International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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of account. Others believe that the area-of-interest method is more akin to the full cost
method applied on an area-of-interest basis.79 ‘Under the area-of-interest concept, all
costs identified with an area of interest would be deferred and capitalised if commercial
reserves are later determined to exist in the area. However, costs incurred up to the
point that an area of interest is identified (prospecting costs) are often charged to
expense by those who consider that they are applying the area-of-interest concept.
Costs of individual unsuccessful activities incurred on a specific area of interest, such as
drilling an exploratory well that finds no reserves, are accumulated as part of the total
cost of the area of interest.’80
While IFRS 6 will often not permit all aspects of an area-of-interest method defined by
a national GAAP, an entity that uses relatively small areas of interest may be able to
implement the method in a meaningful way under IFRS. The area-of-interest method
is more common in the mining sector than in the oil and gas sector. Still, there are some
entities that apply the method to oil and gas activities.
Extract 39.3: BHP Billiton plc (2017)
10 Property, plant and equipment [extract]
Recognition and measurement [extract]
Exploration and evaluation
Exploration costs are incurred to discover mineral and petroleum resources. Evaluation costs are incurred to assess
the technical feasibility and commercial viability of resources found.
Exploration and evaluation expenditure is charged to the income statement as incurred, except in the following
circumstances in which case the expenditure may be capitalised:
In respect of minerals activities:
•
the exploration and evaluation activity is within an area of interest that was previously acquired as an asset
acquisition or in a business combination and measured at fair value on acquisition; or
•
the existence of a commercially viable mineral deposit has been established.
In respect of petroleum activities:
•
the exploration and evaluation activity is within an area of interest for which it is expected that the
expenditure will be recouped by future exploitation or sale; or
•
exploration and evaluation activity has not reached a stage that permits a reasonable assessment of the
existence of commercially recoverable reserves.
A regular review of each area of interest is undertaken to determine the appropriateness of continuing to carry forward
costs in relation to that area. Capitalised costs are only carried forward to the extent that they are expected to be
recovered through the successful exploitation of the area of interest or alternatively by its sale. To the extent that
capitalised expenditure is no longer expected to be recovered, it is charged to the income statement.
Key judgements and estimates [extract]
Exploration and evaluation expenditure results in certain items of expenditure being capitalised for an
area of interest where it is considered likely to be recoverable by future exploitation or sale, or where
the activities have not reached a stage that permits a reasonable assessment of the existence of reserves.
This policy requires management to make certain estimates and assumptions as to future events and
circumstances, in particular whether an economically viable extraction operation can be established.
These estimates and assumptions may change as new information becomes available. If, after having
capitalised the expenditure under the policy, a judgement is made that recovery of the expenditure is
unlikely, the relevant capitalised amount will be written off to the income statement.
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3.2.6
Changes in accounting policies
The standard permits a change in an entity’s accounting policies for E&E expenditures
only if ‘the change makes the financial statements more relevant to the economic
decision-making needs of users and no less reliable, or more reliable and no less relevant
to those needs’. [IFRS 6.13, BC49]. In making such a change, an entity should judge the
relevance and reliability using the criteria in IAS 8. The entity should justify the change
by demonstrating that the change ‘brings its financial statements closer to meeting the
criteria in IAS 8, but the change need not achieve full compliance with those criteria’.
[IFRS 6.14].
3.3
Measurement of exploration and evaluation assets
IFRS 6 draws a distinction between measurement at recognition (i.e. the initial
recognition of an E&E asset on acquisition) and measurement after recognition (i.e. the
subsequent treatment of the E&E asset).
The standard requires that upon initial recognition, E&E assets should be measured at
cost, [IFRS 6.8], which is the same as the initial recognition requirements found in IAS 16,
[IAS 16.15], and IAS 38. [IAS 38.24]. Therefore, the question arises as to what may be
included in the cost of an item. The standard contains considerable guidance on this
matter, under the heading ‘Elements of cost of exploration and evaluation assets’ (see
also 3.3.1 below).
After initial recognition IFRS 6 allows one of two alternatives to be chosen as the
accounting policy for E&E assets that it must apply consistently to all E&E assets, being
either the cost model or the revaluation model. [IFRS 6.12].
Under the cost model, the item is carried at cost less impairment. Entities that apply the
cost model should therefore develop an accounting policy within the constraints of
IFRS 6 (see 3.2.1 above). As a result, an entity will either develop an accounting policy
based on the successful efforts type of method or area-of-interest type of method
(see 3.2.3 and 3.2.5 above) – that requires capitalisation of E&E costs pending
evaluation; or develop a policy similar to the full cost type of method, which capitalises
all E&E costs (successful and unsuccessful), although it is not possible to continue using
this method outside the E&E phase (see 3.2.4 above).
The alternative is the revaluation model, which is not defined in IFRS 6 itself.
Instead, the standard requires an entity to classify E&E assets as tangible or
intangible assets (see 3.4 below) and apply the IAS 16 revaluation model to the
tangible assets and the IAS 38 revaluation model to the intangible assets
(see Chapter 18 at 6 and Chapter 17 at 8.2). Practically what this means is that E&E
classified as intangible assets may not be revalued, since the IAS 38 revaluation
model may only be applied to intangible assets that are traded in an active market.
[IAS 38.72, 75, IFRS 6.BC29-BC30].
3.3.1
Types of expenditure in the exploration and evaluation phase
The standard requires an entity to determine an accounting policy specifying which
expenditures are recognised as E&E assets and apply the policy consistently. Such an
accounting policy should take into account the degree to which the expenditure can be
associated with finding specific mineral resources. Types of expenditure include:
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(a) acquisition of rights to explore;
; (b) topographical, geological, geochemical and geophysical studies;
(c) exploratory
drilling;
(d) trenching;
(e) sampling;
and
(f) activities in relation to evaluating the technical feasibility and commercial viability
of extracting a mineral resource. [IFRS 6.9].
This list is not intended to be exhaustive.
In permitting geological and geophysical costs (G&G costs) to be included in the initial
measurement of E&E assets, IFRS differs from US GAAP – ASC 932 – Extractive
Activities – Oil and Gas, which does not permit capitalisation of G&G costs,81 and may
differ from the requirements under other national standards.
IFRS 6 allows an accounting policy choice as to how to treat expenditures on
administration and other general overhead costs; however, the chosen policy should be
consistent with one of the treatments available under other IFRSs, i.e. expense or
capitalise. [IFRS 6.BC28]. This is because there are inconsistencies between IAS 16 (which
does not allow such costs to be capitalised), IAS 2 (which requires capitalisation of
production overheads but not general administration) and IAS 38 (which only allows
capitalisation if directly attributable to bringing the asset into use, otherwise
capitalisation is prohibited).
Expenditures related to the development of mineral resources should not be recognised
as E&E assets. Instead, the IASB’s Conceptual Framework and IAS 38 should be applied
in developing guidance on accounting for such assets. [IFRS 6.10]. IFRS does not define
‘development of mineral resources’, but notes that ‘development of a mineral resource
once the technical feasibility and commercial viability of extracting the mineral
resource had been determined was an example of the development phase of an internal
project’. [IFRS 6.BC27]. While this is not a full definition, in practice this means that until a
feasibility study is complete and a development is approved, accumulated costs are
considered E&E assets and are accounted for under IFRS 6. The timing of transferring
expenditure from the exploration phase to the development phase is discussed in
further detail at 3.4.1 below.
The standard specifically requires the application of IAS 37 – Provisions, Contingent
Liabilities and Contingent Assets – to any obligations for removal and restoration that
are incurred during a particular period as a consequence of having undertaken the
exploration for and evaluation of mineral resources. [IFRS 6.11]. Although IFRS 6 did not
make a corresponding amendment to the scope of IFRIC 1 – Changes in Existing
Decommissioning, Restoration and Similar Liabilities – which applies to such liabilities
when they are recognised in property, plant and equipment under IAS 16, we believe
that the interpretation should also be applied in relation to E&E assets. However, if the
E&E costs were originally expensed, then the future costs of any related removal and
restoration obligations should also be expensed.
The extract below from Glencore illustrates a typical accounting policy for E&E assets
for a mining company.
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Extract 39.4: Glencore plc (2017)
Notes to the financial statements [extract]
1. Accounting policies [extract]
Property, plant and equipment
(ii) Exploration and evaluation expenditure
Exploration and evaluation expenditure relates to costs incurred in the exploration and evaluation of potential
mineral and petroleum resources and includes costs such as exploration and production licences, researching and
analysing historical exploration data, exploratory drilling, trenching, sampling and the costs of pre-feasibility
studies. Exploration and evaluation expenditure for each area of interest, other than that acquired from another
entity, is charged to the consolidated statement of income as incurred except when the expenditure is expected to
be recouped from future exploitation or sale of the area of interest and it is planned to continue with active and
significant operations in relation to the area, or at the reporting period end, the activity has not reached a stage
which permits a reasonable assessment of the existence of commercially recoverable reserves, in which case the
expenditure is capitalised. As the intangible component (i.e. licences) represents an insignificant and
indistinguishable portion of the overall expected tangible amount to be incurred and recouped from future
exploitation, these costs along with other capitalised exploration and evaluation expenditure are recorded as a
component of property, plant and equipment. Purchased exploration and evaluation assets are recognised at their
fair value at acquisition.
As the capitalised exploration and evaluation expenditure asset is not available for use, it is not depreciated.
All capitalised exploration and evaluation expenditure is monitored for indications of impairment. Where a
potential impairment is indicated, an assessment is performed for each area of interest or at the CGU level. To
the extent that capitalised expenditure is not expected to be recovered it is charged to the consolidated
statement of income.
Administration costs that are not directly attributable to a specific exploration area are charged to the consolidated
statement of income. Licence costs paid in connection with a right to explore in an existing exploration area are
capitalised and amortised over the term of the permit.
The extract below from BP illustrates an accounting policy for E&E assets for an oil and
gas company.
Extract 39.5: BP p.l.c. (2017)
Notes on financial statements [extract]
1. Significant accounting policies, judgements, estimates and assumptions [extract]
Intangible assets
Oil and natural gas exploration, appraisal and development expenditure
Oil and natural gas exploration, appraisal and development expenditure is accounted for using the principles of the
successful efforts method of accounting as described below.
Licence and property acquisition costs
Exploration licence and leasehold property acquisition costs are capitalized within intangible assets and are reviewed
at each reporting date to confirm that there is no indication that the carrying amount exceeds the recoverable amount.
This review includes confirming that exploration drilling is still under way or planned or that it has been determined,
or work is under way to determine, that the discovery is economically viable based on a range of technical and
commercial considerations, and sufficient progress is being made on establishing development plans and timing. If
no future activity is planned, the remaining balance of the licence and property acquisition costs is written off. Lower
value licences are pooled and amortized on a straight-line basis over the estimated period of exploration. Upon
recognition of proved reserves and internal approval for development, the relevant expenditure is transferred to
property, plant and equipment.
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Exploration and appraisal expenditure
Geological and geophysical exploration costs are recognized as an expense as incurred. Costs directly associated with
an exploration well are initially capitalized as an intangible asset until the drilling of
the well is complete and the
results have been evaluated. These costs include employee remuneration, materials and fuel used, rig costs and
payments made to contractors. If potentially commercial quantities of hydrocarbons are not found, the exploration
well costs are written off. If hydrocarbons are found and, subject to further appraisal activity, are likely to be capable of commercial development, the costs continue to be carried as an asset. If it is determined that development will not
occur then the costs are expensed.
Costs directly associated with appraisal activity undertaken to determine the size, characteristics and commercial
potential of a reservoir following the initial discovery of hydrocarbons, including the costs of appraisal wells where
hydrocarbons were not found, are initially capitalized as an intangible asset. When proved reserves of oil and natural
gas are determined and development is approved by management, the relevant expenditure is transferred to property,
plant and equipment.
3.3.2
Capitalisation of borrowing costs in the exploration and evaluation
phase
IAS 23 – Borrowing Costs – requires capitalisation of borrowing costs that are directly
attributable to the acquisition, construction or production of a ‘qualifying asset’ as part
of the cost of that asset. [IAS 23.8]. An E&E asset will generally meet the definition of a
qualifying asset as it ‘necessarily takes a substantial period of time to get ready for its
intended use or sale’. [IAS 23.5]. However, IAS 23 requires capitalisation of borrowing
costs only when it is probable that they will result in future economic benefits to the
entity and the costs can be measured reliably. [IAS 23.9]. Unlike IAS 23, IFRS 6 permits
capitalisation of E&E assets even when it is not probable that they will result in future
economic benefits. Unless an entity’s E&E project has resulted in the classification of
mineral resources as proven or probable, it is unlikely that future economic benefits
from that project can be considered probable. In these circumstances, it is consistent
with the requirements of IFRS 6 and IAS 23 to capitalise an E&E asset but not capitalise