Extractive Activities — Concepts

Status: Research on recognition and measurement issues complete. IASB discussion paper under development.

Background
Activities to Date
Next Steps
Related Information
Contact Information

Background

Reasons for the Project
Activities of extractive industries raise several accounting issues due to the unique nature of the oil & gas and mining industries. Accounting Guideline AcG-16, Oil and Gas Accounting — Full Cost, is the only primary source of Canadian GAAP that addresses unique extractive industry accounting issues (although certain standards provide guidance on narrow issues). Extractive industry issues are not addressed comprehensively by Canadian or US standards, or International Financial Reporting Standards. AcG-16 will not apply to publicly accountable enterprises after the adoption of IFRSs in 2011.

The International Accounting Standards Board (IASB) has asked a group of national standard setters to undertake a comprehensive research project that will form the first step toward the development of an acceptable approach to resolving accounting issues that are unique to upstream extractive activities. The AcSB is participating in this activity together with standard setters from Australia, Norway and South Africa.

Key Issues
The primary focus of the research project is on the financial reporting issues associated with reserves and resources — in particular whether and how to define, recognize, measure and disclose them.  Specifically, this will include determining the following:

Activities to Date

The International Accounting Standards Board's (IASB) predecessor organization, the International Accounting Standards Committee (IASC), established a Steering Committee in 1998 to carry out work on accounting and financial reporting by entities engaged in extractive activities.  The Steering Committee published an Issues Paper (“Extractive Industries,” in November 2000.  In response, 52 comment letters were received.

The research project commenced in April 2004, after the IASB and liaison national standard-setters considered the research project plan developed by the Extractive Activities project team.

An international advisory panel, which includes Canadian members, has been established to provide advice to the project team and the IASB throughout the research project.  The panel consists of analysts and other users of financial reports, individuals from entities engaged in extractive activities (both mining and oil & gas), auditors and securities regulators.

Definitions of Reserves and Resources
Following a request from the research project, an industry working group comprising members of the Committee for Mineral Reserves International Reporting Standards and the Society of Petroleum Engineers Oil and Gas Reserves Committee has undertaken a detailed review of their respective reserve and resource definitions, firstly to identify the potential for greater convergence of the definitions, and secondly to consider alternative approaches that might promote a common understanding of minerals and oil & gas reserve and resource definitions. Also involved in the review were representatives from the International Organization of Securities Commissions and the United Nations Economic Commission for Europe, both of which have an interest in reserve/resource definitions as well. The review was proposed because bringing the definitions closer together is expected to be beneficial to the development of an International Financial Reporting Standard that would apply to mineral and oil & gas reserves and resources.

Representatives of the Society of Petroleum Engineers (SPE) and Committee for Mineral Reserves International Reporting Standards (CRIRSCO) presented their completed report to the IASB in March 2008. The Board expressed the view that the research project’s discussion paper should identify the SPE and CRIRSCO definition and classification systems as representing the preferred sets of definitions for use in supporting accounting and disclosure requirements for minerals, and oil & gas reserves and resources. The project team will also monitor any future decisions made by the SEC with regard to its Concepts Release.

Recognition of Reserves and Resources in Financial Statements
The project is considering asset recognition from the perspective of the asset definition and recognition criteria in the IASB’s “Framework for the Preparation and Presentation of Financial Statements.” This contrasts with existing practice, whereby it is common for entities to capitalize costs or recognize them as expenses according to the different phases of upstream extractive activities, such as exploration and evaluation, development and production.

The economic resource, which relates to minerals or oil & gas, could be identified as three types of asset:

• legal rights, such as exploration rights or mineral rights;
• information (or knowledge); and
• a physical minerals or oil & gas deposit.

These assets can be viewed as forming a continuum representing the maturing of upstream extractive activities from early stage prospecting and exploration activities through to the extraction of minerals or oil & gas from the ground.

However, rather than recognizing each of these assets separately, the legal rights held at various stages along the continuum were identified as the assets that should be recognized. This is because it is the legal rights that provide an entity with the enforceable rights to use and exploit the information and the deposit.

Under this approach, a legal rights asset would be recognized when the rights are acquired. Following the recognition of a legal rights asset (either relating to exploration rights or mineral rights), information obtained from exploration and evaluation activities would be treated as an enhancement of the legal rights asset rather than a separate asset. This is because the information generates a better understanding of the economic resource that underlies the legal rights asset. As further information is obtained, uncertainty surrounding the potential and extent of future economic benefits that may reside in a minerals or oil & gas deposit should decrease. Arguably, as the level of uncertainty decreases, it may be possible to commence recognizing the physical minerals or oil & gas deposit as the asset instead of the legal rights and information. However, it was acknowledged that the asset associated with a minerals or oil & gas deposit is the right to extract the minerals or oil & gas contained in the deposit and that this is the asset that should continue to be recognized. For the purposes of communicating information to users of financial reports regarding the uncertainty surrounding the minerals or oil & gas deposit to which the legal rights relate, it was noted that this should be achieved by asset presentation and the disclosure of reserve and resource information associated with the property rather than by identifying the minerals or oil & gas deposit as the asset.

Unit of account selection is also relevant to initial recognition. It was suggested that the unit of account that would apply during the exploration phase would initially be defined according to the exploration rights held. As more exploration and evaluation takes place, the size of the unit of account would contract to cover only the specific area(s) where detailed exploration and evaluation is taking place. During the development and extraction phases, the unit of account would be no greater than a contiguous area, or areas, for which the legal rights are held and which is managed separately and would be expected to generate largely independent cash flows. The other dimension to unit of account selection is to determine which infrastructure and equipment assets (if any) that are associated with a developed property should be included in the same unit of account as the legal rights asset. On this point, it was noted that the components approach in IAS 16, Property, Plant and Equipment, may be useful in considering which assets should be recognized separately from the legal rights.

Measurement of Reserves and Resources when Recognized in Financial Statements
The project team undertook a survey of users of financial statements of companies in the extractive industries to determine their information needs. Key findings were:

• financial statements and note disclosures provide some information that is necessary for users to make an informed investment decision in relation to a minerals or oil & gas entity – primarily information related to cash flow and current period expenditures – but the information provided in financial statements and note disclosures alone is not sufficient to meet the needs of analysts and much information is sourced elsewhere;
• there is very limited interest in placing a valuation of reserves and resources (at current value or fair value) on the balance sheet;
• there is limited interest in disclosing a valuation of reserves and resources (at current value or fair value);
• measuring reserve and resource assets on the balance sheet according to a historical cost measurement model (e.g., successful efforts, full cost, area of interest) does not generate much useful information;
• analysts generally would prefer more, and/or improved, disclosure of key valuation inputs so that those inputs could be incorporated into their own valuation models; and
• directors sign off was generally identified as the preferred assurance or responsibility process that could be applied to the reporting of reserve information.

The IASB noted that historical cost information on exploration and evaluation assets does not provide information useful to investors and other users of financial statements but also acknowledged the difficulties in estimating fair value for these assets and the concerns of users over fair value information that might be provided by companies (e.g., whether the assumptions used were consistent with those of the user). After discussing the survey findings, the IASB indicated tentative support for the research project’s Discussion Paper to include consideration of both a current value measurement model and a historical cost measurement model supplemented by detailed disclosure.

Next Steps

The project team plans to bring an analysis of disclosure issues related to upstream extractives activities together with an outline of the research project’s Discussion Paper to a future meeting. 

At the conclusion of the research project, a discussion paper will be published for public comment.  The discussion paper is expected to be issued in late 2008.

Related Information

• IASB project page for Extractive Activities

Contact Information

Questions or comments on this project should be directed to:

Mark Walsh, FCA
Principal, Accounting Standards
Telephone:  +1 (416) 204-3453
Fax:  +1 (416) 204-3412

Canadian Accounting Standards Board
277 Wellington Street West
Toronto ON  M5V 3H2  Canada