EITF Issue No. 04-6 FASB Emerging Issues Task Force Issue No. 04-6 Title: Accounting for Stripping Costs in the Mining Industry Document: Working Group Report No. 1, Supplement No. 2 Date prepared: March 4, 2005 FASB Staff: Westerlund (ext. 212)/Larson (ext. 229) Date previously discussed: June 30 July 1, 2004; September 29 30, 2004; November 17 18, 2004 Previously distributed EITF materials: Issue Summary No. 1, dated June 17, 2004; Working Group Report No. 1, dated September 13, 2004; Supplement to Working Group Report No. 1, dated September 28, 2004; Working Group Report No. 1, Supplement No. 1, dated November 3, 2004 References: FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (FAS 3) FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies (FAS 19) FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (FAS 144) FASB Concepts Statement No. 6, Elements of Financial Statements (CON 6) APB Opinion No. 20, Accounting Changes (APB 20) AICPA Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, Chapter 4, "Inventory Pricing" (ARB 43) AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1) The alternative views presented in this Working Group Report are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination and it is ratified by the Board. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 1
SEC Staff Accounting Bulletin No. 40, Depreciation and Depletion Excluded from Cost of Sales (SAB Topic 11-B) Securities Act Industry Guide 7, Description of Property by Issuers Engaged or to be Engaged in Significant Mining Operations (Industry Guide 7) IAS ED 6, Exploration and Evaluation of Mineral Resources (IAS ED 6) International Accounting Standards Committee, An Issues Paper Issued for Comment by the IASC Steering Committee on Extractive Industries (IASC Issues Paper) EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 2
Background 1. In the mining industry, companies may be required to remove overburden and other mine waste materials while accessing mineral deposits. The costs of removing overburden and waste materials are referred to as "stripping costs." During the development of a mine (before production begins) it is generally accepted in practice that stripping costs are capitalized as part of the depreciable cost of building, developing, and constructing the mine. These capitalized costs are typically amortized over the productive life of the mine using the units of production method. These pre-production stripping costs are treated similarly to other mine development costs such as costs to develop roads, processing plants, and other infrastructure. 2. A mining company may continue to remove overburden and waste materials, and therefore continue to incur stripping costs, during the production stage of the mine. It is the accounting for stripping costs incurred during production that has resulted in questions being raised as to the appropriate accounting for those costs, and diversity in practice exists. 3. The question of accounting for stripping costs is difficult to address because stripping costs incurred during production may benefit both future periods (that is, the nature of the cost is the same or similar to stripping costs incurred in the development phase) and current period production. Until the last unit of reserves is extracted from a mine, some believe that all stripping costs incurred in the mining operation provided an element of future benefit, because the removal of the overburden and waste material allowed the entity to gain access to additional reserves. 4. In practice, many mining companies estimate the total material to be mined throughout the mine's productive life. Those companies, using a long-term mine plan, then develop a "life of mine stripping ratio," or a "stripping ratio," which is calculated as the estimated total number of units (for example, tons) of waste material mined during production divided by the estimated total proved and probable reserves contained within the mine (that is, recoverable ore in a unit of measure, for example, pounds of copper or ounces of gold). Diversity in the mechanical calculation of the stripping ratio and the life of mine concept currently exists in practice. However, irrespective of that diversity, using a stripping ratio and the deferred stripping EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 3
accounting model yields a consistent result; the allocation of a ratable amount of stripping costs to each unit of reserves extracted from the mine. 5. Because the physical concentration of mineral deposits is not uniform throughout a mine, a company generally is mining a ratio of waste material to mineral deposits that is different from the stripping ratio. Refer to Exhibit 04-6A for an illustration of a cross section of a mine and calculation of a deferred stripping ratio. For each period, the actual stripping ratio is compared to the life-of-mine stripping ratio. If the actual stripping ratio exceeds the life-of-mine stripping ratio (that is, more waste is removed than the estimated average), the excess stripping cost incurred is recognized as a deferred stripping asset. Alternatively, if the actual stripping ratio is less than the life-of-mine stripping ratio (that is, less waste is removed than the estimated average), the shortfall is recognized as a reduction in the deferred stripping asset. In certain cases, the shortfall is recognized as a deferred credit on the balance sheet (when the deferred stripping asset, if any, does not absorb the amount of the shortfall). Changes in the average lifeof-mine stripping ratio are accounted for prospectively as changes in estimates. The following provides a basic illustration of the application of a deferred stripping ratio: If an entity estimates a stripping ratio of 4:1 and, during the first period of production, it produces 10 units, and incurs a stripping ratio of 6:1 and $300 in stripping costs, the entity would attribute $200 to that period's production and it would capitalize $100 as an asset. Further, if the entity produces 10 units, and incurs a stripping ratio of 2:1 and $100 in stripping costs in the following period, the entity would attribute $200 in costs to that period's production including the costs incurred during the period ($100) and a reduction to the previously capitalized costs ($100). The deferred stripping ratio method may be used in practice in circumstances in which the stripping ratio is expected to vary substantially over the life of the mine. In other situations, entities may expense stripping costs as incurred during production when the stripping ratio over the life of a mine is expected to be relatively consistent. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 4
Scope 6. This Issue applies to mining entities. Mining entities include entities involved in finding and removing wasting natural resources other than oil- and gas-producing entities that are within the scope of FAS 19. 7. Stripping costs are costs incurred for the removal of overburden or waste materials for the purpose of obtaining access to an ore body that will be commercially produced. This Issue applies to all mine stripping costs those incurred in both the pre-production and the production phases of the mine. Prior Task Force Discussion 8. At the June 30 July 1, 2004 EITF meeting, the Task Force discussed the accounting for stripping costs incurred during production but did not reach a consensus. The Task Force asked the FASB staff to further explore and develop with the Mining Industry Working Group (the Working Group) the following alternatives: (a) expense as incurred, (b) include in inventory as a variable production cost, and (c) defer as an asset (no liability recognition) and recognize in earnings using a proportional performance ratio. The Task Force also requested the FASB staff to solicit a recommended view from the Working Group. 9. On August 19, 2004, the FASB staff met with the Working Group to further discuss and develop the alternatives and to reach a Working Group recommendation. At that meeting, the Working Group developed an additional alternative that requires stripping costs incurred during production to be capitalized as a mine development cost and attributed to the proved and probable reserves benefited in a systematic and rational manner. This new alternative became the Working Group Recommendation. 10. At the September 29 30, 2004 EITF meeting, a majority of the Task Force members expressed support for the Working Group Recommendation. However, the Task Force directed the FASB staff to develop additional guidance about what constitutes a systematic and rational method of attribution. Additionally, the Task Force generally agreed that the attribution of stripping costs incurred in the pre-production phase of the mine should be the same as those EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 5
incurred during the production phase. Accordingly, the scope of this Issue has been expanded to address the accounting for all stripping costs both pre-production and production stripping costs. 11. At the November 17 18, 2004 EITF meeting, the Task Force generally agreed that stripping costs are mine development costs that should be capitalized as an investment in the mine to the extent that the stripping costs are expected to provide additional future benefit and that those capitalized costs should be attributed to proved and probable reserves in a systematic and rational manner. Additionally, the Task Force generally agreed that 1 - a. Capitalized stripping costs should be specifically attributed to reserves that directly benefit from the stripping activities. b. Both the units of production method and a proportional performance ratio (such as a stripping ratio) may be systematic and rational methods to attribute capitalized costs to reserves benefited. c. A liability (or accumulated amortization in excess of cumulative capitalized stripping costs) should not be recognized from the application of a proportional performance ratio. d. Estimates used in the attribution of capitalized costs should be reevaluated at least on an annual basis and more frequently if there are changes in facts and circumstances. e. The amortization of stripping costs should be included in the cost of inventory when the costs are attributed to reserves that are extracted. 12. Also at the November meeting, the Task Force asked the FASB staff to further explore whether there are factors that an entity should consider when determining the appropriate attribution method and to determine whether the attribution method should be an accounting policy decision or based on the facts and circumstances associated with the mine. Additionally, the SEC Observer expressed concern over the absence of specific guidance associated with the capitalization of stripping costs as mine development costs and the related attribution of those costs to inventory. However, the SEC Observer agreed to consult further with the SEC staff before concluding on the Issue. 1 The FASB staff has included these decisions in View D of Issue 1. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 6
Accounting Issues and Alternatives 13. This Working Group Report addresses the questions and concerns that were raised by the Task Force and the SEC Observer at the November 17 18 EITF meeting. To address those questions and concerns, the FASB staff (a) held a conference call with the SEC staff on January 7, 2005, (b) received input from the Working Group on a draft of the proposed guidance (a version of View D of Issue 1) and a related questionnaire, and (c) met with certain members of the Working Group and the SEC staff on February 28, 2005. 14. In Issue 1, the FASB staff will ask the Task Force to reconsider its preliminary decisions on the accounting for stripping costs. If the Task Force reaffirms its previous decisions (View D of Issue 1), the FASB staff will ask the Task Force to consider Issue 2, which addresses whether there are factors that an entity should consider when determining the appropriate attribution method and whether the attribution method should be an accounting policy decision or based on the facts and circumstances associated with each mine. 15. This Working Group Report also addresses (a) cash flow and income statement characterization of stripping costs, (b) disclosures, and (c) effective date and transition. Issue 1: How stripping costs in the mining industry should be accounted for. 16. At the November 17 18, 2004 EITF meeting, the Task Force reached a general agreement on a model to account for stripping costs. However, the SEC Observer expressed concern over the lack of specific guidance on the capitalization of stripping costs and attribution of those costs. To assist in addressing this concern, the FASB staff sent a questionnaire to the Working Group to gather suggestions to improve the model to provide increased rigor in its application. The suggestions of the Working Group have been incorporated into View D, as expanded. In spite of those efforts, concerns about the model still exist. Accordingly, the FASB staff will ask the Task Force to reconsider its decisions on the accounting for stripping costs. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 7
Concerns about the Proposed Guidance (View D of Issue 1) 17. The primary concerns about the proposed guidance relate to the attribution of capitalized stripping costs. The Working Group identified two potential attribution methods the units of production method and a proportional performance ratio method. (Refer to Exhibit 04-6C for an explanation and illustration of the units of production method and a proportionate performance ratio.) 18. Some believe that the units of production method does not reflect the economics of the mine. That is, a mining entity will recognizing "artificially high" operating margins in the early years of a mine's life and that those margins would gradually decrease over time, resulting in the entity recognizing "artificially low" gross margins toward the end of the mine's productive life. Attribution under this method ultimately may result in an impairment charge before the mine reaches the end of its productive life. In contrast, others believe that a proportionate stripping ratio does not reflect the economics of the mine specifically because it attributes a similar amount of stripping costs to each unit of ore that is extracted from the mine. That is, a proportionate performance ratio is an income smoothing technique that does not reflect the increasing costs of a mining operation. 19. At the November 17 18, 2004 EITF meeting, certain Task Force member expressed concern over the proposed attribution methods and asked the FASB staff to determine whether there are factors that an entity should consider when choosing an attribution method. In response to a questionnaire, the Working Group members indicated that they were not aware of factors that would result in a consistent conclusion that one attribution method was preferable to another. Some believe that the lack of factors raises questions about whether the premise in View D of Issue 1 that all stripping costs are mine development costs is appropriate. Further, some believe that the uneconomic result of applying the units of production method (refer to the discussion in the preceding paragraph) also raises questions about whether stripping costs are mine development costs. 20. Although the majority of the Working Group continues to support the proposed guidance in View D, the Working Group and the FASB staff acknowledge the concerns that are raised in the EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 8
preceding paragraphs. Accordingly, the FASB staff will ask the Task Force to reconsider Issue 1. The FASB staff has brought forward the arguments for each View from previous Working Group Reports. Additionally, the FASB staff has carried forward examples to illustrate the impact of Views A-D in Exhibit 04-6B. View A: Stripping costs should be expensed as incurred. 21. Proponents of View A believe that once a mine begins production, all subsequent costs to remove materials from the mine should be expensed in the period that those costs are incurred. Some proponents hold the view that stripping costs incurred during production are costs incurred to maintain current production and, while a necessary cost of extracting the ore from the mine, provide little future economic benefit. Accordingly, View A proponents believe that costs incurred to conduct stripping activities during production do not meet the definition of an asset as contemplated by CON 6 and therefore should be expensed as incurred. 22. Some proponents of View A believe that stripping costs incurred during production primarily benefit current production, but they also acknowledge that those activities could provide benefits to future periods (that is, some element of the stripping costs is a development cost). However, because it is difficult to accurately allocate stripping costs between those that benefit current production and those that benefit future periods, as a practical expedient, View A proponents believe immediate recognition as an expense is appropriate. That view is consistent with other areas within U.S. GAAP, such as paragraph 25 of SOP 98-1, which states that when an entity cannot distinguish whether a cost should be capitalized or expensed, the default treatment is for the cost to be expensed as incurred. 23. Proponents of View A observe that mineral deposits are not uniform throughout a mine. In those cases, there will be periods in which more minerals or fewer minerals are produced. View A proponents believe that the inconsistency in stripping costs associated with extracted reserves should be recognized in the operating results of the mining entity. That is, if costs are incurred unevenly, then the financial statements should reflect that economic reality, rather than being smoothed through the use of a matching methodology. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 9
View B: Stripping costs are variable production costs that should be considered a component of mineral inventory cost subject to the provisions of ARB 43. 24. Proponents of View B believe that after a mine begins production; all subsequent costs to remove materials from the mine are costs of current production and therefore represent a component of the inventory cost. Chapter 4, Statement 3, of ARB 43 states that "the primary basis of accounting for inventories is cost. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location." View B proponents believe that the costs incurred to remove waste material are a direct cost incurred to bring the mineral reserves to a condition and location that provides future value to the entity. 25. View B proponents believe that the unit of account to determine the appropriate accounting for stripping costs, is the minerals extracted for the period and not the total minerals extracted over the life of the mine. Accordingly, stripping costs incurred in a given period should be associated with the activities of that period, without consideration to future potential benefits. 26. View B proponents point out that since entities engaged in mining activities are not exempt from the provisions of ARB 43, all costs of producing the reserves should be considered costs of the extracted minerals under a full absorption costing system and recognized as a component of costs of sales in the same period as the related revenue. 27. View B proponents believe that the same methods should be used for accounting for production costs in the mining industry as are used in other industries where inventories are produced and sold. As such, production costs for a period should be attributable to the inventory produced during that period. View C: Stripping costs should be capitalized and recognized in earnings using a stripping ratio, subject to not recognizing a liability in periods when the actual stripping ratio is less than the estimated average stripping ratio for the mine. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 10
28. View C is comparable to View D if the Task Force requires the use of a proportionate performance ratio to attribute capitalized stripping costs (View B of Issue 2). However, View D has more conceptual merit that is, stripping costs are mine development costs. Accordingly, if the Task Force prefers the use of a stripping ratio, the Task Force should reach consensuses on View D of Issue 1 and View B of Issue 2. Therefore, the FASB staff has not included the arguments regarding View C in this Working Group Report. View D (Working Group Recommendation): Stripping costs are a mine development cost that should be capitalized as an investment in the mine and attributed to proved and probable reserves benefited in a systematic and rational manner. 2 2 If the Task Force reaches a consensus on View D of Issue 1, the FASB staff will ask the Task Force to consider the following expanded guidance. This expanded guidance incorporates preliminary decisions made by the Task Force at the November 17 18, 2004 EITF meeting (refer to paragraph 11) and recommendations by the Working Group. View D, as expanded, is subject to changes to the attribution method from Issue 2. The Working Group supports View D, as expanded. Stripping costs are mine development costs that should be capitalized as an investment in the mine to the extent that the stripping costs are expected to provide additional future benefit. Capitalized stripping costs should be attributed to proved and probable reserves in a systematic and rational manner. An enterprise is expected to perform, and document, a detailed analysis of all pertinent facts and circumstances to support its attribution of stripping costs. Those facts and circumstances should be consistent with the enterprise s mine plan. An enterprise should specifically attribute stripping costs to reserves that directly benefit from the stripping activities. That is, if the reserves in the mine are sufficiently distinct from one another (for example, the mine has multiple ore bodies or pits) such that stripping activities benefit the distinct reserves, the enterprise should attribute the related capitalized stripping costs to the specific reserves benefited. For example, if a mine has an ore body that extends east and another ore body that extends northwest, the stripping costs incurred to mine the ore body that extends east do not benefit the ore body that extends northwest and, therefore, the costs that are incurred to mine the ore body that extends east should be attributed solely to that ore body. In other circumstances, the extraction of proved and probable reserves may require the construction of multiple pits to access these reserves. The stripping costs incurred to extract the reserves from a specific pit should be attributed to the reserves that are produced from that pit. An entity generally is expected to specifically attribute stripping costs incurred during production to reserves that represent less than the total proven and probable reserves of a mine. That is, it is expected that in most situations, an enterprise is able to componentize the reserves for the purpose of attributing capitalized stripping costs to the specific reserves benefited. Both the units of production method and a proportional performance ratio (such as a stripping ratio) may be systematic and rational methods to attribute capitalized costs to reserves benefited. However, in no circumstances should an entity recognize a liability (or accumulated amortization in excess of cumulative capitalized stripping costs) that results from the application of a proportional performance ratio. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 11
29. Proponents of View D believe that stripping costs incurred during production are a cost incurred to gain access to reserves and therefore represent an additional development cost that should be capitalized as part of the cost of the mine. These proponents believe that stripping costs incurred during the production phase represent continuous development of the mine because they allow access to additional sources of reserves as waste and reserves are extracted from the mine. For that reason, View D proponents hold the view that all stripping costs represent mine development costs that should be accounted for on a consistent basis irrespective of whether the costs are incurred during initial mine development or during production. 30. View D proponents support the capitalization of stripping costs incurred during production by analogy to FAS 19. Paragraph 21 of FAS 19 states, in part, that "Development costs are incurred to obtain access to proved reserves." Paragraph 22 of FAS 19 states, in part, that "Development costs shall be capitalized as part of the cost of an enterprise's wells and related equipment and facilities." View D proponents believe that stripping costs incurred in the production phase of a mine are a "development cost incurred to obtain access to proved reserves" and, therefore, those costs should be capitalized as part of the cost of an enterprise's mine consistent with treatment of development costs under FAS 19. Opponents of View D believe that the stripping costs incurred during production are production costs, and they note that FAS 19 requires production costs to be included in the costs of the inventory produced. 31. To further support the capitalization of the stripping costs as an asset, View D proponents emphasize that the fair value of a partially developed ore body, where waste material has already been removed, would be greater than a comparable ore body where little or no waste material has The Task Force also generally agreed that estimates used to apply those attribution methods should be reevaluated at least on an annual basis and more frequently if there are changes in facts and circumstances. Changes in the estimates used to apply those attribution methods should be treated as changes in estimates under APB 20. The Task Force also observed that unfavorable changes in estimates used to attribute capitalized stripping costs may be an indication that the capitalized costs are not recoverable and, therefore, may trigger an impairment test under FAS 144 for the capitalized costs of the mine. The Task Force also observed that amortization of stripping costs should be included in the cost of inventory when the costs are attributed to reserves that are extracted and, in turn, should be classified as cost of goods sold (subject to SAB Topic 11-B, for public registrants, which permits the reclassification to depletion, deprecation, and amortization). EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 12
been removed (that is, the ore body is more valuable as a result of the removal of waste because access to future reserves becomes easier and less costly). View D supporters believe that stripping costs should be capitalized on the balance sheet as an asset (additional investment in the mine) as the costs incurred to remove the waste material meet the characteristics of an asset as defined by CON 6. 32. View D proponents believe that stripping costs capitalized as part of an enterprise's investment in the mine should be allocated to the mined reserves in a systematic and rational manner. Issue 2 addresses the attribution of capitalized stripping costs under View D. FASB Staff Recommendation 33. The FASB staff recommends View B. If the Task Force reaches a View B (or View A) consensus, the staff recommends that the scope of the Issue revert back to its original scope that is, the consensus should apply to stripping costs incurred during the production phase. The staff also recommends that the production phase of a mine should be deemed to have begun when operations have begun and revenue is realized from the sale of minerals, irrespective of the level of production. Issue 2: Whether the attribution method for capitalized stripping costs should be an accounting policy decision or based on the facts and circumstances associated with each mine. 34. If the Task Force reaches a consensus on View D of Issue 1, the FASB staff will ask the Task Force to consider Issue 2. 35. At the November 17 18, 2004 EITF meeting, the Task Force asked the FASB staff to (a) develop the facts and circumstances that an entity should consider when determining the appropriate attribution method and (b) consider whether the attribution method should be an accounting policy decision or based on the facts and circumstances associated with each mine. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 13
Factors to consider when determining the appropriate attribution method 36. In response to a questionnaire, the majority of the Working Group indicated that it was not aware of factors that consistently would result in a conclusion that one attribution method was preferable to another. One respondent stated that the lack of factors to determine which method is preferable is likely due to the fact that a proportionate performance ratio and the units of production method are premised upon two different views of what the unit of account is the proportionate performance ratio considers the unit of account to be the mine or ore body and the units of production method considers the extracted ore to be the unit of account. However, one member of the Working Group suggested, primarily to promote consistency in the application of the proposed guidance in this Issue, that the Task Force specify the attribution method based on the general type of mine and geological structure. Specifically, the Working Group member suggested that the units-of-production method should be used for a horizontal geological formation and a proportional performance ratio should be used for a vertical geological formation (this view is discussed in more detail below). Similarly, another Working Group member suggested that since the goal of providing factors to determine the appropriate attribution method is to reduce diversity in practice, the Task Force should reconsider its preliminary decision to permit attribution alternatives. Diversity in practice 37. For stripping costs that are incurred during production, most mining entities currently either apply a life-of-mine stripping ratio or expense them as they are incurred. View D of Issue 1 addresses the question of whether stripping costs should be capitalized as part of the investment in the mine and it will eliminate the expense as incurred method of accounting for stripping costs. However, some diversity will continue if mining entities are permitted to select an attribution method that guidance only requires a systematic and rational attribution method and acknowledges that both the units of production method and a proportionate performance ratio may be systematic and rational methods. 38. No Working Group member's response to the questionnaire identified any situations in which entities currently use the units-of-production method to attribute stripping costs incurred during production to operations (although units-of-production is common to attribute other EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 14
development costs including pre-production stripping costs). Further, the preparers on the Working Group were asked to identify any of their current operations for which they believe it would be preferable to use a units-of-production method to attribute stripping costs that were incurred during production. The preparers indicated that they believe there are no circumstances under which the units-of-production method would be preferable. Although the preparers on the Working Group may not be a representative sample of all mining entities, the FASB staff believes that their conclusions on the use of the units-of-production method is a strong indication of how entities will apply the proposed guidance in this Issue. Additionally, the use of a proportionate performance ratio would result in a continuation of an attribution method for many entities. View A: Both the units of production method and a proportional performance ratio may be systematic and rational methods to attribute capitalized stripping costs to reserves benefited. The method of attribution is an accounting policy decision that should be applied consistently to all of the mining operations of an entity. 39. View A proponents believe that both the units of production method and a proportional performance ratio may be systematic and rational methods to attribute capitalized costs to the reserves benefited. Additionally, View A proponents believe that the attribution method should be an accounting policy decision that should be applied consistently to all of the mining operations of an entity and that the attribution method should be disclosed as a critical accounting policy (refer to the subsequent discussion on disclosures). View A proponents believe that requiring an entity to apply the same accounting policy to all its operations will provide consistency within an entity. Additionally, View A proponents note that the majority of the Working Group believes that no facts and circumstances exist that would distinguish one attribution model as preferable for specific types of mines. Accordingly, there is no basis for using different attribution models for different mines or ore bodies within the same entity. 40. View A opponents believe that View A does not provide any additional guidance and that the diversity in practice between entities will continue. Some opponents believe that the Task EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 15
Force should require the use of an attribution method to reduce the diversity in practice and improve the company-to-company comparability of financial information. View B: A proportional performance ratio should be used to attribute capitalized stripping costs to reserves benefited. 41. View B proponents believe that a proportional performance ratio is a systematic and rational method to attribute capitalized costs to reserves benefited and that it reflects the economics of the mine. Additionally, View B proponents believe that requiring a single attribution method will improve the company-to-company comparability of financial information. 42. View B proponents essentially believe that the unit of account is the mine (or a distinct ore body) and the attribution of costs should be ratable over the production of the mine (or the distinct ore body). View B proponents believe that a proportional performance ratio is the only attribution method that is consistent with the premise underlying View D of Issue 1; that all stripping costs are mine development costs (that is, the mine is the unit of account). For example, assume that a mine has reserves that are located in a vertical seam (relative to the land surface) that requires the removal of overburden to be completed in layers in order to access the full depth of the ore body. That is, the removal of a "layer" of overburden is required to access reserves extracted in the current period, as well as to access reserves extracted in the future. Given this scenario, the stripping activity is directly associated with all the remaining proven and probable reserves within the mine. Therefore, the attribution of capitalized stripping costs to reserves extracted in future periods is appropriate. Under a proportional performance ratio, the entity would capitalize the stripping costs for each layer of waste and attribute those costs based on an estimated performance ratio (stripping ratio). The result of the application of this method is that the entity will attribute a similar amount of stripping costs to each unit of ore that is extracted from the mine. 43. Some View B proponents also believe that if the Task Force permits an entity to choose an attribution method (View A), most entities will use a proportionate performance ratio because it better reflects the economics of the mine and it may not result in a change to their current policy. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 16
Accordingly, they believe that the Task Force could simplify the accounting by requiring a single method of attribution (proportionate performance ratio) and thereby improve the comparability of financial information in the mining industry. 44. Some View B opponents believe that the unit of account is the extracted ore, not the mine. These opponents believe that an entity should attribute the capitalized stripping costs to the extracted ore based on the effort required to extract the ore. They believe that a proportional performance ratio is a mechanism to smooth earnings, which does not provide investors with information about the volatility in operations and escalating costs of certain mines. View C: The units-of-production method should be used to attribute capitalized costs to reserves benefited. 45. View C proponents believe that the units-of-production method is a systematic and rational method to attribute capitalized costs to reserves benefited and that it reflects the economics of extracting the minerals. Additionally, View C proponents believe that requiring a single attribution method will improve the company-to-company comparability of financial information in the mining industry. 46. View C proponents essentially believe that the unit of account is the ore that is extracted from the mine and that the ore should carry costs that reflect the effort required to extract the ore. For example, assume that a mine has reserves that are located in a vertical seam (relative to the land surface) that requires the removal of overburden to be completed in layers in order to access the full depth of the ore body. That is, the removal of a "layer" of overburden is required to access reserves extracted in the current period, as well as to access reserves extracted in the future. Given that scenario, the stripping activity is directly associated with all the remaining proven and probable reserves within the mine. Therefore, the attribution of capitalized stripping costs to reserves extracted in future periods is appropriate. Under a units-of-production method, the entity would capitalize the stripping costs for each layer of waste and amortize those costs over the remaining proven and probable reserves. The result of the application of this method is EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 17
that the cost per unit of ore will be less in earlier periods (for the ore closer to the surface) and greater in later periods (for the ore further from the surface). 47. View C opponents believe that the unit of account is the mine, not the extracted ore, and that View C is inconsistent with the premise underlying View D of Issue 1; that stripping costs are mine development costs. These opponents believe that mining entities assess the economic viability of a mine (or ore body) as a single unit and that the accounting should reflect the economics of the mine (or ore body), not the individual units of extracted ore. In particular, View B opponents are concerned that requiring a units-of-production amortization method may result in a mining entity recognizing "artificially high" operating margins in the early years of a mine's life and that those margins would gradually decrease over time, resulting in the entity recognizing "artificially low" gross margins toward the end of the mine's productive life, which ultimately may result in an impairment charge before the mine reaches the end of its productive life. View D: The units-of-production method should be used to attribute capitalized stripping costs to reserves benefited for an ore body that has a horizontal geological formation. A proportional performance ratio should be used to attribute capitalized costs to reserves benefited for an ore body that has a vertical geological formation. 48. View D proponents believe that methods used to attribute capitalized stripping costs to reserves benefited should be based on the general types of mines and geological structures. Specifically, View D proponents believe that the units of production method should be used for horizontal (relative to the land surface) ore bodies and a proportional performance ratio should be used for vertical (relative to the land surface) ore bodies. View D proponents believe that the Task Force should require these attribution methods primarily to promote consistency in the application of the proposed guidance and to improve the company-to-company comparability of financial information in the mining industry. 49. View D proponents believe that an entity can identify the ore that benefits from stripping costs incurred for a horizontal ore body. Additionally, proponents believe that an entity can EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 18
componentize the ore body into smaller sections and the application of the units of production method will appropriately attribute those costs to the extracted ore. Opponents of View D believe that a proportionate performance ratio also appropriately attributes stripping costs to the extracted ore and will likely result in similar attribution amounts for a horizontal ore body. 50. View D proponents believe that a proportional performance ratio should be applied to vertical ore bodies because some portion of all stripping costs will benefit not only the production of ore immediately underlying the overburden removed, but also the production of ore at the lower levels of the mine in later periods. The arguments to use a proportional performance ratio for a vertical mine are the same as those presented for View B. 51. Opponents of View D believe that View D will result in frequent operational difficulties in determining which attribution method to use because most mines (and ore bodies) have geological formations with both vertical and horizontal characteristics. Further, opponents believe that there is no conceptual basis for using different attribution methods as required by View D. Cash Flow and Income Statement Characterization of Stripping Costs under View D 52. If the Task Force reaches a consensus on View D of Issue 1, the FASB staff will ask the Task Force to consider the effect on the cash flow and income statement characterization of stripping costs. A consensus on a view other than View D will not change current practice. 53. The basic premise of View D of Issue 1 is that all stripping costs improve the mine and, therefore, should be capitalized as an investment in the mine. The FASB staff believes that the cash flow statement and income statement characterization of stripping costs should be consistent with that basic premise. As a result, a consensus on View D of Issue 1 may require a recharacterization of stripping costs in cash flow statements and income statements of mining entities. 54. For the statement of cash flows, mining entities currently report stripping activities incurred during production as operating activities, irrespective of the method used to account for the EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 19
stripping costs. Under a consensus on View D of Issue 1, mining entities will capitalize all stripping costs as a development activity and, therefore, should report the costs as an investing activity in the statement of cash flows. Attribution of the capitalized stripping costs should be included in "depreciation, depletion, and amortization" (DD&A). As a result, cash flows from operations will increase through an increase in DD&A. 55. Mining entities also generally report stripping costs incurred during production in costs of sales, irrespective of the method used to account for the stripping costs. Under a consensus on View D of Issue 1, mining entities will capitalize all stripping costs and attribute those costs to production (inventoriable costs). When the inventory is sold, those stripping costs will then be included with DD&A. For the income statement, most mining entities currently report costs of sales and DD&A as two separate components of operating costs. 3 Accordingly, a consensus on View D of Issue 1 may result in a significant recharacterization of stripping costs from costs of sales to DD&A in the income statement. 56. The FASB staff acknowledges that the recharacterization of stripping costs in the cash flow and income statements is a significant financial reporting change for mining entities. The staff believes that those changes are necessary to remain consistent with the basic premise of View D of Issue 1. If the Task Force reaches a consensus on View D of Issue 1, the FASB staff will acknowledge in the minutes and the abstract that the income statement and cash flow statement characterization of stripping costs should be consistent with the notion that stripping costs are mine development costs. Disclosure 57. If the Task Force reaches a consensus on View D (or View C) of Issue 1, the FASB staff will ask the Task Force to consider requiring additional disclosures. If the Task Force reaches a consensus on View A or View B of Issue 1, stripping costs will be expensed or treated as an inventory cost. Accordingly, the FASB staff believes that additional disclosures would not be required. 3 SAB Topic 11-B requires public companies to use a line item description that indicates that Costs of Sales does not include depreciation charges that are shown separately on the income statement. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 20
58. Under View D for Issue 1, the Working Group and FASB staff believe that the following disclosures should be required: (a) the accounting policy for stripping costs, in particular the methods and assumptions used to capitalize and amortize those stripping costs, (b) the amount of capitalized stripping costs included in property, equipment, and mine development (or comparable balance sheet caption) at each balance sheet date, (c) the estimated period over which capitalized stripping costs will be amortized, and (d) the amount of stripping costs attributed to production, the amount recognized in the income statement during each period that an income statement is presented, and where those amounts are reported in the income statement. Transition 59. Current practice for the accounting for stripping costs is diverse. Given the significant costs associated with stripping activities for the mining industry, reaching a consensus on this Issue will result in a significant change in accounting and financial reporting for certain entities. Accordingly, the FASB staff believes that the Task Force should consider transition alternatives for any consensus reached on this Issue. The staff has identified the following transition alternatives. View A: The guidance in this consensus shall be effective for financial statements issued for fiscal years beginning after December 15, 2005, with early adoption permitted. An entity shall recognize the cumulative effect of initially applying this consensus in accordance with the provisions of APB 20. Entities that elect to early adopt the guidance in this consensus during an interim period, shall report the effects of this change in interim financial statements in accordance with the provisions of FAS 3. To the extent necessary, balance sheet amounts are required to be reclassified for all years presented to conform to the presentation requirements of this consensus. For example, if an entity previously included a caption for deferred stripping costs on its balance sheet and the Task Force reaches a consensus on View D of Issue 1, the entity should reclassify the amounts previously reported as deferred stripping costs as property, plant, and equipment (or similar balance sheet caption). Additionally, where practicable, income statements and statements of cash flows should be reclassified for all years presented to conform to the presentation requirements of this consensus. EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 21
60. Proponents of View A believe that the change in financial reporting resulting from a consensus on this Issue will have significant effects on the financial statements of certain entities. Accordingly, these proponents believe that reporting the effect of a significant change in accounting principle is most effectively accomplished through the reporting of a cumulative effect adjustment, with pro-forma disclosures to highlight the effects of retroactive application of the consensus on previously issued financial statements. An effective date of fiscal periods beginning after December 15, 2005, is proposed to allow entities adequate time to prepare for the adoption of the guidance in this Issue. 61. Opponents of View A believe that this transition alternative is impractical (particularly under View D of Issue 1). These proponents cite the difficulty in determining the cumulative effect in those circumstances under which the mines may have been in operation for long periods of time. View B: The guidance in this consensus shall be applied for fiscal years beginning after December 15, 2005, with earlier application permitted. The effects of applying this guidance shall be reported by retroactive restatement of prior period financial statements in accordance with paragraphs 27 and 28 of APB 20. 62. Proponents of View B believe that the change in accounting and financial reporting resulting from this consensus will be a significant change in practice for certain mining entities. Additionally, View B proponents believe the advantages of restating prior periods (that is, comparability in financial reporting period-to-period and among entities in the mining industry) outweigh the disadvantages, and, therefore, mandatory restatement of prior period financial statements should be required. An effective date of fiscal periods beginning after December 15, 2005, is proposed to allow entities adequate time to prepare for the adoption of the consensus guidance in this Issue. 63. Opponents to View B believe that re-creating the financial statements in prior years to conform to a consensus in this Issue (particularly under View D of Issue 1) would be impractical EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 22
and virtually impossible in some circumstances. Accordingly, opponents to this view believe that the costs of requiring restatement would far outweigh any perceived benefits. View C: The guidance in this consensus shall be effective for financial statements issued for fiscal years beginning after December 15, 2005, with early adoption permitted and shall be applied to stripping costs incurred after the consensus has been adopted. Recognition of a cumulative effect in accordance with the provisions of APB 20 and FAS 3 would not be permitted, except in the case in which an enterprise had previously recognized a liability pursuant to a stripping ratio accounting policy. In that case, the liability should be derecognized and recognized as a cumulative effect of an accounting change in accordance with APB 20 and FAS 3. Amounts previously recognized as stripping assets are required to be reclassified to property, equipment, and mine development (or comparable balance sheet caption), for all years presented and accounted for in accordance with the guidance in this consensus on a prospective basis. Where practicable, income statements and statements of cash flows should be reclassified for all years presented to conform to the presentation requirements of this consensus. Restatement of prior period financial statements to conform to the guidance in this consensus is permitted but not required. 64. Proponents of View C believe that prospective transition is acceptable for a change of this nature. Proponents of View C also believe that restatement of prior period financial statements to conform to the guidance in this consensus in those circumstances when it is practical and results in improved financial reporting should be permitted. If the Task Force reaches a consensus on View A or View B of Issue 1, this transition alternative is not preferable as it would have the effect of prolonging the continued capitalization of past stripping costs over extended periods (thereby prolonging the diversity in practice). EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 23
EXHIBIT 04-6A CROSS SECTION OF A MINE AND CALCULATION OF A DEFERRED STRIPPING COST RATIO Waste/Ore Stripping Ratio Year 1 - Initial stripping-all waste material (capitalized) Year 2 6:1 Stripping ratio is high as waste material is removed to reach lower portions of the ore body Year 3 3:1 Stripping ratio is slightly lower as the ore body is being accessed Year 4 2:1 Stripping ratio is low as most waste was removed in prior phases Life-of-Mine 3:1 EITF Issue No. 04-6 Working Group Report No. 1, Supplement No. 2, p. 24