International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  17.3.6

  Identifying lease payments included in the measurement of the lease

  liability

  Some lease agreements include payments that are described as variable or may appear

  to contain variability but are in-substance fixed payments because the contract terms

  require the payment of a fixed amount that is unavoidable. Such payments are lease

  payments included in the measurement of the lease liability and right-of-use assets at

  the commencement date.

  For example, consideration paid for the use of equipment, such as drilling rigs, is

  typically expressed as a rate paid for each operating day, hour or fraction of an hour.

  The types of rates a lessee may be charged include:

  • full operating rate – a rate charged when the rig is operating at full capacity with a

  full crew (in which case there could be a non-lease component of crew services);

  • standby rate or cold-stack rate – a rate charged when the lessee unilaterally puts

  the rig on standby;

  • major maintenance rate – a minimal rate, or in some cases a ‘zero rate’ charged

  when the lessor determines that maintenance needs to be performed and the rig is

  not available for use by the lessee; or

  • inclement weather rate – a minimal rate, or in some cases a ‘zero rate’ charged

  when weather makes it dangerous to operate the rig and, therefore, it is not

  available for use by the lessee.

  There will likely be variability in the pricing of a drilling contract, however typically

  there will be a minimum rate in these types of contracts. This amount would likely be

  the lowest rate that the lessee would pay while the asset is available for use by the lessee.

  Depending on the contract, this rate may be referred to using terms such as a standby

  or cold-stack rate. When identifying lease payments in an arrangement, mining

  companies and oil and gas companies should only consider rates that apply when the

  asset is available for use.

  Example 39.17: Identifying lease payments – inclement weather

  Upstream Entity A enters into a 3-year contract with Rig Owner for the right to use Drilling Rig 1 over a

  three year period. The contract is considered to contain a lease. The contract specifies the rates a lessee may

  be charged and these include:

  • full operating rate of 100,000 CU per day – charged when the rig is operating at full capacity with a full crew;

  • standby rate of 40,000 CU per day – charged when the lessee unilaterally puts the rig on standby; and

  • inclement weather rate of zero CU per day – charged when weather makes it dangerous to operate the

  rig and, therefore, it is not available for use by the lessee.

  Analysis

  In calculating the lease liability, the standby rate of 40,000 CU per day for 3 years would be used. The

  inclement weather rate is not applicable in calculating the minimum lease payments as the rate only applies

  when the asset is not available for use.

  Example 39.18: Identifying lease payments – major maintenance

  Mining entity Z enters into an arrangement with Equipment Supplier T for the lease of a piece of processing

  equipment to be utilised at the mine site. The contract requires payment of 10,000 CU per day for the

  equipment, but stipulates Supplier T perform10 days per annum of major maintenance that is required on the

  equipment. The day rate for those 10 major maintenance days is zero CU per day.

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  Analysis

  In calculating the lease liability, the rate of 10,000 CU per day would be used. However, the rate would only

  be applied for 355 days each year on the basis that the contractual arrangement clearly sets out that there are

  10 days per annum where the equipment will not be available for use to allow for major maintenance to be

  undertaken, and that a zero day rate will apply on those days. Accordingly, contractually, the minimum lease

  payments are in fact lower, as the equipment will only be available for 355 days per annum.

  This differs from the zero day rate that applies for inclement weather in example 39.17 above because the

  period of time when the inclement weather rate will apply, is outside of the control of both parties.

  See Chapter 24 at 4.5.1 for further discussion.

  17.3.7

  Allocating contract consideration

  Lessees allocate the consideration in the contract to the lease and non-lease components

  on a relative stand-alone price basis. However, IFRS 16 provides a practical expedient that

  permits lessees to make an accounting policy election, by class of underlying asset, to

  account for each separate lease component of a contract and any associated non-lease

  components as a single lease component. Lessors are required to apply IFRS 15 to allocate

  the consideration in a contract between the lease and non-lease components, generally, on

  a relative stand-alone selling price basis. See Chapter 24 at 3.2.3.B for further information.

  17.3.8

  Interaction of leases with asset retirement obligations

  When undertaking remediation and rehabilitation activities, it may be possible that a

  mining company or oil and gas company enters into an arrangement with a supplier that

  is, or contains, a lease that is considered to be an operating lease under IAS 17. The costs

  associated with these activities form a significant component of the costs which make

  up the asset retirement obligation (ARO) that was recognised by the mining company or

  oil and gas company at commencement of the mine or field.

  Upon adoption of IFRS 16, assuming this lease is not a short-term lease and does not

  relate to the lease of a low-value asset, a right-of-use asset and lease liability will need

  to be recognised. One of the issues that has arisen as a result of IFRS 16, is whether the

  mining company or oil and gas company’s recognition of the lease liability results in the

  derecognition of the ARO liability recognised on the balance sheet. Given that prior to

  the commencement of any ARO-related activities, the mining company or oil and gas

  company still has an obligation to rehabilitate under IAS 37, it cannot derecognise the

  ARO liability. Instead, it now has a separate lease liability for the financing of the lease

  of the asset. Accordingly, acquiring the right-of-use asset does not result in the

  derecognition of the ARO liability, rather, it would be the activity undertaken or output

  of the asset which would ultimately settle the ARO liability. This approach would be

  consistent with a scenario where an asset, e.g. the leased asset, had been purchased,

  using bank finance, and the finance liability relating to the bank debt used to purchase

  the asset, is separately recognised on the balance sheet.

  As such, at the point prior to any ARO activity (assuming this occurs at end of mine/field

  life), the mining company or oil and gas company has:

  • no ARO asset (fully amortised);

  • an ARO liability for the full ARO estimate;

  • a right-of-use asset; and

  • a lease liability.

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  See Chapter 24 at 5.2 for discussion on measurement of the right-of-use asset and

  lease liability.

  The impacts of this will include:

  • amortisation of the right-of-use asset across the period of use;

  • in
terest expense on the lease liability;

  • interest expense arising from the unwinding on the discount on the ARO liability,

  assuming interest continues to unwind over the remediation and rehabilitation

  activity period; and

  • the use (reduction) of the ARO liability (as the leased asset is used to settle

  the obligation).

  Consideration should be given to the requirements of IAS 37, [IAS 37.61-62], which sets out

  that a provision shall be used only for expenditures for which the provision was

  originally recognised, i.e. that expenditures that relate to the original provision are set

  against it. See Chapter 27 at 4.9.

  18 TOLLING

  ARRANGEMENTS

  In the mining sector it is common for entities to provide raw material to a smelter

  or refiner for further processing. If the raw material is sold to the smelter or refiner

  and the relevant criteria are satisfied, the mining company recognises revenue in

  accordance with IFRS 15. However, under a ‘tolling’ arrangement a mining

  company generally supplies, without transferring ownership, raw material to a

  smelter or refiner which processes it for a fee and then returns the finished product

  to the customer. Alternatively, the mining company may sell the raw material to the

  smelter or refiner, but is required to repurchase the finished product. In the latter

  two situations, no revenue should be recognised when the raw material is shipped

  to the smelter or refiner as there has not been a transfer of the risks and rewards.

  An entity should carefully assess the terms and conditions of its tolling

  arrangements to determine:

  • when it is appropriate to recognise revenue;

  • whether those arrangements contain embedded leases that require separation

  under IFRIC 4 (see 17.1 above);

  • whether the tolling arrangement is part of a series of transactions with a joint

  arrangement; and

  • whether the toll processing entity is a structured entity that requires consolidation

  under IFRS 10 (see Chapter 6 at 4.4.1 for more information).

  Extract 39.44 below describes a tolling arrangement between Norsk Hydro and one of

  its joint arrangements.

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  Extract 39.44: Norsk Hydro ASA (2013)

  Notes to the consolidated financial statements [extract]

  Note 26 – Investments in jointly controlled entities [extract]

  Aluminium Norf GmbH (Alunorf) located in Germany is the world’s largest rolling mill and is owned by Hydro and

  Hindalco Industries (50 percent each). Alunorf produces flat rolled products from raw material from the partners based

  on a tolling arrangement. Sales from Alunorf to Hydro amounted to NOK 1,499 million in 2013 and NOK 1,423 million

  in 2012. Hydro’s capital and financing commitments are regulated in the Joint Venture agreement. Alunorf has

  investment commitments amounting to NOK 444 million as of December 31, 2013. Hydro’s financing commitment

  based on its interest is NOK 189 million as of December 31, 2013. Alunorf is part of Rolled Products.

  For a discussion on the impacts of IFRS 15 on repurchase agreements, see 12.14 above.

  19 TAXATION

  As mentioned at 1.1 above, one of the characteristics of the extractive industries is the

  intense government involvement in their activities, which ranges from ‘outright

  governmental ownership of some (especially petroleum) or all minerals to unusual tax

  benefits or penalties, price controls, restrictions on imports and exports, restrictions on

  production and distribution, environmental and health and safety regulations, and others’.147

  Mining companies and oil and gas companies typically need to make payments to

  governments in their capacity as:

  • owner of the mineral resources;

  • co-owner or joint arrangement partner in the projects;

  • regulator of, among other things, environmental matters and health and safety

  matters; and

  • tax authority.

  The total payment to a government is often described as the ‘government take’. This includes

  fixed payments or variable payments that are based on production, revenue, or a net profit

  figure; and which may take the form of fees, bonuses, royalties or taxes. Determining whether

  a payment to government meets the definition of income tax is not straightforward.

  IAS 12 should be applied in accounting for income taxes, defined as including:

  (a) all domestic and foreign taxes which are based on taxable profits; and

  (b) taxes, such as withholding taxes, which are payable by a subsidiary, associate or

  joint arrangements on distributions to the reporting entity. [IAS 12.1-2].

  As discussed in Chapter 29 at 4.1, it is not altogether clear what an income tax actually is.

  In the extractive industries the main problem with the definition in IAS 12 occurs when:

  (a) a government raises ‘taxes’ on sub-components of net profit (e.g. net profit before

  financing costs or revenue minus allowed costs); or

  (b) there is a mandatory government participation in certain projects that entitle the

  government to a share of profits as defined in a joint operating agreement.

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  A considerable amount of judgement is required to determine whether a particular

  arrangement falls within the definition of ‘income tax’ under IAS 12 or whether it is

  another form of government take. From a commercial perspective the overall share of

  the economic benefits that the government takes is much more important than the

  distinction between its different forms. In practice, most governments receive benefits

  from extractive activities in several different ways, as discussed below. Governments

  can choose any of these methods to increase or decrease their share of the benefits.

  However, the distinction is crucial given the considerable differences in the accounting

  treatments and disclosures that apply to income taxes, other taxes, fees and government

  participations. For example, it will affect where these amounts are presented in the profit

  or loss, e.g. in operating costs or income tax expense; and it will determine whether

  deferred tax balances are required to be recognised and the related disclosures provided.

  19.1 Excise duties, production taxes and severance taxes

  Excise duties, production taxes and severance taxes result in payments that are due on

  production (or severance) of minerals from the earth. Depending on the jurisdiction and

  the type of mineral involved, they are calculated:

  (a) as a fixed amount per unit produced;

  (b) as a percentage of the value of the minerals produced; or

  (c) based on revenue minus certain allowable costs.

  19.1.1 Production-based

  taxation

  If the tax is based on a fixed amount per unit produced or as a percentage of the value

  of the minerals produced, then it will not meet the definition of an income tax under

  IAS 12. In these cases the normal principles of liability recognition under IAS 37 apply

  in recognising the tax charge.

  Another issue that arises is whether these taxes are, in effect, collected by the entity

  from customers on behalf of the taxing authority, as an agent. In other cases, the

  taxpayer’s role is more in the nature of principal than agent. The regulations differ


  significantly from one country to another. The practical accounting issue that arises

  concerns the interpretation of the requirements of IFRS 15 which states that the

  ‘transaction price is the amount of consideration to which an entity expects to be

  entitled in exchange for transferring promised goods or services to a customer,

  excluding amounts collected on behalf of third parties (for example, some sales taxes)’.

  [IFRS 15.47]. Specifically, should excise duties, production taxes and severance taxes be

  deducted from revenue (net presentation) or included in the production costs and,

  therefore, revenue (gross presentation)? See 12.11.2 above for further discussion on the

  impact of IFRS 15 on the presentation of royalty payments.

  The appropriate accounting treatment will depend on the particular circumstances. In

  determining whether gross or net presentation is appropriate, the entity needs to

  consider whether it is acting in a manner similar to that of an agent or principal. For

  further discussion of principal versus agent under IFRS 15 see 12.11 above and

  Chapter 28 at 5.4 and presentation of royalties at 5.7.5 above.

  Given that excise duties, production taxes and severance taxes are aimed at taxing the

  production of minerals rather than the sale of minerals, they are considered to be a tax

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  on extractive activities rather than a tax collected by a mining company or oil and gas

  company on behalf of the government. Based on this, the tax should be presented as a

  production cost.

  However, it may be considered that when the excise duty, production tax or severance

  tax is payable in kind, that the mining company or oil and gas company never receives

  any of the benefits associated with the production of the associated minerals. Hence, it

  would be more appropriate to present revenue net of the production or severance tax

  as it is in substance the same as a royalty payment.

  19.1.2

  Petroleum revenue tax (or resource rent tax)

  Determining whether a petroleum revenue tax (or resource rent tax) is a production- or

  profit-based tax is often not straightforward. Example 39.19 below describes the

  petroleum revenue tax in the United Kingdom.

  Example 39.19: Petroleum revenue tax148

  Petroleum revenue tax (PRT) is a special tax that seeks to tax a high proportion of the economic rent (super-