Comments from ACCA to the International Accounting Standards Board, July 2010.
ACCA is pleased to have this opportunity to respond to the above discussion paper, which has been considered by ACCA's Financial Reporting Committee. The conclusions were informed by a sub-group of ACCA members who work in the extractive activities sector across a number of countries.
ACCA supports the IASB in proceeding with a project to standardise financial reporting of entities operating in extractive activities. It has now been over five years since the IASB issued the interim standard, IFRS6, and there continues to be divergence in accounting practices both across jurisdictions and within the industry itself. Given the significance of companies operating in extractive industries to global capital markets, we believe it is important that users of their financial reports are provided with consistent information.
We acknowledge that entities in the industry may have concerns about applying existing IFRS and many members of our industry sub-group felt that a specific standard was worthy of consideration. In principle, ACCA is sceptical about industry specific standards, especially where the recognition and measurement criteria may differ from existing IFRS. Thus, although the project team has put together some interesting proposals, we believe the DP still lacks a clear rationale for why a distinct accounting approach is needed for entities operating in the extractive activities sectors. We believe the IASB should further investigate why the current suite of IFRS cannot be appropriately applied by these sectors. As we note in our responses to the specific questions raised in the DP, activities such as exploration and evaluation carried out by these entities could be seen as analogous to research and development conducted in other industries such as the pharmaceutical and software development industries which are able to apply existing IFRS in a consistent manner and provide decision-useful information.
However, while we believe that any changes to the accounting model should be subject to further field-testing of the applicability of current IFRS, we do believe that the project should proceed forthwith in terms of providing industry guidance on disclosure and on the applicability of existing IFRS. Due to the nature of these activities and how entities within the industry are analysed, we do believe that specific disclosure requirements which are consistent across the industry will ensure that users will be provided with more meaningful information. To this end we are generally supportive of the disclosure objectives in the DP, although some of the specific requirements themselves appear to be onerous.
As the DP notes, a number of entities in the industry apply jurisdictional rules, with requirements issued by the SEC commonly used. It is therefore also important that the Board work closely with the FASB, taking into account these requirements and ensure any final guidance is converged.
Specific questions posed in the discussion paper
Questions 1 and 2 are commented on together.
Should IFRS include only upstream activities for minerals, oil & natural gas or are there are any other similar activities that should also fall within the scope of an IFRS for extractive activities?
and
Should there be a single accounting and disclosure model that applies to extractive activities in both the minerals industry and the oil and gas industry?
We agree that additional guidance in IFRS is needed to drive consistency in the financial reporting of entities involved in these areas. While there may be some differences in terms of how units of production are identified and allocated, we believe that the minerals and the oil and gas industries in general are quite similar in nature and have similar risks.
However, we note that the DP has a narrower scope than the activities covered by IFRS6. We believe that the Board should clarify whether the scope is suitably broad to cover existing (and anticipated) activities that have similar risks. This is particularly the case with emerging 'green' technologies such as the 'carbon capture' and waste disposal industries which involve finding and developing 'sinks', in similar ways to developing reserves.
Should the definitions for mineral reserve and resource established by CRIRSCO and the oil and gas reserve and resource definitions established by SPE be used in an IFRS for extractive activities?
We support the use of established industry definitions within IFRS. There is evidence that the CRIRSCO and SPE definitions are widely accepted in their respective industries. Common definitions should lead to greater consistency where companies in different jurisdictions currently follow definitions from alternative sources, leading to more useful information on measures of reserves and resources which are vital for the users of financial statements for entities involved in extractive activities.
The Board itself would not be expected to have the specialised expertise to develop relevant definitions of their own accord, although it is important for the Board to constantly review the appropriateness (in terms of relevance and acceptability) of those definitions. Given the wide use of SEC definitions internationally, we also believe it is important for the Board to ensure that both sets of definitions are converged or at least sufficiently aligned.
In Chapter 3, the project team proposes that legal rights, such as exploration rights or extraction rights, should form the basis of an asset referred to as a 'minerals or oil and gas property'. The property is recognised when the legal rights are acquired. Information obtained from subsequent exploration and evaluation activities and development works undertaken to access the minerals or oil and gas deposit would each be treated as enhancements of the legal rights.
Do you agree with this analysis for the recognition of a minerals or oil and gas property? If not, what assets should be recognised and when should they be recognised initially?
While we agree that it is important for entities operating in extractive activities to report on a more consistent basis, we strongly believe there should be consistency across IFRS in general. As noted in our general comments, we do not believe that the DP has adequately addressed the need for a specific accounting model for extractive activities. This is clearly a difficult area to conclude on, and indeed our industry sub-group, largely consisting of ACCA members from the oil and gas industries, was also unable to decisively conclude on whether specific recognition and measurement criteria were needed for these industries. We therefore believe that the project team and the IASB need to conduct sound field-testing to consider whether current IFRS cannot be applied satisfactorily in these industries especially with regards recognition and measurement of assets.
The proposals on capitalisation of legal rights and subsequent expenditure (which enhances the value of the underlying asset) will for many entities, be a significant change to how they currently account for such expenditure. Specifically those entities that currently apply a 'successful efforts' or an 'area of interest' approach to capitalising costs could see a considerable increase in the value of their 'minerals or oil and gas property' assets.
Costs which could result in 'unsuccessful' activities could still be capitalised, which appears inconsistent with the approach taken by entities who incur analogous R&D costs in for example the pharmaceutical and software development industries. There is little evidence that the criteria in IAS38 for capitalising and expensing costs in those industries, does not produce decision-useful information. We believe that the IASB should therefore investigate more fully the costs and benefits of removing the scope exemption from IAS38 before developing a sector specific standard.
We also question whether the capitalisation of all subsequent expenditure as proposed is consistent with the Framework definition of an asset for recognition purposes.
We do accept the specific nature of extractive activities, and that the applicability of IAS38 may therefore not be entirely practicable. Should the results of further field-testing show a need for industry specific recognition requirements, we would prefer an approach largely based on the commonly used 'successful efforts' method in the oil and gas industry, where
Indeed, although questions arise as to the compatibility of IAS38 with regards recognition of research activity in extractive activities, we believe that is should in fact be easier to effectively assess and value costs relating to successful exploration and evaluation activities in the mining or oil and gas industries than it is for research and development costs in the pharmaceutical industry.
Chapter 3 also explains that selecting the unit of account for a minerals or oil and gas property involves identifying the geographical boundaries of the unit of account and the items that should be combined with other items and recognised as a single asset.
The project team's view is that the geographical boundary of the unit of account would be defined initially on the basis of the exploration rights held. As exploration, evaluation and development activities take place, the unit of account would contract progressively until it becomes no greater than a single area, or group of contiguous areas, for which the legal rights are held and which is managed separately and would be expected to generate largely independent cash flows.
The project team's view is that the components approach in IAS 16 Property, Plant and Equipment would apply to determine the items that should be accounted for as a single asset.
Do you agree with this being the basis for selecting the unit of account of a minerals or oil and gas property? If not, what should be the unit of account and why?
The selection of the unit of account is clearly an important aspect of the accounting for extractive activities and we understand that the consistency in how this is defined and applied in current practice is an issue. However, we again question why the DP has failed to justify the basis of identifying cash generating units in IAS36 as not applicable in these circumstances.
We believe that the requirements in IAS36 are a suitably high level, set of guiding principles which would allow management to reflect how they structure their activities and then take into account the relevant facts and circumstances before concluding on either the upper or lower limit of the unit of account. It is important however, for appropriate disclosure to be provided on the basis used to identify the unit of account as this will also have an impact on assessments for impairment, as discussed in Question 7.
Chapter 4 identifies current value (such as fair value) and historical cost as potential measurement bases for minerals and oil and gas properties. The research found that, in general, users think that measuring these assets at either historical cost or current value would provide only limited relevant information. The project team's view is that these assets should be measured at historical cost but that detailed disclosure about the entity's minerals or oil and gas properties should be provided to enhance the relevance of the financial statements (see Chapters 5 and 6).
In your view, what measurement basis should be used for minerals and oil and gas properties and why?
As a principle we have consistently argued that operating assets should in general be subsequently measured at historical cost. We therefore support the conclusions in the DP that historical cost would be the most appropriate basis for initial and subsequent measurement of mining or oil and gas property assets.
We also agree that a major obstacle for using the current value approach is the uncertainty in respect of eventual outcomes of exploration activities. This coupled with other crucial inputs such as price volatility in these activities would mean that the usefulness of the information provided from such a measurement would not be sufficient to outweigh the potentially considerable costs of preparing it.
Chapter 4 also considers various alternatives for testing exploration properties for impairment. The project team's view is that exploration properties should not be tested for impairment in accordance with IAS 36 Impairment of Assets. Instead, the project team recommends that an exploration property should be written down to its recoverable amount in those cases where management has enough information to make this determination. Because this information is not likely to be available for most exploration properties while exploration and evaluation activities are continuing, the project team recommends that, for those exploration properties, management should:
(a) write down an exploration property only when, in its judgement, there is a high likelihood that the carrying amount will not be recoverable in full; and
(b) apply a separate set of indicators to assess whether its exploration properties can continue to be recognised as assets.
Do you agree with the project team's recommendations on impairment? If not, what type of impairment test do you think should apply to exploration properties?
As noted in the response to Question 4, we believe there is a strong case for reviewing the applicability of current IFRS for recognition and measurement for related assets. If IAS38 were applied, it is clear that exploration and evaluation costs would have been expensed up until the criteria for technical feasibility and commercial viability had been met. Therefore impairment testing itself would only commence from this point in any case. We would therefore again start with the position that IAS36 should be applicable for impairment testing also, unless sufficient evidence exists to show that it would not be relevant to extractive activities.
In the proposed model, it is clear that applying the indicators for impairment in IAS36 would almost invariably lead to impairment as there would be limited evidence to support the carrying value of the asset. Therefore under the proposed model for asset recognition, it would be appropriate to have the caveat of a 'high likelihood' of the asset not being recoverable for an impairment test to be triggered. We also agree that if evidence exists to suggest an exploration asset is impaired then the requirements of IAS 36 should apply.
Under Question 4, we suggested that if further research showed that a distinct recognition model was required for extractive activities, an approach similar to the successful efforts method used by many companies in the oil and gas industries in particular would be more appropriate. We believe that the proposals on impairment in the DP would be applicable under such a method. The capitalised legal rights and pre-licence surveying costs would in effect be rarely tested for impairment, until there was clear evidence that the project was 'unsuccessful' or facts and circumstances suggested that the carrying amount would not be recovered from the anticipated future net cash flows.
Q8 - Disclosure objectives
In Chapter 5 the project team proposes that the disclosure objectives for extractive activities are to enable users of financial reports to evaluate:
(a) the value attributable to an entity's minerals or oil and gas properties;
(b) the contribution of those assets to current period financial performance; and
(c) the nature and extent of risks and uncertainties associated with those assets.
Do you agree with those objectives for disclosure? If not, what should be the disclosure objectives for an IFRS for extractive activities and why?
While we have raised concerns about the need for specific recognition and measurement requirements for upstream extractive activities, we wholly support the need to have additional disclosure guidance for these industries. The disclosure of reserves and resources are arguably as important as other primary statements for users of their financial statements.
Overall, we support the disclosure objectives set out in the DP, although we would prefer the objective in point (a) to refer to sufficient information on resources and reserves, to enable users to make their own assessments on an entity's minerals or oil and gas properties, rather than explicitly refer to the 'value attributable'.
We also believe that reference should be made to the expected timing of cash flows, as this would clearly impact on any external assessment on the value of the entity's assets and reserves.
Q9 - Disclosure requirements
Also in Chapter 5, the project team proposes that the types of information that should be disclosed include:
(a) quantities of proved reserves and proved plus probable reserves, with the disclosure of reserve quantities presented separately by commodity and by material geographical areas;
(b) the main assumptions used in estimating reserves quantities, and a sensitivity analysis;
(c) a reconciliation of changes in the estimate of reserves quantities from year to year;
(d) a current value measurement that corresponds to reserves quantities disclosed with a reconciliation of changes in the current value measurement from year to year;
(e) separate identification of production revenues by commodity; and
(f) separate identification of the exploration, development and production cash flows for the current period and as a time series over a defined period (such as five years).
Would disclosure of this information be relevant and sufficient for users?
Are there any other types of information that should be disclosed? Should this information be required to be disclosed as part of a complete set of financial statements?
The disclosure requirements as proposed appear to be too onerous, and particularly so for the mining industries who would have to disclose information on a host of separate commodities. We therefore believe the proposals on disclosure could be reduced significantly without compromising the significance of them for users.
Information on proved and probable reserves is important and this should be clearly distinguished from proved reserves. As we noted in our response to Question 8, we believe users would be particularly interested in the timing of future cash flows and therefore disclosure on developed and undeveloped reserves would also be important.
As information regarding quantities of reserves would be made available, we do not believe it would add any further value to provide either current value or fair value measurements both of which would be too subjective and unreliable. This could be a considerable cost for preparers, and moreover, users would largely formulate their own expectations of future cash flows from the inputs made available on reserves and related assumptions and estimates.
Moreover, we also question why entities involved in extractive activities should have to provide such detailed disclosure on current and fair values. Pharmaceutical companies and other industries that include high levels of internally generated intangible assets, which ultimately drive future profits, do not have to provide such information.
Q10 - PWYP disclosure proposals
Chapter 6 discusses the disclosure proposals put forward by the Publish What You Pay coalition of non-governmental organisations. The project team's research found that the disclosure of payments made to governments provides information that would be of use to capital providers in making their investment and lending decisions. It also found that providing information on some categories of payments to governments might be difficult (and costly) for some entities, depending on the type of payment and their internal information systems.
In your view, is a requirement to disclose, in the notes to the financial statements, the payments made by an entity to governments on a country-by-country basis justifiable on cost-benefit grounds?
We believe that the wider social and environmental implications of a company's activities can be important to all stakeholders, including shareholders and that the provision of such information should be encouraged as much as possible. However, we believe much of that information should be presented in the wider corporate reporting framework, either in the management commentary or independently of the financial statements, unless of course it is materially relevant.
With regards the PWYP proposals, overall we believe many of them would provide useful information for investment decision-making. Indeed, much of those proposals appear to be captured by the proposals made in the DP and some are already being disclosed on a voluntary basis. Perhaps the key differentiating requirement is that of disclosing information on a country-by-country basis. Entities do disclose information on a segmental basis, but this is only based on a country-by-country basis if they are relevant to the risks.
We appreciate the rationale for providing such information as clearly outlined by the PWYP, in the broader corporate and social responsibility reporting framework. However, as we have stated in previous submissions to the Board, we believe that the core objective of general purpose financial statements is to provide decision-useful information for providers of capital. Only where there is clear evidence from those users that this information is relevant and important in assessing the financial position and performance of an entity, should any additional disclosure requirements in IFRS be considered by the Board. This would be especially so, were there to be an additional cost in preparing that information. As with the other recognition and measurement proposals in the DP, the PWYP proposals should be subject to a cost/benefit assessment.
Again, the IASB should not be seen to single out a particular industry when setting their standards for the narrow users they are aimed at. Perhaps the PWYP proposals could be more closely linked to the wider corporate reporting standards issued by the Global Reporting Initiative (GRI).