The International Financial Reporting Standards are the focus of three recent articles:
1. This review which links you to major reports on the standards and other articles and discussions on implementing the standards—we do what can only be done on a computer: give you the chance to browse and decide for yourself by consulting many e-documents.
3. An article in the Canadian Mining Journal that I came across after writing this piece. I recommend you read it—you may find it more focused than this piece.
Now for my survey of the International Reporting Standards. (The pictures have nothing to do with the topic—I include them for color and general interest.)
Other well written documents on the topic:
Ø Financial Reporting in the Global Mining Industry. Issued by Deloitte Touche Tohmatsu in 2003 report on the topic. I recommend its most beautiful photos.
Ø Valuation from early 2006 is an InfoMine’s review on an associated topic.
Ø Real Time International Financial Reporting Standards in the Mining Sector. Issued by PricewaterhouseCoopers in mid 2006
"How does a patch of ground get the okay from the money people to become a mine? Given that the patch of ground is going to take about 10 years before something saleable comes out of it, there are many assumptions that will have to be made, such as the future value of the metal, the cost of production and the cost of cleaning up once all the metal is gone. How do you put a money figure on all these future factors and make the results comparable so you can meet industry standards and make your project comparable with all the other potential investment opportunities out there?”
This the question asked by my Peer Reviewer. So I pose the question, and now I proceed to answer it in my dry way.
The International Financial Reporting Standards are intended to increase the transparency and comparability of financial statements. Thus they are particularly applicable to a mining company’s financial statements and aspects of mining accounting such as derivatives, interest rates, and currency swaps. I will attempt to explain all this as we proceed.
Common mining related derivatives are long-term commodity sales contracts and long-term contracts to purchase electricity or fuel. In short, how do you put a value on these when the “value”, cost, or income is not absolutely determined, and no current income or expenditure is involved?
Contracts indexed to market-based variables may contain an “embedded derivative”. For example if the contract price or income is linked to consumer price of labor indexes, foreign exchange rates, or the price of coal or electricity, it may be difficult to establish just what the value of the contract is. This is not just of interest to the accountant. It may affect the underling value of the company, the mine, or a department’s budget provisions—and thus the poor engineer is involved and affected.
A mining contract based on a derivative is to be valued in accordance with the International Financial Reporting Standards at fair value. Can you imagine setting that number as you fight for next years budget increase or try to justify your consultant’s latest estimate of closure costs for a newly planned tailings impoundment.
Here are some key points from the PriceWaterHouse report:
1) Mining activities begin with the exploration and evaluation of an area of interest. If the exploration and evaluation are successful, a mine can be developed and commercial mining begin. Many years and significant costs precede mining. Many exploration projects do not result in a mine. Some mining companies capitalize exploration and evaluation expenditure; others write off the costs preceding a decision to start production. Another approach is to “provide in full against exploration costs”; if the project is abandoned, the costs are written off; if the project proceeds the provision is reversed.
2) The commissioning period may be long. During commissioning of the mine production gradually increases to design capacity. For example, commissioning a block caving operation may involve increasing production as the cave goes higher. Which costs are capital costs, involved in “establishing” a mine, and which costs are “production” costs in the traditional sense of the word? Defining all costs and revenues as operating may result in a large reported trading loss on expenditures that in reality will produce substantial future income.
3) Mines may be tempted to recognize decommissioning liabilities when the mine starts commercial production. In practice, the liability arises at the development stage—you will have to decommission even though no product has yet been produced.
I will not attempt to summarize the rest of the discussion on the accounting complexity of decommissioning costs. We can all quote cases were the cost estimates and provisions vary wildly from time to time as mine plans change, as regulations change, and as expectations change. Inevitably thought the engineer is affected by the accounting procedures implemented to provide for these costs. Here is a case history from the PricewaterhouseCoopers report:
“An obligation to incur decommissioning and site rehabilitation costs occurs when environmental disturbance is caused by development or ongoing production. Costs are estimated on the basis of a formal closure plan and are subject to peer review. The cost for restoration of site damage is provided for at net present values and charged against operating profits as extraction progresses. Changes in the measurement of liability related to site damage created during production is charged against operating profit.
Other mining activities where the accounting gets complex
and may affect real-time
The PricewaterhouseCoopers report notes that accounting procedures in these and many others areas of mining are developing and changing. They encourage individual and industry groups to actively participate in interpreting and applying the standards.
The PriceWaterHouse report is beautifully produced—as are all the reports on this topic—a measure of the cost of accounting? Unfortunately the writing is not. The issues are not that hard—see the KPMG report: a model of clear prose is this statement:
“Over the last five years there has been much debate about how to properly account for the Extractive Industries (oil, gas and mining). The International Accounting Standards Board has tackled the issue. So have many national accounting standards authorities. The sector has also been subject to greater scrutiny due to the launch of the Publish What You Pay campaign (PWYP) and the Extractive Industries Transparency Initiative (EITI). Despite this, and the support of many within the industry and within the world’s largest accounting firms for one set of accounting standards for this global sector, there has to date been little progress in this direction. Publish What You Pay coalition partners, Global Witness, Save the Children UK, CARE International UK, CAFOD, the Open Society Institute and Transparency International UK have come together to publish the report "Extracting Transparency: the Need for an International Financial Reporting Standard for the Extractive Industries" (September 2005). The report argues that country-by-country reporting by oil, gas and mining companies on commercial performance, reserves, taxes and other benefits paid to governments, is essential information for investors, analysts and all other users of company financial statements when making investment decisions about extractive companies. This information is also vital to citizens who are concerned with the management of this important global industry.”