• IFRS 16 – does not apply to ‘leases to explore for or use minerals, oil, natural gas
and similar non-regenerative resources’. [IFRS 16.3(a)]. However, leases including
leases of right-of-use assets in a sublease of assets used for exploration or
evaluation activities are in the scope of IFRS 16.
• IAS 38 – does not apply to ‘expenditure on the exploration for, or development
and extraction of, minerals, oil, natural gas and similar non-regenerative resources’
or to the recognition and measurement of E&E assets. [IAS 38.2(c)-(d)].
• IAS 40 – does not apply to ‘mineral rights and mineral reserves such as oil, natural
gas and similar non-regenerative resources’. [IAS 40.4(b)].
• IFRIC 4 – does not apply to arrangements that are, or contain, leases excluded
from the scope of IAS 17. [IFRIC 4.4].
3.2
Recognition of exploration and evaluation assets
3.2.1
Developing an accounting policy under IFRS 6
When developing its accounting policy for E&E expenditures, IFRS 6 requires an entity
recognising E&E assets to apply paragraph 10 of IAS 8. [IFRS 6.6, BC19]. Hence
management should use its judgement in developing and applying an accounting policy
that results in information that is relevant and reliable. [IAS 8.10]. However, IFRS 6 does
provide an exemption from paragraphs 11 and 12 of IAS 8, [IFRS 6.7, BC17], which ‘specify
sources of authoritative requirements and guidance that management is required to
consider in developing an accounting policy for an item if no IFRS applies specifically
to that item’ (the so-called ‘GAAP hierarchy’, see Chapter 3 at 4.3). In developing such
a policy, IFRS 6 imposes a number of significant constraints on an entity’s choice of
accounting policy because:
• an entity needs to specify which expenditures are recognised as E&E assets and
apply that accounting policy consistently (see 3.3.1 below); [IFRS 6.9]
• expenditures related to the development of mineral resources should not be
recognised as E&E assets (see 3.3.1 below); [IFRS 6.10] and
• the requirement to apply IAS 16, IAS 38 and IAS 36 after the E&E phase affects the
choice of accounting policies during the E&E phase. In January 2006 the IFRIC
Extractive
industries
3215
clarified that ‘it was clear that the scope of IFRS 6 consistently limited the relief
from the hierarchy to policies applied to E&E activities and that there was no basis
for interpreting IFRS 6 as granting any additional relief in areas outside its scope’.72
For example, an entity may be able to apply the full cost method of accounting
(see 3.2.4 below) during the E&E phase, but it will not be able to apply that policy
after the E&E phase.
The IASB believed that waiving these requirements in IFRS 6 would ‘detract from the
relevance and reliability of an entity’s financial statements to an unacceptable degree’.
[IFRS 6.BC23].
3.2.2
Options for an exploration and evaluation policy
Entities active in the extractive industries have followed, and continue to follow, a large
variety of accounting practices for E&E expenditure, which range ‘from deferring on the
balance sheet nearly all exploration and evaluation expenditure to recognising all such
expenditure in profit or loss as incurred’. [IFRS 6.BC17]. As mentioned earlier, IFRS 6 provides
an exemption from paragraphs 11 and 12 of IAS 8. The inference from this is that the
standard ‘grandfathers’ all existing practices by not requiring these to have any authoritative
basis. The Basis for Conclusions states that ‘the Board decided that an entity could continue
to follow the accounting policies that it was using when it first applied the IFRS’s
requirements, provided they satisfy the requirements of paragraph 10 of IAS 8 ... with some
exceptions ...’. [IFRS 6.BC22]. These exceptions in IFRS 6, described above, have a rather more
profound impact than may be obvious at first sight and, in fact, instead of allowing previous
national GAAP accounting policies, IFRS 6 effectively prohibits many of them.
There are several methods adopted by oil and gas companies (and modified by
some mining companies) to account for E&E costs. These include successful efforts,
full cost and area of interest accounting. These methods have evolved through the
use of previous GAAPs and industry practice. While these terms and methods (or
similar methods) are commonly used in the sector, none of these is specifically
referred to in IFRS.
We explore below each of these methods and consider to what extent they are
compliant with the requirements of IFRS.
3.2.3
Successful efforts method
The successful efforts methods that have been developed by different accounting
standard-setters are generally based on the successful efforts concept as set out in US
GAAP, under which generally only those costs that lead directly to the discovery,
acquisition, or development of specific, discrete mineral resources and reserves are
capitalised and become part of the capitalised costs of the cost centre. Costs that when
incurred fail to meet this criterion are generally charged to expense in the period they
are incurred. Some interpretations of the successful efforts concept allow entities to
capitalise the cost of unsuccessful development wells.73
Under the successful efforts method an entity will generally consider each individual
mineral lease, concession, or production sharing contract as a cost centre.
When an entity applies the successful efforts method under IFRS, it will need to
account for prospecting costs incurred before the E&E phase under IAS 16 or IAS 38.
3216 Chapter 39
As economic benefits are highly uncertain at this stage of a project, prospecting costs
will typically be expensed as incurred. Costs incurred to acquire undeveloped mineral
rights, however, should be capitalised under IFRS if an entity expects an inflow of
future economic benefits.
To the extent that costs are incurred within the E&E phase of a project, IFRS 6 does not
prescribe any recognition and measurement rules. Therefore, it would be acceptable for
such costs to be recorded as assets and written off when it is determined that the costs
will not lead to economic benefits or to be expensed as incurred if the outcome is
uncertain. Deferred costs of an undeveloped mineral right may be depreciated over some
determinable period, subject to an impairment test each period with the amount of
impairment charged to expense, or an entity may choose to carry forward the deferred
costs of the undeveloped mineral right until the entity determines whether the property
contains mineral reserves.74 However, E&E assets should no longer be classified as such
when the technical feasibility and commercial viability of extracting mineral resources are
demonstrable. [IFRS 6.17]. At that time the asset should be tested for impairment under
IAS 36, reclassified in the statement of financial position and accounted for under IAS 16
or IAS 38. If it is determined that no commercial reserves are present, then the costs
capitalised should be expensed. Costs incurred after the E&E phase should be accounted
for in
accordance with the applicable IFRSs (i.e. IAS 16 and IAS 38).
It is worth noting that with the emergence of unconventional resource E&E projects,
such as shale, coal seam and tight oil or gas, the potential timeframe to determine the
technical feasibility and commercial viability of a resource can be considerably longer
than that of a conventional resource. This is primarily due to the scale of work required
to determine the technical feasibility and commercial viability of these more complex
and/or less accessible resources in a higher cost environment. Such feasibility
determinations may include the drilling and analysing of a significant number of wells
over an extended period of time. As such, the overall success of a drilling campaign
targeting unconventional resources may not be determined until completion of the
campaign – as opposed to the more common well by well basis that is often the case for
conventional projects.
Therefore, the costs incurred on unconventional projects over an extended E&E
campaign, may be carried forward under existing policies adopted, including
capitalisation under a successful efforts policy that permits such treatment, until such
time as the broader resource body is deemed to be either successful or unsuccessful.
The essence of most successful efforts approaches is that costs are capitalised pending
evaluation, and this would be acceptable under IFRS.
The following extract from the financial statements of Premier Oil illustrates a typical
successful efforts method accounting policy applied under IFRS.
Extract 39.2: Premier Oil plc (2017)
Accounting Policies [extract]
For the year ended 31 December 2017
Oil and gas assets [extract]
The Company applies the successful efforts method of accounting for exploration and evaluation (‘E&E’) costs,
having regard to the requirements of IFRS 6 Exploration for and Evaluation of Mineral Resources.
Extractive
industries
3217
(a) Exploration and evaluation assets
Under the successful efforts method of accounting, all licence acquisition, exploration and appraisal costs are
initially capitalised in well, field or specific exploration cost centres as appropriate, pending determination.
Expenditure incurred during the various exploration and appraisal phases is then written off unless commercial
reserves have been established or the determination process has not been completed.
Pre-licence costs
Costs incurred prior to having obtained the legal rights to explore an area are expensed as they are incurred.
Exploration and evaluation costs
Costs of E&E are initially capitalised as E&E assets. Payments to acquire the legal right to explore, costs of
technical services and studies, seismic acquisition, exploratory drilling and testing are capitalised as intangible
E&E assets.
Tangible assets used in E&E activities (such as the Group’s vehicles, drilling rigs, seismic equipment and other
property, plant and equipment used by the Company’s Exploration Function) are classified as property, plant and
equipment. However, to the extent that such a tangible asset is consumed in developing an intangible E&E asset,
the amount reflecting that consumption is recorded as part of the cost of the intangible asset. Such intangible costs
include directly attributable overhead, including the depreciation of property, plant and equipment utilised in E&E
activities, together with the cost of other materials consumed during the exploration and evaluation phases. E&E
costs are not amortised prior to the conclusion of appraisal activities.
Treatment of E&E assets at conclusion of appraisal activities
Intangible E&E assets related to each exploration licence/prospect are carried forward until the existence (or
otherwise) of commercial reserves has been determined subject to certain limitations, including review for
indications of impairment. If commercial reserves have been discovered, the carrying value, after any impairment
loss, of the relevant E&E assets, is then reclassified as development and production assets, once a field
development plan has been approved or a gas sales agreement has been signed. If, however, commercial reserves
have not been found, the capitalised costs are charged to expense after conclusion of appraisal activities.
(b) Oil and gas properties
Oil and gas properties are accumulated generally on a field-by-field basis and represent the cost of developing the
commercial reserves discovered and bringing them into production, together with the E&E expenditures incurred
in finding commercial reserves transferred from intangible E&E assets, as outlined in accounting policy (a) above.
The cost of oil and gas properties also includes the cost of acquisitions and purchases of such assets, directly
attributable overheads, finance costs capitalised, and the cost of recognising provision for future restoration and
decommissioning.
Depreciation of producing assets
The net book values of producing assets (including pipelines) are depreciated generally on a field-by-field basis
using the unit-of-production method by reference to the ratio of production in the year and the related commercial
(proved and probable) reserves of the field, taking into account future development expenditures necessary to
bring those reserves into production.
Producing assets are generally grouped with other assets that are dedicated to serving the same reserves for
depreciation purposes, but are depreciated separately from producing assets that serve other reserves.
3.2.4
Full cost method
The full cost method under most national GAAPs required all costs incurred in
prospecting, acquiring mineral interests, exploration, appraisal, development, and
construction to be accumulated in large cost centres, e.g. individual countries, groups of
countries, or the entire world.75 However, although an entity is permitted by IFRS 6 to
develop an accounting policy without reference to other IFRSs or to the hierarchy, as
described at 3.2.1 above, IFRS 6 cannot be extrapolated or applied by analogy to permit
3218 Chapter 39
application of the full cost method outside the E&E phase. This was confirmed by the
Interpretations Committee in January 2006.76
There are several other areas in which application of the full cost method under IFRS
is restricted because:
• IFRS 6 requires E&E assets to be classified as tangible or intangible assets
according to the nature of the assets. [IFRS 6.15]. In other words, even when an entity
accounts for E&E costs in relatively large pools, it will still need to distinguish
between tangible and intangible assets.
• While the full cost method under most national GAAPs requires the application of
some form of ‘ceiling test’, IFRS 6 requires – when impairment indicators are
present – an impairment test to be performed in accordance with IAS 36 (although
in accordance with IFRS 6, E&E assets can be allocated to CGUs or groups of CGUs
(which may include producing CGUs), provided certain criteria are met – see 3.5.2
below for further information).
• Once the technical feasibility and commercial viability of extracting mineral
resources are demonstrable, IFRS 6 requires that E&E assets shall no longer be
classified as such and need t
o be tested for impairment under IAS 36 and
reclassified in the statement of financial position and accounted for under IAS 16
or IAS 38. [IFRS 6.17]. This means that it is not possible to account for successful and
unsuccessful projects within one cost centre or pool.
For these reasons it is not possible to apply the full cost method of accounting under
IFRS without making very significant modifications in the application of the method.
An entity might want to use the full cost method as its starting point in developing its
accounting policy for E&E assets under IFRS. However, it will rarely be appropriate to
describe the resulting accounting policy as a ‘full cost method’ because key elements of
the full cost method are not permitted under IFRS.
In July 2009, the IASB published an amendment to IFRS 1 – Additional Exemptions for
First-time Adopters (Amendments to IFRS 1), which introduced a first-time adoption
exemption for first-time adopters that accounted under their previous GAAP for
‘exploration and development costs for oil and gas properties in the development or
production phases ... in cost centres that include all properties in a large geographical
area’ (i.e. the full cost method).77 Under the exemption, a first-time adopter may elect to
measure oil and gas assets at the date of transition to IFRSs on a deemed cost basis (see
Chapter 5 at 5.5.3), but does not permit continued application of the previous GAAP
accounting policy.
3.2.5 Area-of-interest
method
The area-of-interest method is an accounting concept by which ‘costs incurred for
individual geological or geographical areas that have characteristics conducive to
containing a mineral reserve are deferred as assets pending determination of whether
commercial reserves are found. If the area of interest is found to contain commercial
reserves, the accumulated costs are capitalised. If the area is found to contain no
commercial reserves, the accumulated costs are charged to expense’.78
Some consider the area-of-interest method to be a version of the successful efforts
method that uses an area-of-interest, rather than an individual licence, as its unit
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 636
