revenue arising from the extraction of mineral ores was outside the scope of IAS 18,
[IAS 18.6(h)], the sales method was similar to the revenue recognition approach in IAS 18
because revenue was only recognised when an entity transferred ownership of the
goods and the amount of revenue could be measured reliably.
Under the entitlements method, net revenue reflected the participant’s share of
production regardless of which participant in the joint operation had actually made the
sale to a customer and issued an invoice. This was achieved by either adjusting revenue,
or adjusting cost of goods sold.
Recent developments challenge the extent to which this hierarchy of guidance remains
relevant. The first of these relates to some US GAAP guidance. The SEC announced in
March 2016 it would rescind its guidance that provided US GAAP upstream oil and gas
entities with the choice to use either the sales method or entitlements method to
account for production and sales imbalances (e.g. gas imbalances), effective upon
adoption of the US GAAP equivalent to IFRS 15 (Accounting Standards Codification
(ASC) 606 – Revenue from Contracts with Customers).116
The SEC staff indicated it would not challenge entities that continue to apply the sales
method but did not say whether it would continue to consider the entitlements method
acceptable once the new revenue standard was adopted. Rather, in the Basis for
Conclusions of ASU 2014-09,117 the FASB said entities need to determine whether
arrangements that require entities to periodically settle imbalances create vendor-
customer relationships. This is relevant because this rescindment will remove one
source of accounting literature and accepted industry practice that has been observed
in determining that the entitlements method is acceptable under IFRS.
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Secondly, the decommissioning of the former OIAC SORP (see 1.4 above), coupled with
the need to overlay IFRS pronouncements and guidance where available, means the
guidance set out in the former OIAC SORP may now be less relevant.
Below we analyse the main reasons that the entitlement method is not considered
consistent with the requirements of IFRS 15.
12.4.2
Accounting for imbalances in revenue under IFRS 15
Revenue from contracts with customers that falls within the scope of IFRS 15 should be
accounted for in accordance with the requirements of IFRS 15. Sales of the participant
in a joint operation to external customers are likely to be within the scope of IFRS 15
and should be recognised when the sales actually occur i.e. when the entity satisfies its
performance obligation by transferring a promised good or service (i.e. an asset) to a
customer. An asset is transferred when (or as) the customer obtains control of that asset.
[IFRS 15.31].
Transactions with other joint operation participants are unlikely to fall within the scope
of IFRS 15 and, hence, may not form part of revenue from contracts with customers.
[IFRS 15.5(d), 6]. This is also consistent with paragraphs BC52-BC56 in the Basis for
Conclusion to IFRS 15, the March 2015 IFRIC agenda decision on IFRS 11 (‘Recognition
of revenue by a joint venture’), and IFRS 11 which states that ‘A joint operator shall
account for the assets, liabilities, revenues and expenses relating to its interest in a joint
operation in accordance with the IFRSs applicable to the particular assets, liabilities,
revenues and expenses’. [IFRS 11.21, IFRS 15 BC52-BC56].
Where a participant in a joint operation has contractual arrangements with customers
which do fall in the scope of IFRS 15, it should record revenue from those contracts under
IFRS 15. No adjustments should be recorded in revenue to account for any variance
between the actual share of production volumes sold to date and the share of production
which the party has been entitled to sell to date. Under IFRS 15, a participant in a joint
operation should recognise revenue based on its actual sales to customers in that period.
Revenue from contracts with customers recognised in accordance with IFRS 15 is a
subset of total revenue recognised by an entity, and should be presented separately as
required by IFRS 15. [IFRS 15.113(a)]. However, recording adjustments through other
revenue in order to align total revenue earned (i.e. revenue from contracts with
customers under IFRS 15 plus other revenue) with the share of production the joint
operation participant is entitled to in the period, would not be appropriate. Recording
the amounts earned in one period in other revenue and, subsequently, recording them
as revenue under IFRS 15 in a future period (or vice versa), would result in recycling of
revenue earned between two line items in profit or loss. Furthermore, in periods where
the adjustment being recorded through other revenue is to reduce total revenue
recognised in the period, this would result in a debit entry or ‘negative revenue’ being
disclosed in other revenue.
In September 2018, the Interpretations Committee added a new item to its Work in
Progress agenda paper with respect to IFRS 11 and ‘Output received by a Joint Operator’.
The matter is briefly described as ‘Difference between a joint operator’s right to receive
a particular proportion of output and the actual output received’ and therefore is
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potentially going to deal with underlifts and overlifts. However, no further details were
available at the time of writing to be able to clarify.
12.4.3
Consideration of cost of goods sold where revenue is recognised in
accordance with IFRS 15
If revenue is recognised based on actual sales to customers in the period, and costs are
based on invoiced costs to the participants in a joint operation in proportion to their
equity interest, there will be a mismatch between the proportion of revenue lifted and
sold and the proportion of costs borne. Entities may determine that is it appropriate to
adjust production costs to align volumes for which production costs are recognised with
volumes sold (for which revenue has been recognised in accordance with IFRS 15).
The accounting for the adjustments to cost of goods sold will depend on whether the
imbalances are settled between/among joint operation participants in cash or by physical
settlement, as well as whether the joint operation is in an overlift or underlift position.
Entities applying the sales method historically have generally addressed this mismatch
in one of two ways in the case of physical settlement:
(a) Accrue or defer expenses – With this approach, an overlift participant would
accrue for future expenses by way of future production costs that are not matched
by corresponding future revenues. That is, if the overlift liability meets the
definition of a provision under IAS 37 the joint operation participant should follow
the principles of IAS 37.
That is, an overlift liability generally meets the definition of a provision under
IAS 37 as the timing and amount of the settlement are uncertain and are not
payable in cash, but in kind. In applying IAS 37, the amount recognised as a
provision should be ‘the best estimate of the expenditure requir
ed to settle the
present obligation at the end of the reporting period’, [IAS 37.36], which is ‘the
amount that an entity would rationally pay to settle the obligation at the end of the
reporting period’. [IAS 37.37]. The overlift liability is recorded at market value or at
cost, whichever is more appropriate in light of the terms of the contractual
arrangement in place.
Conversely, an underlift participant would defer expenses and match them against
future catch-up production, by recognising the underlift asset as a prepaid. This is
because an underlift asset gives the joint operation participant the right to receive a
quantity of product from another participant. This right would be equivalent to a
prepaid commodity purchase or may be considered to represent a right to additional
physical inventory and therefore, IAS 2 should be applied by analogy. The underlift
asset is measured at the lower of cost or net realisable value, or otherwise at net
realisable value, but only if there is a well-established industry practice.
(b) No
adjustment – Not accounting for the effects of imbalances has been justified on the
grounds that operating costs for the period should be expensed as incurred because
they relate to the period’s production activity and not to the revenues recognised.118
In the case of cash balancing, the underlift asset or overlift liability meets the definition
of a financial asset or financial liability respectively, in accordance with IAS 32 and
therefore, should be accounted for in accordance with IFRS 9. The initial recognition
of that financial asset or financial liability would be at fair value. Depending on the
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designation of the financial asset or financial liability, subsequent measurement would
be either at amortised cost or fair value. The fair value in such cases would equal the
cash settlement amount that participants are entitled to or required to pay.
12.4.4 Facility
imbalances
Imbalances that are similar to overlifts and underlifts can also arise on facilities such as
pipelines when a venturer delivers more or less product into a pipeline than it takes out
in the same period. The resulting accounting issues arising are similar to those
concerning overlifts and underlifts.
12.5 Production sharing contracts/arrangements (PSCs)
These arrangements are discussed more generally at 5.3 above. It is necessary to
consider whether such contracts are within the scope of IFRS 15. That is, whether the
relationship between the government entity and the contracting enterprise (i.e. the
mining company or oil and gas company) represents one between a customer and a
supplier. IFRS 15 defines a customer as ‘a party that has contracted with an entity to
obtain goods or services that are an output of the entity’s ordinary activities in exchange
for consideration’. See Chapter 28 at 3.2 for details. [IFRS 15 Appendix A].
There are no specific requirements within IFRS governing the accounting for PSCs,
which has resulted in accounting approaches that have evolved over time. These
contracts are generally considered to be more akin to working interest relationships
than pure services contracts. This is because the contracting enterprise assumes risks
associated with performing the exploration, development and production activities and
receives a share (and often a greater share) of future production as specified in the
contract. When an entity determines it has an interest in the mineral rights themselves,
revenue is recognised only when the mining company or oil and gas company receives
its share of the extracted minerals under the PSC and sells those volumes to third-party
customers. In other arrangements, the entity’s share of production is considered a fee
for services (e.g. construction, development and/or operating services) which is
recognised as the services are rendered to the national government entity.
IFRS 15 notes that, in certain transactions, while there may be payments between parties
in return for what appears to be goods or services of the entity, a counterparty may not
always be a ‘customer’ of the entity. Instead, the counterparty may be a collaborator or
partner that shares the results from the activity or process (such as developing an asset
in a collaboration arrangement) rather than to obtain the output of the entity’s ordinary
activities. Generally, contracts with collaborators or partners are not within the scope
of the standard, except as discussed below. [IFRS 15.6].
The IASB decided not to provide additional application guidance for determining
whether certain revenue generating collaborative arrangements are in the scope of the
standard. In the Basis for Conclusions to IFRS 15, it explains that it would not be possible
to provide application guidance that applies to all collaborative arrangements.
[IFRS 15.BC54].
In determining whether the contract between a government entity and a contracting
enterprise is within the scope of the standard, an entity must look to the definition of a
customer and what constitutes its ‘ordinary activities’ and there should also be a transfer
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of control of a good or service to the customer (if there is one). It may be that certain
parts of the PSC relationship involve the contracting enterprise and the national
government entity acting as collaborators (and, hence, that part of the arrangement
would be outside the scope of IFRS 15), while for other parts of the arrangement the
two parties may act as supplier and customer. The latter will be within the scope of
IFRS 15 and an analysis of the impact of the requirements will be necessary.
See Chapter 28 at 3.3.
12.6 Forward-selling contracts to finance development
Mineral and oil and gas exploration and development are highly capital intensive
businesses and different financing methods have arisen. At times, obtaining financing
for these major projects may be difficult, particularly if equity markets are tight and loan
financing is difficult to obtain. Some increasingly common structured transactions
continue to emerge which involve the owner of the mineral interests, or oil and gas
interests, i.e. a mining entity or oil and gas entity (the producer), selling a specified
volume of future production from a specified property/field to a third party ‘investor’
for cash. Such arrangements can be referred to as streaming arrangements.
A common example in the mining sector might be a precious metal streaming arrangement
where a bulk commodity producer (e.g. a copper producer who has a mine that also
produces precious metals as a by-product) enters into an arrangement with a streaming
company (the investor). Here the producer receives an upfront cash payment and (usually)
an ongoing predetermined per ounce payment for part or all of the by-product precious
metal (the commodity) production – ordinarily gold and/or silver, which is traded on an
active market. By entering into these contracts, the mining entity is able to access funding
by monetising the non-core precious metal, while the investor receives the future
production of precious metals without having to invest directly in, or operate, the mine.
We also note that similar types of arrangements are increasingly being used in the oil
and gas sector as a source of funding.
These arrangements can take many forms and accounting for such arrangements can be
highly complex. In many situations there is no specific guidance for accounting for these
types of arrangements under IFRS.
12.6.1
Accounting by the producer
Generally, the accounting for these arrangements by the producer could be one of
the following:
• a financial liability (i.e. debt) in accordance with IFRS 9. A key factor in
determining whether the contract is a financial liability is whether the contract
establishes a contractual obligation for the producer to make payments in cash or
another financial asset, [IAS 32.11, IAS 32.16(a)], that is, whether the arrangement has
more of the characteristics of debt;
• a sale of a mineral interest (under IAS 16 or IAS 38) and a contract to provide
services such as extraction, refining, etc., in accordance with IFRS 15. This would
occur when the arrangement effectively transfers control over a portion of the
mine from the producer to the investor and there is an obligation to provide future
extraction services; or
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• a commodity contract, which is outside the scope of IFRS 9 and in the scope of
IFRS 15. This would only occur when the arrangement is an executory contract to
deliver an expected amount of the commodity in the future to the investor from
the producer’s own operation (i.e. it meets the ‘own-use’ exemption). If the
commodity contract does not meet the own-use exemption, the arrangement will
be in scope of IFRS 9.
Whether the arrangement constitutes debt, a sale of mineral interest and a contract to
provide services or a forward sale of a commodity, is subject to significant judgement.
In each classification, the producer must assess and determine whether the arrangement
contains separable embedded derivatives. That is, the producer would need to
determine whether the arrangement contains a component or terms which had the
effect that some of the cash flows of the combined instrument (being the arrangement)
vary in a similar way to a stand-alone derivative (i.e. an embedded derivative).
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 654
