment and in IAS 38 for intangible assets. DI 13 Once the stripping campaign is complete, no further stripping costs would be capitalised. The draft interpretation provides no further guidance on the meaning of directly attributable costs. However, since this principle is consistent with the initial measurement principles of IAS 16 and IAS 38, we would expect those standards to be used as guidance. For example, we would expect directly attributable costs to include an allocation of fixed and variable overheads, such as haulage, transportation and labour. Assuming that the stripping campaign component is a qualifying asset, borrowing costs also would be capitalised. 5.2 Subsequent measurement DI 16 The measurement model proposed to be applied to the stripping campaign component is consistent with the cost model under IAS 16 and IAS 38: cost less accumulated depreciation/ amortisation and any accumulated impairment losses. The revaluation model would not be permitted. DI 17, IE DI 17 DI 18, BC18, BC21 DI 19 The draft interpretation proposes that the stripping campaign component be depreciated/amortised, in a rational and systemic manner, based on the expected useful life of the specific section of the ore body that becomes directly accessible as a result of the stripping campaign. The application guidance that forms part of the draft interpretation provides a simple worked example illustrating a number of different stripping campaigns occurring in a single ore body over a number of reporting periods, and shows the impact of each stripping campaign and the specific ore associated with each campaign. The unit-of-production method of depreciation/amortisation would be applied unless another method is more appropriate. The draft interpretation notes that the expected useful life of a specific section of the ore body may differ from that of life-of-mine assets because the stripping campaign will give access only to a portion of the total ore body. The basis for conclusions includes a comment to the effect that the Interpretations Committee does not expect depreciation/amortisation to be based on a life-ofmine calculation; this is because the principle in the draft interpretation is to allocate the stripping component to an appropriate section of the ore body. The suspension or planned suspension of extraction activities would be an indication of impairment for the stripping campaign component, which would be tested for impairment in accordance with IAS 36 Impairment of Assets.

11 New on the Horizon: Production stripping costs 10 As noted in the basis for conclusions to the proposals, life-of-mine or whole-of-life depreciation/ amortisation profiles generally would not be expected. This would be a significant change to current practice in which, in our experience, the use of a stripping ratio reflecting life-of-mine expectations is common. In our experience, the unit-of-production method of calculating depreciation/amortisation generally has been accepted in practice as an appropriate way to allocate mine development costs over the life of a mine; this is because it results in an averaged allocation per unit of output across the whole life of the mine even when the costs of accessing different areas of the ore body are in fact different. The approach taken in the draft interpretation inevitably would mean that costs would be allocated more specifically. It is unclear from the proposals whether using the life-of-mine basis of depreciation/ amortisation always will be inappropriate. At first glance, it appears that some form of life-ofmine basis, while expected to be extremely rare, has not been prohibited in all circumstances. A stripping campaign in an open pit mine may relate less to the extraction of ore and more to other reasons, e.g. undertaking a major pushback to change the slope of the pit wall for safety reasons. This type of campaign component is more likely to be able to depreciated/amortised over a larger reserves basis than a specific campaign. Based on the application guidance, despite reserves at the bottom of a pit benefiting indirectly from the removal of ore and waste material in the layers above, the lower ore quantities would not qualify as part of the section of ore that becomes directly accessible as a result of the stripping activity. These reserves would be associated with a component only when they are the subject of a stripping campaign and will be extracted. This may be an over-simplification in the example in the application guidance and it is not clear whether this outcome was intended. Entities should consider whether the proposals relating to depreciation/amortisation methodology are specified in too much detail. It may be more appropriate for entities to be required to use their judgement in determining the most appropriate rational and systematic manner of depreciation/amortisation for each particular set of circumstances that they face. The proposed indications of impairment generally are consistent with factors to be considered in applying IAS 36 currently, which in practice would apply to the mine as a whole. However, the proposals could be read as implying a component-level impairment test, whereas in other areas of IFRSs the components of an asset are included in the impairment testing of the asset as a whole, which may itself be included in a larger cash-generating unit for the purposes of impairment testing. Although in our experience few entities apply the revaluation model to mine assets under IAS 16, the proposals explicitly preclude revaluation as a measurement basis for the stripping campaign component. It is not clear how this proposal interacts with the overall choice of measurement model available to an entity.

12 11 New on the Horizon: Production stripping costs 6. Disclosure There are no specific disclosure proposals in the draft interpretation. However, the Interpretations Committee asks constituents to comment on whether specific disclosures for a stripping campaign component would be useful. The stripping campaign component represents a part of a larger asset. In existing IFRSs there are no disclosure requirements that apply only to a component of an asset, and in our experience it would be unusual for the stripping campaign component to represent a significant balance when compared to the larger asset, for example the mine asset.

13 New on the Horizon: Production stripping costs Effective date and transition DI 20 DI 21 DI 22 DI App The draft interpretation does not propose an effective date, but notes that early adoption of the final interpretation would be permitted. The final interpretation would be applied prospectively, to production stripping costs incurred on or after the beginning of the earliest period presented following adoption of the final interpretation. Any existing asset balance related to production stripping upon adoption of the final interpretation would be reclassified as a component of the larger asset to which it relates, and accounted for in accordance with the proposals prospectively; if the component cannot be associated with an identifiable section of the ore body, then the asset would be recognised in profit or loss at the beginning of the earliest period presented. Any existing liability balance related to production stripping upon adoption of the final interpretation would be recognised in profit or loss at the beginning of the earliest period presented. The draft interpretation proposes an amendment to IFRS 1 First-time Adoption of International Financial Reporting Standards to give first-time adopters the option of applying the above transition requirements. In that case the first-time adopter would adopt the requirements at the later of the effective date of the final interpretation and the date of transition to IFRSs. We expect that many entities that currently are using a whole-of-mine or life-of-mine stripping ratio would have to derecognise part of their capitalised balance at the date of adoption as the specific ore to which the costs relate has either been extracted previously or cannot be identified. The amount derecognised would be recognised in profit and loss, as opposed to retained earnings, which would require the adjustment of comparatives and may reduce the comparability of results. For first-time adopters it is unclear whether the proposals would require any adjustment to previously recognised stripping cost balances to be recognised in retained earnings at the date of transition (as is common with other IFRS 1 exemptions) or in profit or loss immediately following transition.

14 13 New on the Horizon: Production stripping costs Country contacts Australia Simon Crane KPMG in Australia Tel: +61 (7) Brazil Andre Castello Branco KPMG in Brazil Tel: +55 (21) Canada Lee Hodgkinson KPMG in Canada Tel: Chile Patrick Hanley KPMG in Chile Tel: +56 (2) China Melvin Guen KPMG in China Tel: France Jacques-Francois Lethu KPMG in France Tel: jlethu@kpmg.fr India Hiranyava Bhadra KPMG in India Tel: +91 (223) hbhadra@kpmg.com Kazakhstan Alun Bowen KPMG in Kazakhstan Tel: +7 (727) abowen@kpmg.kz Kuwait Charles Milner KPMG in Kuwait Tel: cjmilner@kpmg.com Oman Michael Armstrong KPMG in Oman Tel: +968 (24) marmstrong@kpmg.com Qatar Gopal Balasubramaniam KPMG in Qatar Tel: gopalbala@kpmg.com Russia Alexandra Bouriko KPMG in Russia Tel: +7 (495) alexandrabouriko@kpmg.ru Saudi Arabia Tim Rockell KPMG in Saudi Arabia Tel: +966 (3) timrockell@kpmg.com South Africa Carel Smit KPMG in South Africa Tel: +27 (11) carel.smit@kpmg.co.za United Arab Emirates Sharad Bhandari KPMG in the U.A.E. Tel: +971 (2) sbhandari@kpmg.com United Kingdom Jimmy Daboo KPMG in the UK Tel: +44 (0) jimmy.daboo@kpmg.co.uk United States Sheri Pearce KPMG in the US Tel: spearce@kpmg.com

15 New on the Horizon: Production stripping costs 14 Global contacts Michiel Soeting Global Chair, Energy and Natural Resources (ENR) KPMG in the UK Tel: +44 (0) Jimmy Daboo Global Audit Lead, ENR KPMG in the UK Tel: +44 (0) Lee Hodgkinson Global Director of Mining KPMG in Canada Tel:

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