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(c)
Proved and probable reserves
The arguments in favour of using ‘proved and probable reserves’ as the reserves base in
applying the units of production method are similar to those discussed at (b) above. The
IASC’s Issues Paper summarised the arguments in favour of this approach as follows:
‘Proponents of [using “proved and probable reserves” as the reserve base] use the
same arguments given for including proved undeveloped reserves and related
future costs in calculating depreciation. They point out that in a cost centre in
which development has only begun a large part of capitalised prospecting, mineral
acquisition, exploration, and appraisal costs may apply to probable reserves. Often
in this situation there are large quantities of probable reserves, lacking only
relatively minor additional exploration and/or appraisal work to be reclassified as
proved reserves. They argue that, in calculating depreciation, it would be possible
to defer all costs relating to the probable reserves if either proved developed
reserves only, or all proved reserves, were to be used as the quantity on which
depreciation is based. They contend that using probable and proved reserves in
the reserve base and including in the depreciable costs any additional costs
anticipated to explore and develop those reserves provides more relevant and
reliable information.’137
The main drawbacks of this approach are that estimates of probable reserves are almost
certainly different from actual reserves that will ultimately be developed and estimates
of the costs to complete the development are likely to be incorrect because of the
potentially long time scales involved.138 Nevertheless, this approach has also found a
considerable degree of acceptance under IFRS among mining companies and oil and
gas companies that were permitted to apply the approach under their national GAAP
before (e.g. UK GAAP). Both Tullow Oil and Anglo American apply this approach, as
illustrated in Extracts 39.39 and 39.40 below.
Extract 39.39: Tullow Oil plc (2017)
ACCOUNTING POLICIES [extract]
YEAR ENDED 31 DECEMBER 2017
(l) Commercial reserves
Commercial reserves are proven and probable oil and gas reserves, which are defined as the estimated quantities of
crude oil, natural gas and natural gas liquids which geological, geophysical and engineering data demonstrate with a
specified degree of certainty to be recoverable in future years from known reservoirs and which are considered
commercially producible. There should be a 50 per cent statistical probability that the actual quantity of recoverable
reserves will be more than the amount estimated as proven and probable reserves and a 50 per cent statistical
probability that it will be less.
(m) Depletion and amortisation [extract]
All expenditure carried within each field is amortised from the commencement of production on a unit of production
basis, which is the ratio of oil and gas production in the period to the estimated quantities of commercial reserves at the end of the period plus the production in the period, generally on a field-by-field basis or by a group of fields which are reliant on common infrastructure. Costs used in the unit of production calculation comprise the net book value of
capitalised costs plus the estimated future field development costs required to recover the commercial reserves remaining.
Changes in the estimates of commercial reserves or future field development costs are dealt with prospectively.
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Extract 39.40: Anglo American plc (2017)
NOTES TO THE FINANCIAL STATEMENTS
OTHER ITEMS [extract]
38. ACCOUNTING POLICIES [extract]
Property, plant and equipment [extract]
Depreciation of property, plant and equipment
Mining properties are depreciated to their residual values using the unit of production method based on Proved and
Probable Ore Reserves and, in certain limited circumstances, other Mineral Resources included in the Life of Mine
Plan. These other Mineral Resources are included in depreciation calculations where, taking into account historical
rates of conversion to Ore Reserves, there is a high degree of confidence that they will be extracted in an economic
manner. This is the case principally for diamond operations, where depreciation calculations are based on Diamond
Reserves and Diamond Resources included in the Life of Mine Plan. This reflects the unique nature of diamond
deposits where, due to the difficulty in estimating grade, Life of Mine Plans frequently include significant amounts
of Indicated or Inferred Resources.
(d)
Proved and probable reserves and a portion of resources expected to be
converted into reserves (mining entities only)
We observe in practice that some mining entities adopt a slightly different approach
when depreciating some of their mining assets. They use proven and probable reserves
and a portion of resources expected to be converted into reserves. Such an approach
tends to be limited to mining companies where the type of mineral and the
characteristics of the ore body indicate that there is a high degree of confidence that
those resources will be converted into reserves. For example, this is very common for
underground operations that only perform infill drilling just prior to production
commencing. This is done so that capital is not spent too early before it is really needed.
Such resources can comprise measured, indicated and inferred resources, and even
exploration potential. Determining which of those have a high degree of confidence of
being extracted in an economic manner will require judgement. Such an assessment will
take into account the specific mineralisation and the ‘reserves to resource’ conversion
that has previously been achieved for a mine.
Such an approach is generally justified on the basis that it helps to ensure the
depreciation charges reflect management’s best estimate of the useful life of the assets
and provides greater accuracy in the calculation of the consumption of future
economic benefits.
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Anglo American applies this approach, as illustrated in Extract 39.40 above, as does Rio
Tinto, as illustrated in Extract 39.41 below.
Extract 39.41: Rio Tinto plc (2017)
Notes to the 2017 financial statements [extract]
1 Principal accounting policies [extract]
(i) Depreciation and impairment (notes 13 and 14) [extract]
Depreciation of non-current assets [extract]
Units of production basis
For mining properties and leases and certain mining equipment, consumption of the economic benefits of the asset is
linked to production. Except as noted below, these assets are depreciated on the units of production basis.
In applying the units of production method, depreciation is normally calculated based on production in the period as
a percentage of total expected production in current and future periods based on ore reserves and, for some mines,
other mineral resources. Other mineral resources may be included in the calculations of total expected production in
limited circumstances where there are very large areas of contiguous mineralisation, for which the economic viabi
lity
is not sensitive to likely variations in grade, as may be the case for certain iron ore, bauxite and industrial minerals
deposits and where there is a high degree of confidence that the other mineral resources can be extracted
economically. This would be the case when the other mineral resources do not yet have the status of ore reserves
merely because the necessary detailed evaluation work has not yet been performed and the responsible technical
personnel agree that inclusion of a proportion of measured and indicated resources in the calculation of total expected
production is appropriate based on historical reserve conversion rates.
The required level of confidence is unlikely to exist for minerals that are typically found in low-grade ore (as
compared with the above), such as copper or gold. In these cases, specific areas of mineralisation have to be evaluated
in considerable detail before their economic status can be predicted with confidence.
Where measured and indicated resources are used in the calculation of depreciation for infrastructure, primarily rail
and port, which will benefit current and future mines, then the measured and indicated resources may relate to mines
which are currently in production or to mines where there is a high degree of confidence that they will be brought
into production in the future. The quantum of mineral resources is determined taking into account future capital costs
as required by the JORC code. The depreciation calculation, however, applies to current mines only and does not take
into account future development costs for mines which are not yet in production. Measured and indicated resources
are currently incorporated into depreciation calculations in the Group’s Australian iron ore business.
An entity preparing its financial statements under IFRS will need to choose between using
‘proved developed reserves’, ‘proved developed and undeveloped reserves’, ‘proved and
probable reserves’ and, for mining entities in relation to certain mines, ‘proved and probable
reserves and a portion of resources expected to be converted into reserves’ as its reserves
base. Each of these approaches is currently acceptable under IFRS. Preparers of financial
statements should, however, be aware of the difficulties that exist in ensuring that the
reserves base and the costs that are being depreciated correspond. Users of financial
statements need to understand that comparability between entities reporting under IFRS
may sometimes be limited and need to be aware of the impact that each of the approaches
has on the depreciation charge that is reported. Given this, detailed disclosures are essential.
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16.1.3.C
Unit of measure
Under the units of production method, an entity assigns an equal amount of cost to each
unit produced. Determining the appropriate unit by which to measure production
requires a significant amount of judgement. An entity could measure the units of
production by reference to physical units or, when different minerals are produced in a
common process, cost could be allocated between the different minerals on the basis of
their relative sales prices.
(a)
Physical units of production method
If an entity uses the physical units of production method, each physical unit of reserves
(such as barrels, tonnes, ounces, gallons, and cubic metres) produced is assigned a pro
rata portion of undepreciated costs less residual value.
Example 39.16: Physical units of production method139
If an entity produces 100 units during the current period and the estimated remaining commercial reserves at
the end of the period are 1,900 units, the units available would be 2,000. The fractional part of the depreciable
basis to be charged to depreciation expense would be 100/2,000. Therefore, if the depreciable basis was 5,000
monetary units, the depreciation for the period would be 250 monetary units.
In applying the physical units of production method a mining company needs to decide
whether to use either the quantity of ore produced or the quantity of mineral contained
in the ore as the unit of measure.140 Similarly, an oil and gas company needs to decide
whether to use either the volume of hydrocarbons or the volume of hydrocarbons plus
gas, water and other materials. When mining different grades of ore, a mining company’s
gross margin on the subsequent sale of minerals will fluctuate far less when it uses the
quantity of minerals as its unit of measure. While a large part of the wear and tear of
equipment used in mining is closely related to the quantity of ore produced, the
economic benefits are more closely related to the quantity of mineral contained in the
ore. Therefore, both approaches are currently considered to be acceptable under IFRS.
(b)
Revenue-based units of production method
Another possible approach in applying the units of production method that may have
been used by some entities previously is to measure the units produced based on the
gross selling price of mineral.141 However, this approach is no longer permitted. This is
because as part of the 2011-2013 cycle of annual improvements the IASB approved an
amendment to IAS 16 and IAS 38 to clarify that a revenue-based depreciation or
amortisation method would not be appropriate.
16.1.3.D
Joint and by-products
In the extractive industries it is common for more than one product to be extracted from
the same reserves (e.g. copper mines often produce gold and silver; lead and zinc are
often found together; and many oil fields produce both oil and gas). When the ratio
between the joint products or between the main product and the by-products is stable,
this does not pose any complications. Also, if the value of the by-products is immaterial
then it will often be acceptable to base the depreciation charge on the main product. In
other cases, however, it will be necessary to define a unit of measure that takes into
account all minerals produced. The IASC’s Issues Paper listed the following approaches
in defining conversion factors for calculating such a unit of measure:142
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‘(a) physical
characteristics:
(i) based on volume: such as barrels, litres, gallons, thousand cubic feet or cubic
metres;
(ii) based on weight: such as tonnes, pounds, and kilograms; or
(iii) based on energy content (British thermal units) of oil and gas;
(b) gross revenues for the period in relation to estimated total gross revenues of the
current period and future periods (more commonly seen in the mining sector); and
(c) net revenues for the period in relation to total net revenues of the current and
future periods’.
Calculation of a conversion factor based on volume or weight has the benefit of being easy
to apply and can lead to satisfactory results if the relative value of the products is fairly
stable. For example, some mining companies that produce both gold and silver from the
same mines express their production in millions of ounces of silver equivalent. This is
calculated as the sum of the ounces of silver produced plus their ounces of gold produced
multiplied by some ratio of the gold price divided by the silver price. For example, if the
gold price was
$900 and the silver price was $12, this would provide a ratio of 1/75 – so the
quantity of gold would be multiplied by 75 to determine the equivalent ounces of silver.
However these ratios can change depending on the relationship between gold and silver.
Calculation of a conversion factor based on other physical characteristics is quite
common in the oil and gas sector. Typically production and reserves in oil fields are
expressed in millions of barrels of oil equivalent (mmboe), which is calculated by dividing
the quantity of gas expressed in thousands of cubic feet by 6 and adding that to the
quantity of oil expressed in barrels. This conversion is based on the fact that one barrel of
oil contains as much energy as 6,000 cubic feet of gas. While this approach is commonly
used, it is important to recognise two limiting factors: the actual energy conversion factor
will not always be 1:6 but may vary between 1:5½ to 1:6½ and the market price of gas per
unit of energy (typically BTU) is often lower than that of oil because of government price
controls and the need for expensive infrastructure to deliver gas to end users.
An approach that is commonly used (more so in the mining sector than the oil and gas
sector) in calculating a conversion factor when joint products are extracted, is to base it
on gross revenues. As discussed at 16.1.3.C above, the main drawback of this method is
that it requires an entity to forecast future commodity prices. Despite this drawback,
there will be situations where no other viable alternative exists for calculating an
appropriate conversion factor.
Finally, it is possible to calculate a conversion factor based on net revenue after deducting
certain direct processing costs. An argument in favour of this method is that gross
revenues do not necessarily measure the economic benefits from an asset. However,
taken to an extreme this argument would lead down a path where no depreciation is
charged in unprofitable years, which is clearly not an acceptable practice.
Accounting for the sale of joint products and by-products is addressed at 14.2 above.
16.2 Block caving – depreciation, depletion and amortisation (mining)
Given the nature of mining operations, determining the appropriate unit of account has
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 667
