Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

Chapter 20
Accounting for the extractive industries
Review questions
20.1

Pursuant to paragraph Aus7.3 of AASB 6:

An area of interest refers to an individual geological area whereby the presence of a
mineral deposit or an oil or natural gas field is considered favourable or has been
proved to exist. It is common for an area of interest to contract in size progressively, as
exploration and evaluation lead towards the identification of a mineral deposit or an oil
or natural gas field, which may prove to contain economically recoverable reserves.
When this happens during the exploration for and evaluation mineral resources,
exploration and evaluation expenditures are still included in the cost of the exploration
and evaluation asset notwithstanding that the size of the area of interest may contract
as the exploration and evaluation operations progress. In most cases, an area of interest
will comprise a single mine or deposit or a separate oil or gas field.

20.2

To the extent that carried forward costs do not exceed the net-realisable value of
economically recoverable reserves, the full-cost method allows all exploration and
evaluation expenditure to be carried forward as an asset to be amortised against future
production revenue. Adopting a larger cost base, and not requiring each area of interest to be
accounted for separately and expensed as it becomes evident that economically recoverable
reserves do not exist on a particular site, means that the full-cost method will provide a
lower volatility of earnings relative to the area-of-interest method.

20.3

Pursuant to the IASB/AASB Conceptual Framework, an asset shall be recognised in the

financial statements when, and only when:
(a)

it is probable that the future economic benefits embodied in the asset will eventuate

(b)

the asset possesses a cost or other value that can be measured reliably.

Apart from permitting costs to be carried forward where such costs are expected to be
recouped through successful development and exploitation of the area of interest, AASB 6
also states that where exploration and/or evaluation activities in the area of interest have not
yet reached a stage which permits a reasonable assessment of the existence or otherwise of
economically recoverable reserves, and active and significant operations in, or in relation to,
the area are continuing, then such costs may be carried forward. Specifically, paragraph
Aus7.2 of AASB 6 states:
An exploration and evaluation asset shall only be recognised in relation to an area of
interest if the following conditions are satisfied:
(a) the rights to tenure of the area of interest are current; and
(b) at least one of the following conditions is also met:

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

(i)

the exploration and evaluation expenditures are expected to be recouped

through successful development and exploitation of the area of interest, or
alternatively, by its sale; and

(ii) exploration and evaluation activities in the area of interest have not at the end
of the reporting period reached a stage which permits a reasonable assessment
of the existence or otherwise of economically recoverable reserves, and active
and significant operations in, or in relation to, the area of interest are
continuing.
The ability to carry forward such costs in the absence of assessing that economic benefits
are probable would not directly seem to pass the probable test of the AASB Conceptual
Framework. However, it may be argued that as the work is ongoing then management must
consider it probable that future benefits will eventuate.
The costs-written-off-and-reinstated method would seem to be consistent with the
requirements of the AASB Conceptual Framework. This method would require that all
exploration and evaluation costs initially be written off due to the low probability of success,
but be reinstated if economically recoverable resources are proven to exist. The AASB
Conceptual Framework permits assets to be reinstated where the related expenditure was
previously expensed.

20.5

An entity in the extractive industry should recognise restoration costs throughout the various
phases of its operations. That is, if a particular activity generates the need for subsequent
restoration work, then restoration expenses should be recognised at that time rather than
waiting until such time as the restoration work will ultimately be undertaken. AASB 6 does
not provide guidance in relation to restoration work. Rather, reference needs to be had to
AASB 137 Provisions, Contingent Liabilities, and Contingent Assets. Paragraph 11 of
AASB 6 states:
In accordance with AASB 137 Provisions, Contingent Liabilities and Contingent
Assets an entity recognises 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.
Provisions, including provisions for restoration, are to be measured at present values.
Specifically, paragraphs 36, 45 and 47 of AASB 137 require:
36. The amount recognised as a provision shall be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting
period.
45. Where the effect of the time value of money is material, the amount of a
provision shall be the present value of the expenditures expected to be required
to settle the obligation.
47. The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s)
current market assessments of the time value of money and the risks specific to
the liability. The discount rate(s) shall not reflect risks for which future cash
flow estimates have been adjusted.
Appendix C to AASB 137 provides an illustration of a provision that has a bearing on this
question. This Appendix is reproduced in Chapter 20. As the Appendix indicates, if the
construction of particular facilities, such as drilling platforms and so forth necessitates future
remediation or restoration works when such facilities are removed, then a provision for

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

restoration should be recognised at the time the facilities are constructed and the expected
cost of restoration should be included as part of the cost of the assets, with the total cost
being amortised over the useful life of the site. Other restoration costs necessitated by the
ongoing operations of the site should be provided for throughout the operations and treated
as part of the cost of the respective phases of operations. These costs will ultimately form
part of the cost of the inventory of the organisation.
The reporting entity would be required periodically to reassess the amount provided for the
restoration provision in the light of changes in expected future costs, changes in expectations
relating to the amount of disturbance being caused, changes in relevant laws and changes in
technologies utilised to perform the restoration and rehabilitation works.
Entities involved in the extractive industries might also be held responsible for
environmental damage caused by spills and leakages to land or water. Cost related to
required clean-ups would typically be treated as expenses in the periods in which the spills
or leakages occur.

20.6

The recognition of liabilities is not restricted to liabilities that only arise because of legal
obligations. Provisions for restorations should be recognised where there is an expectation
that an area of interest will be restored. AASB 137 does not restrict recognition to those
situations where there is a legal obligation to restore the land.
Pursuant to the IASB/AASB Conceptual Framework, liabilities would include those
obligations required by law, as well as obligations that are equitable or constructive. As the
Conceptual Framework states:
An essential characteristic of a liability is that the entity has a present obligation. An
obligation is a duty or responsibility to act or perform in a certain way. Obligations
may be legally enforceable as a consequence of a binding contract or statutory
requirement. This is normally the case, for example, with amounts payable for goods
and services received. Obligations also arise, however, from normal business
practice, custom and a desire to maintain good business relations or act in an
equitable manner. If, for example, an entity decides as a matter of policy to rectify
faults in its products even when these become apparent after the warranty period has
expired, the amounts that are expected to be expended in respect of goods already
sold are liabilities.
Any obligation for restoration would typically be considered to be a provision. According to
paragraph 14 of AASB 137 Provisions, Contingent Liabilities and Contingent Assets, a
provision shall be recognised when:
(a)

an entity has a present obligation (legal or constructive) as a result of a past

event;

(b)

it is probable that an outflow of resources embodying economic benefits will be

required to settle the obligation; and

(c)

a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision shall be recognised.

A constructive obligation is defined in AASB 137 as:
An obligation that derives from an entitys actions where:

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

(a)

by an established pattern of past practice, published policies or a sufficiently

specific current statement, the entity has indicated to other parties that it will
accept certain responsibilities; and

(b)

as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities.

Hence, reporting entities should recognise obligations for restoration, typically as a

provision, even when there is not a specific legal requirement to do so, if there is an
expectation that such factors as custom, or normal business practices would require them
to do so.

20.7

The cost of inventories should include all the expenses necessarily incurred to get the
inventory into the condition and position at the point of sale. This will necessarily require
amounts attributed to:
amortisation of pre-production costs (either on a production or time basis)
production costs.
The above costs would be allocated in respect of exploration and evaluation expenditures;
restoration costs; costs incurred in establishing access to the deposit or field; and costs
incurred in establishing necessary infrastructure.
Under the area-of-interest method, the cost of inventories would not include expenses
relating to operations in other areas of interest, some of which may have been abandoned.

20.9

Amortisation based on the expiration of time is relevant where production is limited by time,
for example, where the area is under a fixed period of tenure and the expected reserves are
expected to outlast the period of the tenure. However, if activities are to be continued in the
area of interest until such time that the economically recoverable reserves have been
exhausted then amortisation of carry forward costs should be undertaken on a production
basis with the denominator being expected recoverable reserves.

20.10 AASB 6 restricts its attention to activities undertaken in the exploration and evaluation
phases. During the exploration and evaluation phase there is typically no revenue against
which capitalised costs can be amortised. Nevertheless, the carried-forward expenditure is
required to be subject to regular impairment testing. As paragraph 18 of AASB 6 states:
Exploration and evaluation assets shall be assessed for impairment when facts and
circumstances suggest that the carrying amount of an exploration and evaluation
asset may exceed its recoverable amount. When facts and circumstances suggest
that the carrying amount exceeds the recoverable amount, an entity shall measure,
present and disclose any resulting impairment loss in accordance with AASB 136.
Because the capitalised exploration and evaluation expenditure has not generated an asset
that is available for use, it would not be depreciated but, as indicated above, it would need to
be tested for impairment.
Amortisation based on time is suitable where production is limited by time, as it would be
under a fixed-period tenure of the area of interest. It may also be appropriate where reserves

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

are so large as to approach an infinite life to adopt some arbitrary time limit for the purposes
of amortisation.
One important issue to consider in determining the useful life of assets associated with the
extractive industries is whether the assets can be transferred to some other area of interest or
whether they may have further use not necessarily connected with any particular area of
interest. If they are portable, or transferable to other uses, then they should be depreciated
over their own specific useful life. If they are not transferable then their useful life will not
be greater than the expected life of the particular area of interest. Such non-transferable
assets would be depreciated over the life of the area of interest, using either a time basis, or a
production basis (whichever is the more appropriate).

20.11 The Accounting Standard AASB 6 states that assets associated with exploration and
evaluation activities may be carried forward, as long as a reasonable probability of success
exists in that area of interest. Therefore, the expenditure can be expensed as incurred if an
entity chooses. Specifically, paragraphs Aus 7.1 and 7.2 of AASB 6 state:
Aus7.1 An entitys accounting policy for the treatment of its exploration and evaluation
expenditures shall be in accordance with the following requirements. For each
area of interest, expenditures incurred in the exploration for and evaluation of
mineral resources shall be:
(a)

expensed as incurred; or

(b)

partially or fully capitalised, and recognised as an exploration and evaluation

asset if the requirements of paragraph Aus7.2 are satisfied.
An entity shall make this decision separately for each area of interest.
Aus7.2 An exploration and evaluation asset shall only be recognised in relation to an
area of interest if the following conditions are satisfied:
(a)

the rights to tenure of the area of interest are current; and

(b)

at least one of the following conditions is also met:

(i)

the exploration and evaluation expenditures are expected to be recouped

through successful development and exploitation of the area of interest,
or alternatively, by its sale; and

(ii)

exploration and evaluation activities in the area of interest have not at

the reporting date reached a stage which permits a reasonable
assessment of the existence or otherwise of economically recoverable
reserves, and active and significant operations in, or in relation to, the
area of interest are continuing.

Hence, pursuant to AASB 6, a reporting entity can elect to write-off all exploration and
evaluation expenditure as incurred, regardless of their expectations regarding the likelihood
that the expenditure will lead to the discovery of economically recoverable reserves.
Students should be encouraged to consider why a reporting entity might elect to write-off all
exploration and evaluation expenditure.

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

20.12 Such an approach would be excessively conservative and would lead to an understatement
of a reporting entitys assets. Exploration and evaluation expenditure would not be
undertaken if it was considered that none of the expenditure would lead to economic
benefits. Clearly, some of the expenditure will lead to future economic benefits, and as such,
some of the expenditure should be carried forward to future periods. Further, if every
reporting entity were simply to write-off all its exploration and evaluation expenditure as
incurred, readers of financial statements would be unable to discriminate between entities
that have undertaken successful exploration and evaluation, and those that have not.
20.13 (a)

Area-of-interest method
2013
Dr Exploration and evaluation assetsGood Site

23

Dr

Exploration and evaluation assetsBad Site

16

Dr

Exploration and evaluation assetsIndifferent Site

25

Cr

Cash, payables, accumulated depreciation, etc.

64

(To account for the initial exploration and evaluation costs incurred in each site; the
expenditure is initially measured at cost and, subject to the requirements of AASB
116 and AASB 138, can be revalued. It is assumed, however, that the entity adopts
the cost model and does not perform revaluations.)
2014
Dr Impairment lossexploration and evaluation assets

16

Cr Exploration and evaluation assetsBad Site

Dr Assets under constructionproperty, plant and equipment
(Good Site)
Dr Assets under constructionintangible mineral assets (Good
Site)
Cr Exploration and evaluation assetsGood Site

16
18.4
4.6
23

(To reclassify the balance of the exploration and evaluation expenditure at Good Site
to assets under construction (or similar account) consistent with paragraph 17 of
AASB 6 and to recognise an impairment loss in relation to Bad Site since the site has
been abandoned. Because Indifferent Site has not reached a stage where a reasonable
assessment can be made of the existence of recoverable reserves, then there is no
reclassification of the related expenditure.)

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

Dr Assets under constructionproperty, plant and equipment

(Good Site)

20

Dr Assets under constructionintangible mineral assets (Good

Site)

Cr Cash/Payables/accumulated depreciation, etc.

27

(To recognise the development costs incurred in relation to Good Site. Such
capitalised costs will be reclassified when the development phase concludes. Because
the assets are not ready for use they will not be depreciated; however, they will be
subject to impairment testing. The capitalised costs will ultimately form part of the
cost of inventories as a result of applying the entitys amortisation/depreciation
policies.)

Dr Property, plant and equipment (Good Site)

38.4

Dr Intangible mineral assets (Good Site)

11.6

Cr Assets under constructionproperty, plant and equipment

(Good Site)

38.4

Cr Assets under constructionintangible mineral assets (Good

Site)

11.6

(to reclassify the assets as a result of the movement from the preproduction phase to
the production phase)
Dr Inventory of crude oil

10

Cr Accumulated depreciationproperty, plant and equipment

(Good Site)
Cr Accumulated depreciationintangible mineral assets (Good
Site)
(3 m $3.3333 where $50 m/15 m = $3.3333 per tonne)
Dr

Inventory of crude oil

Cr

Cash, payables, accumulated depreciation, etc.

Dr

Cash/receivables

Cr

Sales revenue

7.68
2.32

4
4
57
57

(1.9 m $30)
Dr

Cost of goods sold

Cr

Inventory of crude oil

[(10 + 4)/3] 1.9 = 8.87

8.87
8.87

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

20.14 (a)

Area-of-interest method
2013
Dr
Exploration and evaluation assetsIan site
Dr

Exploration and evaluation assetsEddie site

Cr

Cash, payables, accumulated depreciation, etc.

1 500
2 000
3 500

2014
Dr

Exploration and evaluation assetsIan site

2 000

Dr

Exploration and evaluation assetsEddie site

3 000

Cr

Cash, payables, accumulated depreciation, etc.

5 000

2015
Dr

Exploration and evaluation assetsIan site

3 000

Dr

Exploration and evaluation assetsEddie site

4 000

Cr

Cash/payables

Dr

Assets under constructionproperty, plant and

equipment

5 200

Dr

Assets under constructionintangible mineral

assets

1 300

Cr

Exploration and evaluation assetsIan site

Dr

Impairment lossexploration and evaluation assets

Cr

Exploration and evaluation assetsEddie site

7 000

6 500
9 000
9 000

2016
Dr

Property plant and equipment

Cr

Cash, payables, accumulated depreciation, etc.

Dr

Buildings

Cr

Cash/payables

Dr

Property, plant and equipment

5 200

Dr

Intangible mineral assets

1 300

Cr

Assets under constructionproperty, plant and

equipment

5 200

Assets under constructionproperty, plant and

equipment

1 300

Cr

Dr

Inventory of crude oil

2 000
2 000
500
500

2 268

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

Cr

Accumulated depreciationproperty, plant and

equipment

1 920

Accumulated depreciationintangible mineral

assets

348

(400 $5.67, where ($5200 + $1300 + $2000)/1500 = $5.67 per tonne)

Dr

Inventory of crude oil

Cr

Accumulated depreciation: portable buildings

50
50

(It is assumed buildings were acquired at the commencement of the year.

50 = 500/10)
Dr

Inventory of crude oil

Cr

Cash, payables, accumulated depreciation, etc.

2 000
2 000

(400 5.00)
Dr

Cash/receivables

Cr

Sales revenue

6 250
6 250

(250 25.00)
Dr

Cost of goods sold

Cr

Inventory of crude oil

[(2268 + 50 + 2000)/400] 250 = 2699

2 699
2 699

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

10

Challenging questions
20.15
$ million
Exploration and evaluation assetsGreen site

$ million

Exploration and evaluation assetsTree site

10

Exploration and evaluation assetsFrog site

10

Cash/payables/accumulated depreciation, etc.

29

(to account for the initial exploration and evaluation costs incurred in each site)
Dr

Assets under constructionproperty plant and

equipment (Green site)

Dr

Assets under constructionintangible mineral assets

(Green site)

Cr

Exploration and evaluation assets (Green site)

Dr

Impairment lossexploration and evaluation assets

Cr

Exploration and evaluation assets (Tree site)

9
10
10

(To signify that a judgment has been made that economically recoverable resources exist.
Also, to write-off the carried forward costs in relation to Tree site)
Dr

Property, plant and equipment (Green site)

Cr

Cash/payables/accumulated depreciation, etc.

Dr

Property, plant and equipment (Green site)

Dr

Intangible mineral assets (Green site)

Cr

Assets under construction property, plant and

equipment (Green site)

Assets under construction intangible minerals assets

(Green site)

Cr

12
12

Dr

Inventory of crude oil

Cr

Accumulated depreciation property, plant and

equipment (Green site)

1.5

Accumulated depreciation intangible minerals assets

(Green site)

0.6

Cr

2.1

(Amortisation of costs carried forward. The amount is calculated as 5000 $420 where
$21 m/50 000 = $420 per tonne.)
Dr

Inventory of crude oil

Cr

Cash/payables/accumulated depreciation, etc.

2
2

(to recognise the production costs which are treated as a cost of the inventory, rather than
being written-off directly)

Q: 1, 2, 3, 5, 6, 7, 9, 10, 11, 12, 13(a), 14(a), 15, 16

Dr

Cash/receivables

Cr

Sales revenue

11
12
12

(to recognise sales made, where $12 million equals 4000 tonnes multiplied by $3000 per
tonne)
Dr

Cost of goods sold

Cr

Inventory of crude oil

3.28
3.28

(to acknowledge the cost of goods sold, which is calculated as: ($2.1 million + $2 million)/
5000 4000 = $3.7 million)

20.16 AASB 6 requires that costs arising from exploration and evaluation related to an area of
interest shall be written off as incurred, except that they may be carried forward provided
that rights to tenure of the area of interest are current and provided further that at least one of
the following conditions is met:
(a)

such costs are expected to be recouped through successful development and

exploitation of the area of interest, or alternatively, by its sale

(b)

exploration and evaluation activities in the area of interest have not, at the end of the
reporting period, reached a stage which permits a reasonable assessment of the
existence or otherwise of economically recoverable reserves, and active and
significant operations in, or in relation to, the area of interest are continuing.

The company therefore has a choice. It can write off the exploration and evaluation costs
incurred. Alternatively, on the basis that activities have not reached a stage that permits a
reasonable assessment of the existence or otherwise of economically recoverable reserves,
the company might elect to capitalise the expenses in an asset account identified as
exploration and evaluation assets (or similar). The company would need to clearly segregate
the costs associated with the particular area of interest from other areas of interest.