Mining Financial Reporting Survey kpmg.ca. For Placement Only

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1 Mining Financial Reporting Survey 2012 kpmg.ca For Placement Only

2 Foreword KPMG s Mining Industry practice is pleased to present the Mining Financial Reporting Survey This document publishes the results of a survey of financial reporting under IFRS by 20 major mining companies. The information builds on KPMG s previous Global Mining Reporting Surveys. The 2012 Survey focuses on some of the key issues currently facing mining companies in an increasingly challenging operating environment. Companies need to grow through exploration and development and/or by acquisition, while at the same time ensuring that existing operations continue to be run effectively, and that mines are closed safely within legislative requirements. Timely and transparent financial reporting has a key role to play for mining financial executives who are looking to understand business performance and communicate it to external stakeholders. The purpose of this publication is to help you understand the financial statements of companies in the mining industry that have been prepared in accordance with International Financial Reporting Standards. This publication does not necessarily represent what KPMG might consider to be industry best practice; rather, the disclosures included in this publication represent a range of current presentation and disclosure practices that you may find useful. This publication does not critique specific disclosures or accounting policies. The issues studied have been limited to those that were most significant based on financial reporting for fiscal They provide a high-level overview of the requirements of IFRS, but do not give a detailed analysis of the underlying standards and interpretations. Additionally, this publication does not provide an exhaustive illustration of all disclosures required in a set of consolidated financial statements under IFRS, and does not consider separate or individual financial statements. Therefore, this publication should not be used as a substitute for referring to the standards and interpretations themselves. Care must be taken when applying the observations outlined in this document in a rapidly changing environment. While we hope this survey proves to be a useful guide, we encourage you to consult your local KPMG professionals for individual guidance. Editorial team: Lee Hodgkinson Partner & Canadian Mining Industry Leader David Oldham Partner, Mining Key contributors: Jessica Budd Heather Cheeseman Lianne Hannaway Sheila Magallon Dan Ricica

3 Mining Financial Reporting Survey 2012 Table of Contents Exploration and Evaluation (E&E) expenditure 3 Development costs 13 Impairment 23 Mine closure and rehabilitation 35 Business combinations and asset acquisitions 43

4 2 Exploration and Evaluation (E&E) expenditure Companies Surveyed for the Mining Financial Reporting Survey 2012: n Anglogold Ashanti Limited n Barrick Gold Corporation n BHP Billiton Limited n Cameco Corporation n Centerra Gold Inc. n Detour Gold Corporation n Eldorado Gold Corporation n First Quantum Minerals Ltd. n Gold Fields Limited n Goldcorp Inc. n Hudbay Minerals Inc. n Iamgold Corporation n Inmet Mining Corporation n Kinross Gold Corporation n Lundin Mining Corporation n Rio Tinto plc n Teck Resources Limited n Vale S.A. n Xstrata plc n Yamana Gold Inc.

5 Exploration and Evaluation (E&E) expenditure 3 1 Exploration and Evaluation (E&E) expenditure

6 4 Exploration and Evaluation (E&E) expenditure 1 Exploration and Evaluation (E&E) expenditure 1Key Messages FROM OUR SURVEY GROUP All companies presented an accounting policy for exploration and evaluation expenditure, while only one company presented an accounting policy for pre-e&e (pre-license) expenditure. Over one-half of the companies capitalized at least some of their E&E expenditure, with the remaining companies expensing all E&E expenditure as incurred. The differences in accounting policies and disclosures among the surveyed companies highlights the significant flexibility allowed by IFRS 6, as well as the lack of general guidance in all the IFRS Standards for mining activities, including terminology. IFRS 6 Exploration for and Evaluation of Mineral Resources, identifies E&E expenditures as those incurred in connection with the acquisition of rights to explore, investigate, examine and evaluate an area for mineralization to assess the technical feasibility and commercial viability of extracting the mineral resource from that area. E&E expenditures are those incurred after the entity has obtained the legal rights to explore a specific area, but before technical feasibility and commercial viability of extracting a mineral resource are demonstrable. Those expenditures incurred before an entity has obtained the legal rights to explore would be considered preexploration expenditures. Those expenditures incurred after an entity has demonstrated the technical feasibility and commercial viability of extracting a mineral resource would be considered development expenditures. Pre-exploration expenditures and development expenditures must be identified and accounted for separately from E&E expenditures, in accordance with other IFRS Standards. The costs involved in E&E and development activities can be considerable, and years can pass between the start of exploration and commencement of production. Even with today s advanced technology, exploration is a risky and complex activity. The accounting for E&E expenditure is critical for ensuring that the financial statements of mining companies fairly represent their business activities.

7 Exploration and Evaluation (E&E) expenditure 5 All 20 companies included in the survey disclosed an accounting policy on E&E expenditures. IFRS 6 allows a company to choose an accounting policy of expensing or capitalizing each type of E&E expenditure. The Standard provides an illustrative list of E&E expenditures that may be capitalized, including the costs of topographical, geological, geochemical and geophysical studies, the acquisition of rights to explore, exploratory drilling, trenching, sampling and activities related to evaluating the technical feasibility and commercial viability of extracting a mineral resource. Figure 1.1 Accounting policy for E&E expenditure NUMBER OF COMPANIES All expensed as incurred 8 Some portion capitalized 12 Figure 1.2 End of E&E phase NUMBER OF COMPANIES Disclose point at which expenditures are no longer considered E&E Disclose point at which expenditures are no longer considered E&E and discuss impairment testing of E&E assets 8 8 Silent on matter 4

8 6 Exploration and Evaluation (E&E) expenditure Of the 20 companies surveyed, 60 percent capitalized at least some E&E expenditure and 40 percent expensed all E&E expenditure as incurred. Of the 12 companies surveyed that capitalized at least some E&E expenditure, seven of them did so when it became probable that future economic benefits or economic recoverability would be realized. It appears that this point is reached prior to the company achieving technical feasibility or commercial viability. While IFRS 6 does not require companies to distinguish between exploration expenditures and evaluation expenditures, 25 percent of companies surveyed distinguished each as a separate type of expenditure within their accounting policy disclosures. Sixty percent of these companies also disclosed separate accounting treatments for exploration expenditures and evaluation expenditures; for instance, exploration expenditures are expensed as incurred and evaluation expenditures are capitalized. Disclosure 1.1: The following accounting policy specifies that E&E expenditure is expensed as incurred until it is determined that it is likely to be realized. 1 Anglogold Ashanti Exploration and evaluation expenditure The group s accounting policy for exploration and evaluation expenditure results in certain items of expenditure being capitalized for an area of interest where it is considered likely to be recoverable by future exploitation. This policy requires management to make certain estimates and assumptions as to future events and circumstances, in particular whether an economically viable extraction operation can be established. Any such estimates and assumptions may change as new information becomes available. If, after having capitalized the expenditure, a judgement is made that recovery of the expenditure is unlikely, the relevant capitalized amount will be written off to the income statement. Of the five companies that distinguished between exploration expenditures and evaluation expenditures, four separately disclosed dollar amounts related to these two different types of expenditures. Of the 20 companies surveyed, 80 percent provided disclosure about the point at which expenditures are no longer considered E&E, most often by utilizing the IFRS 6 terms technical feasibility or commercial viability. Of the 16 companies that disclosed the point at which expenditures are no longer considered E&E, eight also provided some discussion of the impairment assessment process for E&E assets. The remaining four companies were silent on both matters. 1. Source: Anglogold Ashanti Limited, Annual Financial Statements 2011, p. 192.

9 Exploration and Evaluation (E&E) expenditure 7 Disclosure 1.2: The following accounting policy describes the difference between exploration expenditures and evaluation expenditures as well as their individual accounting treatments. 1 IAMGOLD Mineral exploration and evaluation costs Mineral exploration costs are charged to earnings in the period in which they are incurred. Evaluation costs are expenditures for activities that relate to the evaluation of the technical feasibility and commercial viability of extracting a mineral resource on sites where the Company does not have mineral deposits already being mined or constructed, and are capitalized as exploration and evaluation assets. Upon determination of technical feasibility and commercial viability of extracting a mineral resource, capitalized costs in exploration and evaluation assets are transferred into mine and other construction in progress, which are classified as a component of mining assets. The application of the Company s accounting policy for exploration and evaluation expenditures requires judgment in determining whether future economic benefits may be realized, which are based on assumptions about future events and circumstances. Estimates and assumptions made may change if new information becomes available. If, after expenditures are capitalized, any information becomes available suggesting that the expenditures are not recoverable, the amount capitalized is recognized in the consolidated statement of earnings as impairment in the period when the new information becomes available. Acquired exploration and evaluation expenditures Where E&E assets are acquired as part of a business combination, they are recognized initially at fair value as required by IFRS 3 Business Combinations. When E&E assets are acquired by themselves and not as part of a business combination, they are recognized at the fair value of the consideration paid. IFRS 6 does not explicitly state how to account for acquired E&E assets; nevertheless, companies have devised accounting policies to address this circumstance. Forty-five percent of surveyed companies did not disclose a specific accounting policy for acquired E&E expenditure. The 55 percent of companies surveyed that made specific disclosures about acquired E&E expenditures included companies that expense E&E expenditures and those that capitalize them. Therefore, while a company may have a policy to expense E&E expenditures as incurred, it appears that acquired E&E may still be capitalized. Four of the eight companies above (see Figure 1.1) that expense E&E expenditures as incurred disclosed that acquired E&E is capitalized. No company disclosed a policy of expensing acquired E&E expenditure. 1. IAMGOLD Corporation, Annual Financial Statements 2011, p. 86.

10 8 Exploration and Evaluation (E&E) expenditure Disclosure 1.3: The following accounting policy excerpt describes how acquired E&E expenditure is recognized. 1 Detour Purchased exploration and evaluation assets are recognized as assets at their cost of acquisition, or at fair value if purchased as part of a business combination. Disclosure 1.4: The following accounting policy excerpt describes how all E&E expenditures are expensed as incurred except for acquired E&E expenditure. 2 Inmet Exploration and evaluation expenditures We expense the costs of exploration and evaluation as incurred, except for the following: n in areas currently under development n where we can reasonably expect to convert existing mineral resources into mineral reserves or add additional mineral resources with further drilling and evaluations n the cost to acquire an early stage entity conducting primarily exploration and evaluation activities. In the first two instances, we capitalize costs as development expenditures. In the third instance, we capitalize costs as exploration and evaluation assets. 1. Source: Detour Gold Corporation, Annual Report 2011, p Source: Inmet Mining Corporation, Annual Report 2011, p. 85.

11 Exploration and Evaluation (E&E) expenditure 9 Disclosure and presentation of Exploration and Evaluation expenditures IFRS 6 requires mining companies to disclose the amounts of assets and liabilities, income and expenses, and operating and investing cash flows arising from E&E activities. Capitalized E&E expenditure, referred to commonly as E&E assets, is a separate class of asset that is measured initially at cost. E&E assets are classified as tangible or intangible assets depending on their nature. Tangible E&E assets may include the items of plant and equipment used for exploration activity, such as vehicles, drilling rigs and surveying equipment. Intangible E&E assets may include such items as the costs of exploration permits and drilling rights. Figure 1.3 Classification of E&E assets NUMBER OF COMPANIES Entirely as tangible assets Entirely as intangible assets Combination of tangible and intangible assets Entirely as separate type of asset

12 10 Exploration and Evaluation (E&E) expenditure All the companies in the survey group included disclosures of assets, income and expenses and operating or investing cash flows from E&E in different places in the notes to the financial statements. However all were silent about the liabilities arising from E&E activities. Where surveyed companies had an accounting policy under which at least some E&E expenditure is capitalized, 59 percent classified E&E assets entirely as tangible assets, 25 percent classified as a combination of tangible and intangible assets, eight percent classified entirely as intangible assets, and the remaining eight percent recognized E&E assets as a separate asset, which was labeled neither tangible nor intangible. Only one company surveyed showed the carrying value of E&E assets as a separate line item on the face of the statement of financial position. Eighty-five percent of surveyed companies disclosed their E&E expenditure for the period on the statement of operations. This result is not unexpected given the significance of exploration costs to mining companies. During the period, an entity presents cash flows classified by operating, investing and financing activities in the manner most appropriate to its business. When an entity elects to expense E&E expenditure as incurred, the related cash flows are classified as operating activities. Cash flows from investing activities include only expenditure that results in the recognition of an asset. Only two companies surveyed were explicit in their treatment of cash flows related to E&E expenditure (see Disclosure 1.5 for an example). Disclosure of E&E expenditure was seen in the cash flow statements of only three of the companies surveyed and all of these were included within investing activities. Disclosure 1.5: The following accounting policy excerpt describes how the entity classifies cash flows related to E&E expenditure. 1 Hudbay Cash flows associated with acquiring exploration and evaluation assets are classified as investing activities in the statement of cash flows; those associated with exploration and evaluation expenses are classified as operating activities. IFRS impact on E&E expenditure - first time adoption There was no standard that specifically addressed E&E activities until IFRS 6 was approved by the International Accounting Standards Board (IASB) in 2005, effective for annual periods beginning on or after January 1, Before adopting IFRS, a number of countries such as Canada had specific guidance and industry practice on E&E expenditure. However, there was limited consistency in practice among the different countries before the adoption of IFRS 6. The transition to IFRS gave mining companies the opportunity to revisit their policies for E&E activities, albeit with retroactive application in accordance with IFRS 1. Of the 20 companies surveyed, 14 had transitioned to IFRS for the first time in the years disclosed in the most recent financial statements. Four of these 14 recognized an adjustment upon transition relating to E&E expenditures, indicating a change in accounting policy from their previous GAAP to IFRS. Of these four companies, two capitalized certain E&E activities at an earlier point than under their previous GAAP, while two capitalized certain E&E activities at a later point than under their previous GAAP. The very limited inclusion of E&E expenditures in the cash flow statement is not unexpected if the company expenses E&E expenditures in arriving at net income. It would then not be disclosed in the cash flow statement for companies utilizing the indirect method, which is based on net income. 1. Source: Hudbay Minerals Inc., Annual Financial Statements 2011, p. 17.

13 Section or Brochure name 11

14 12 Exploration and Evaluation (E&E) expenditure

15 Exploration and Evaluation (E&E) expenditure 13 2 Development costs

16 14 Development costs 2 Development costs 2Key Messages FROM OUR SURVEY GROUP All companies surveyed disclosed an accounting policy for development costs; furthermore, 40 percent of the companies included a detailed description of which expenditures are considered to be development costs. However, differences exist among companies in the policies disclosed. This highlights the lack of specific guidance in IFRS with respect to mining activities outside the E&E phase. The absence of specific guidance for extractive activities other than those requiring E&E expenditures means that mining companies must exercise significant judgment when developing their accounting policies. The unit-of-production method is the preferred method used by the surveyed companies to depreciate mining assets. In the extractive industries, development costs are those related to gaining access to the identified mineral resource after the decision has been made to develop the ore body. These costs are usually incurred once the technical feasibility and commercial viability of extracting a mineral resource have been demonstrated, and an identified mineral reserve is being prepared for production. IFRS 6, Exploration for and Evaluation of Mineral Resources, is the only guidance in IFRS that specifically applies to companies in the extractive industries. The scope of IFRS 6 specifically excludes expenditures incurred after the technical feasibility and commercial viability of extracting a mineral resource are demonstrable. Although entities are required to identify and account for development expenditures separately from exploration and evaluation expenditures, the IFRS Standards do not contain a definition of development activities or expenditures specific to mining companies. Accordingly, mining companies must use judgment when applying IFRS to account for development expenditures and other activities outside the exploration and evaluation phase. The key areas of judgment are: n Determining when the technical feasibility and commercial viability of extracting a mineral resource are demonstrated and the E&E phase ends and the pre-production development phase commences n Determining which expenditures can be capitalized during the development phase

17 Development costs 15 n Determining when operational readiness is reached and the production phase and the depreciation and depletion of assets commences n Identifying and accounting for development costs incurred during the production phase of a mine. Commencement of the development phase (preproduction expenditures) Once the technical feasibility and commercial viability of extracting a mineral resource are established, IFRS 6 no longer applies and the development phase to gain access to the mineral resource is generally considered to have commenced. Significant judgment is required to assess when technical feasibility and commercial viability have been achieved. Various sources of information are used and include: approval by an appropriate level of management to develop the project; geologic and metallurgic information; history of conversion of mineral resources to reserves; existence of proven and probable reserves; commodity prices; estimated future cash flows; proximity of operating facilities; and any legal or other barriers to accessing the mineral deposit, including the ability to obtain necessary permits and sufficient financing. Eight of the companies surveyed linked the determination of technical feasibility and commercial viability to the point when economically recoverable mineral reserves have been established. One of those companies noted that this determination may be affected by management s assessment of certain modifying factors, including legal, environmental, social and governmental factors. Five companies specified other qualitative factors that are considered when determining whether a deposit is commercially viable and technically feasible. Seven companies did not disclose how they determine the technical feasibility or commercial viability of a mineral deposit. Disclosure 2.1 and 2.2: The following two excerpts describe the judgements applied by management to assess when a project is economically viable. 1, 2 Goldcorp The critical judgements that the Company s management has made in the process of applying the Company s accounting policies, apart from those involving estimations (note 6), that have the most significant effect on the amounts recognized in the Company s consolidated financial statements are as follows: (b) Economic recoverability and probability of future economic benefits of exploration, evaluation and development costs Management has determined that exploratory drilling, evaluation, development and related costs incurred which have been capitalized are economically recoverable. Management uses several criteria in its assessments of economic recoverability and probability of future economic benefit including geologic and metallurgic information, history of conversion of mineral deposits to proven and probable reserves, scoping and feasibility studies, accessible facilities, existing permits and life of mine plans. Yamana The preparation of consolidated financial statements in conformity with IFRS requires the Company s management to make judgements, estimates and assumptions about future events that affect the amounts reported in the consolidated financial statements and related notes to the financial statements. Although these estimates are based on management s best knowledge of the amount, event or actions, actual results may differ from those estimates. a) Critical Judgements in the Application of Accounting Policies Information about critical judgements and estimates in applying accounting policies that have most significant effect on the amounts recognized in the consolidated financial statements are as follows n Determination of economic viability of a project Management has determined that costs associated with projects under construction or developments including C1 Santa Luz, Ernesto/Pau-a-Pique, Pilar and Mercedes have future economic benefits and are economically recoverable. In making this judgement, management has assessed various sources of information including but not limited to the geologic and metallurgic information, history of conversion of mineral deposits to proven and probable mineral reserves, scoping and feasibility studies, proximity of operating facilities, operating management expertise, existing permits and life of mine plans. 1. Source: Goldcorp Inc., Annual Report 2011, p Source: Yamana Gold Inc., Annual Report 2011, p.70

18 16 Development costs Recognition and measurement of development costs in the pre-production phase During the development phase, mining companies capitalize the costs incurred to build the infrastructure necessary to extract the minerals, and the cost of the plant and equipment to be used in transporting and processing the product. These costs are capitalized in accordance with IAS 16 Property, Plant and Equipment. Of the companies surveyed, 15 disclosed a specific policy related to the accounting for pre-production development costs. However, only eight of the surveyed companies provided a detailed description of what they consider to be development costs. The types of costs included were: costs related to infrastructure to physically access ore, shaft systems, and waste rock removal; costs to define and delineate mineral deposits; and interest and financing costs related to development and construction. The remaining 12 companies surveyed did not disclose what would be considered a development cost incurred in the pre-production phase, or at best refer to such costs as those incurred to build a mine. Disclosure 2.3: The following excerpt describes the company s accounting policy for development costs. 1 Gold Fields Mining assets, including mine development and infrastructure costs and mine plant facilities, are recorded at cost less accumulated depreciation and accumulated impairment losses. Expenditure incurred to evaluate and develop new orebodies, to define mineralization in existing orebodies and to establish or expand productive capacity, is capitalized until commercial levels of production are achieved, at which times the costs are amortized as set out below. Moving into the Production Stage In accordance with IAS 16, costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of being operated in the manner intended by management should be capitalized. After this point, capitalization ceases and depreciation commences. In the mining industry, typically the development phase ends when the mine is capable of being operated as intended by management and it moves into the production stage. The point at which a mine is considered to be in the production stage varies due to the unique nature of each mine construction project. The assets at a mine are typically intended to extract ore from the mineral deposit and process it to produce a saleable product. Substantial amounts of time are often required to start up a mine and operate it as intended. In some cases, a mine may never reach the production levels expected in technical feasibility studies or the mine plan. In addition, operational management evaluates several factors when determining whether a mine is operating as intended, including the amount of material mined, the throughput, the recovery, and the production (quality and quantity). Accordingly, it is often difficult to identify the point at which a mine is capable of being operated as intended by management, and apply this assessment consistently to different mine sites. Management must select an accounting policy to determine when a mine site is operationally ready and use judgment to apply it consistently to different construction projects. Of the 20 companies surveyed, only eight discussed the point at which development is complete and how operational readiness is determined. Their disclosures included a list of the criteria used by management to determine when a mine is ready for its intended use. Criteria commonly used were: - Operating results have been consistently achieved - Reasonable testing period is completed - Demonstrated ability to produce saleable minerals and sustain ongoing production - Capital expenditures made in comparison to budget for development project 1. Source: Gold Fields Limited, Annual Report 2011, p.49.

19 Development costs 17 Disclosure 2.4 and 2.5: The below disclosure excerpts detail the factors considered to determine when production commences. 1, 2 AngloGold Ashanti The group assesses the stage of each mine construction project to determine when a mine moves into the production stage. The criteria used to assess the start date are determined by the unique nature of each mine construction project and include factors such as the complexity of a plant and its location. The group considers various relevant criteria to assess when the mine is substantially complete and ready for its intended use and moves into the production stage. Some of the criteria would include but are not limited to the following: n the level of capital expenditure compared to the construction cost estimates; n completion of a reasonable period of testing of the mine plant and equipment; n ability to produce gold in saleable form (within specifications and the de minimis rule); and n ability to sustain ongoing production of gold. When a mine construction project moves into the production stage, the capitalization of certain mine construction costs ceases and costs are either regarded as inventory or expensed, except for capitalizable costs related to mining asset additions or improvements, underground mine development or Ore Reserve development. Yamana Assets under construction consist of expenditures for the construction of future mines and include pre-production revenues and expenses prior to achieving commercial production. Commercial production is a convention for determining the point in time at which a mine and plant has completed the commissioning and has operational results that are expected to remain at a sustainable commercial level over a period of time, after which production costs are no longer capitalized and are reported as operating costs. The determination of when commercial production commences is based on several qualitative and quantitative factors including but not limited to the following: n A significant portion of planned capacity, production levels, grades and recovery rates are achieved at a sustainable level n Achievement of mechanical completion and operating effectiveness n Significant milestones such as obtaining necessary permits and production inputs are achieved to allow continuous and sustainable operations n Positive and sustainable cash flows. 1. Source: Anglogold Ashanti Limited, Annual Financial Statements 2011, p Source: Yamana Gold Inc., Annual Report 2011, p.93.

20 18 Development costs Due to the length of time required to start the production of a mine, companies may earn revenue from production prior to the date the mine is considered ready to be operated as intended by management. IAS 16 states that income and expenses related to incidental operations are recognized in profit or loss when they are not necessary to bring an item to the location and condition necessary for it to be capable of operating in the manner intended by management. Three of the companies surveyed stated that all revenue in the development stage is included in the cost of the constructed asset. One company stated that any revenue earned in the process of preparing an asset to be capable of operating in the manner intended by management is included in the cost of the constructed asset, but that any other revenue earned prior to the start up of the mine is recognized in the income statement. The remaining 16 companies did not disclose a policy for revenue earned in the development stage. This appears to demonstrate that at least some mining companies consider that an asset is capable of operating in the manner intended by management some period of time after production activities have commenced, due to the factors noted above. Accounting treatment post-production expenditure In the mining industry, development activities such as waste stripping and construction of infrastructure frequently continue to be carried out during the production phase. When these costs are incurred to access the ore body for production in the current period, they are typically considered operating costs and are included in the cost of inventory. In contrast, development costs to expand existing capacity or develop new ore bodies are capitalized in accordance with IAS 16 when it is probable that future economic benefits will flow to the company. Of the companies surveyed, 12 companies disclosed an accounting policy for capitalizing development costs incurred during the production phase indicating they are capitalized when they provide access to reserves in future periods; expand existing capacity; or generally, provide future economic benefits. Of the 12 companies that disclosed an accounting policy for development costs during the production phase, four specified that development costs incurred to maintain current production are included in operating costs. IFRIC 20 which is effective January 1, 2013 may impact this area going forward with respect to open pit mines. Figure 2.1 Capitalization of development costs during the production phase NUMBER OF COMPANIES Expand existing capacity 4 Provide access to reserves in future periods 4 Provide future economic benefit 4 Policy not disclosed 8 Disclosure 2.6: The following discloses the accounting policy for capitalization of costs during the production phase. 1 Goldcorp Capitalization of costs incurred ceases when the mining property has reached operating levels intended by management. Costs incurred prior to this point, including depreciation of related plant and equipment, are capitalized and proceeds from sales during this period are offset against costs capitalized. Development costs incurred to maintain current production are included in mine operating costs. These costs include the development and access (tunnelling) costs of production drifts to develop the ore body in the current production cycle. During the production phase of a mine, stripping costs incurred that provide access to reserves and resources that will be produced in future periods that would not have otherwise been accessible are capitalized. Capitalized stripping costs are amortized based on the estimated recoverable ounces contained in reserves and resources that directly benefit from the stripping activities. Costs for waste removal that do not give rise to future economic benefits are included in mine operating costs in the period in which they are incurred. 1. Source: Goldcorp Inc., Annual Report 2011, p.114.

21 Development costs 19 Barrick Disclosure 2.7: The following excerpt describes the accounting for underground mine development costs and open pit mining costs incurred in the production phase. 1 At our underground mines, Barrick incurs development costs to build new shafts, drifts and ramps that will enable Barrick to physically access ore underground. The time over which Barrick will continue to incur these costs depends on the mine life. These underground development costs are capitalized as incurred. Capitalized underground development costs incurred to enable access to specific ore blocks or areas of the underground mine, and which only provide an economic benefit over the period of mining that ore block or area, are depreciated on a UOP basis, whereby the denominator is estimated ounces/pounds of gold/copper in proven and probable reserves and a portion of resources within that ore block or area where it is considered probable that those resources will be extracted economically. Open Pit Mining Costs In open pit mining operations, it is necessary to remove overburden and other waste materials to access ore from which minerals can be extracted economically. The process of mining overburden and waste materials is referred to as stripping. Stripping costs incurred in order to provide initial access to the ore body (referred to as pre-production stripping) are capitalized as open pit mine development costs. Depreciation An entity is required to begin depreciating an asset when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. An asset is depreciated over its useful life using a method that reflects the pattern in which the asset s future economic benefits are expected to be consumed by the entity. All 20 companies surveyed utilized a combination of straight-line and unit-of-production depreciation methods for property, plant and equipment related to mining assets; the method used depended on the nature of the assets and how their future economic benefits are consumed. Sixty-five percent of the surveyed companies disclosed that the number of years used to depreciate an asset under the straight-line method cannot exceed the expected life of the mine. The unit-of-production method typically utilizes proven and probable reserves as its basis; however, some companies include other non-reserve material (mineral resources) in excess of proven and probable reserves depending on the degree of confidence in its extraction. 1. Source: Barrick Gold Corporation, Annual Report 2011, pp KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms

22 20 Development costs Figure 2.2 Basis of unit-of-production depreciation NUMBER OF COMPANIES Proven and probable reserves 14 Proven and probable reserves plus potential for non-reserve material 6 Fourteen of the surveyed companies used reserve material only as the basis for their unit-of-production calculation. Nine of these 14 companies specified that all mining assets, or a portion of mining assets, are depreciated using the unit-ofproduction method based on the reserves to which the asset relates. The remaining five companies did not specify whether assets were only depreciated based on the reserves to which the asset relates, or whether all proven and probable reserves were used as the basis. Six of the surveyed companies disclosed that additional non-reserve material (mineral resource) is, or may be included within, their unit-of-production basis. The amount of non-reserve material included in the basis for the unit-ofproduction calculation varied across the companies, but it always depended on a high degree of confidence in its economic extraction. The inclusion of non-reserve material requires further management judgment to determine the appropriate quantity to include. Since mineral resources often require development costs to access the ore in the future, it is unclear under IFRS whether future development costs should be included in the unit-ofproduction depreciation calculation. The companies surveyed that may include non-reserve material in the calculation of depreciation did not disclose any information about these considerations. Disclosure 2.8: The following accounting policy excerpt states that mining assets are depreciated using both the straight-line and unit-of-production methods. The unit-of-production method is based on proven and probable reserves. 1 BHP Billiton Depreciation of property, plant and equipment The carrying amounts of property, plant and equipment (including initial and any subsequent capital expenditure) are depreciated to their estimated residual value over the estimated useful lives of the specific assets concerned, or the estimated life of the associated mine, field or lease, if shorter. Estimates of residual values and useful lives are reassessed annually and any change in estimate is taken into account in the determination of remaining depreciation charges. Depreciation commences on the date of commissioning. The major categories of property, plant and equipment are depreciated on a unit of production and/or straight-line basis using estimated lives indicated below. However, where assets are dedicated to a mine, field or lease and are not readily transferable, the below useful lives are subject to the lesser of the asset category s useful life and the life of the mine, field or lease: n Buildings n Land n Plant and equipment n Mineral rights and Petroleum interests n Capitalized exploration, evaluation and 25 to 50 years not depreciated 3 to 30 years straight-line based on reserves on a unit of production basis based on reserves on a unit of production basis development expenditure 1. Source: BHP Billiton Limited, Annual Report 2011, p. 171.

23 Development costs 21 Disclosure 2.9: The following accounting policy excerpt states that mining assets are depreciated utilizing both the straight-line and unit-of-production methods. The straight-line number of years cannot exceed that of the life of the mine. The unit-of-production method is based on proven and probable reserves, and for some mines, on other mineral resources as well. 1 Rio Tinto Depreciation of non-current assets Property, plant and equipment is depreciated over its useful life, or over the remaining life of the mine if that is shorter and there is no alternative use for the asset. The useful lives of the major assets of a cash-generating unit are often dependent on the life of the orebody to which they relate. Where this is the case, the lives of mining properties, and their associated refineries, concentrators and other long lived processing equipment generally relate to the expected life of the orebody. The life of the orebody, in turn, is estimated on the basis of the life-of-mine plan. Where the major assets of a cashgenerating unit are not dependent on the life of a related orebody, management applies judgment in estimating the remaining service potential of long lived assets. In the case of smelters, factors affecting the remaining service potential include smelter technology and electricity contracts when the power is not sourced from the company s own electricity generating capacity. Depreciation commences when an asset is available for use. The major categories of property, plant and equipment are depreciated on a units of production and/or straight line basis as follows: Units of production basis For mining properties and leases and certain mining equipment, the consumption of the economic benefits of the asset is linked to the production level. Except as noted below, these assets are depreciated on a units of production basis. In applying the units of production method, depreciation is normally calculated using the quantity of material extracted from the mine in the period as a percentage of the total quantity of material to be extracted in current and future periods based on proved and probable reserves and, for some mines, other mineral resources. These other mineral resources may be included in depreciation calculations in limited circumstances and where there is a high degree of confidence in their economic extraction. Straight line basis Assets within operations for which production is not expected to fluctuate significantly from one year to another or which have a physical life shorter than the related mine are depreciated on a straight line basis. Development costs that relate to a discrete section of an orebody, and which only provide benefit over the life of those reserves, are depreciated over the estimated life of that discrete section. Development costs incurred which benefit the entire orebody are depreciated over the estimated life of the orebody. 1. Source: Rio Tinto Group, Annual Report 2011, pp

24 22 Impairment

25 Impairment 23 3 Impairment

26 24 Impairment 3 Impairment 3Key Messages FROM OUR SURVEY GROUP All companies disclosed an accounting policy on the impairment of nonfinancial assets. The level of disclosure varied among companies. However, those companies that had recognized significant impairment losses during the period provided more disclosure of the assumptions used to determine the recoverable amount for their impairment testing and specifics of their specific impairment loss. Few companies surveyed disclosed a sensitivity analysis, including key assumptions, that would cause the recoverable amount to equal the carrying amount. The valuation of non-financial assets is a complex issue for mining companies. Given the current market conditions and increasing volatility of capital and operating costs in the mining industry, regulators may put increased emphasis on the disclosures related to goodwill and the assumptions used to determine an asset s recoverable amount.

27 Impairment 25 A number of factors can have a significant impact on the recoverable amount of a mine or cash-generating unit (CGU). The volatility of commodity prices, foreign exchange rates, and market multiples combined with increasing capital and operating costs regularly require mining companies to consider potential impairment. Cash-generating units The impairment testing of non-financial assets is carried out in accordance with IAS 36 Impairment of Assets. Whenever possible, an impairment test is performed for an individual asset; otherwise, assets are tested for impairment in CGUs. A CGU is the smallest group of assets that generates cash inflows from continuing use that is largely independent of the cash inflows from other assets or groups. The composition of a CGU is often straightforward to determine in the mining industry because the assets grouped together in an individual mine will often constitute a single CGU. Accordingly, in this publication, the terms mine and CGU are used interchangeably when discussing impairment. However, when multiple mines share infrastructure or represent vertically integrated operations, the determination of CGUs can be more complex. In the first scenario, management judgment is required to determine whether the mining infrastructure at each site is capable of generating independent cash inflows or whether it is more appropriate for the mines and infrastructure to be grouped together as a single CGU. For vertically integrated operations, management needs to exercise judgment in considering whether there is an active market for any of the intermediate products, even if some or all of the output is used internally, to determine whether there are independent cash inflows and in fact the operation is composed of separate CGUs. Of the 20 companies surveyed, ten included detail on how CGUs were determined; eight disclosed general comments that assets were grouped together at the lowest level for which independent cash inflows are identified; and two did not provide any detail on how CGUs were determined. Six of the ten companies that provided details regarding the definition of a CGU stated that a CGU would typically represent an individual mine. Figure 3.1 Definition of a CGU NUMBER OF COMPANIES Details provided 10 General comments 8 No disclosure 2

28 26 Impairment Frequency and timing An entity must assess at each reporting date whether or not there are indicators of impairment. When an impairment indicator is identified, impairment testing is required. In addition, there is a requirement to test goodwill and indefinite-lived intangible assets for impairment at least annually, even when no indicator of impairment exists. In determining whether there is an impairment indicator, an entity considers both internal factors (e.g., adverse changes in performance) and external factors (e.g., adverse changes in the business or regulatory environment). Possible indicators of impairment for mining companies include the value of market capitalization compared to net carrying amount, lack of available cash and future financing when developing a mine, projects on hold, declines in long-term commodity price forecasts, capital expenditure over budget during the construction of a new mine, adverse forward exchange rates, increased production costs, and expected increases in mine closure and rehabilitation costs. Yes No Of the 20 companies surveyed, 16 have goodwill and therefore are required to test for impairment annually; eight of these companies disclosed that the annual impairment test was performed at the end of the fiscal year; five disclosed the annual test was performed at a point other than year-end, and one disclosed that the annual impairment test for each operating segment is performed at different times during the year. Figure 3.2 Annual requirement to test for impairment NUMBER OF COMPANIES NUMBER OF COMPANIES Yes - at fiscal year end Yes - at other than year end Yes varies by segment 1 4 Figure 3.3 Timing of annual impairment test disclosed Not disclosed 2 Not applicable 4 Of the companies surveyed, four disclosed that a triggering event for possible impairment resulted in a test being performed between the annual tests. Of these, two disclosed an external indicator (market capitalization, regulatory environment changes) as the possible trigger of impairment. One disclosed both external and internal indicators (planned closures and increased capital costs) as the possible triggers of impairment, and the other only made a general disclosure of impairment indicators.

29 Impairment 27 Disclosure 3.1: The following disclosure excerpt details Hudbay Minerals Inc s triggering events for impairment assessment of property, plant and equipment. 1 Hudbay As described in note 3j, at the end of each reporting period, the Group reviews the carrying amounts of its property, plant and equipment, exploration and evaluation assets and computer software to determine whether there is any indication of impairment. One of the factors management considers in making this assessment is whether the carrying amounts of the Group s net assets exceeds its market capitalization, in which case management applies judgment to determine the reason for the difference. Based on Hudbay s listed share price of $10.14 at December 31, 2011, the carrying amount of the Group s net assets exceeded its market capitalization by approximately $70,000. Management determined that this decline reflected a temporary correction in the market and was not a reflection of issues in any one of the Group s cash-generating units. Management concluded this decline was not an indicator of impairment as at December 31, Calculation of recoverable amount The recoverable amount of an asset or CGU is the higher of its fair value less costs to sell (FVLCS) and its value in use (VIU). Cash flow estimates to determine value in use should reflect the asset in its current condition, i.e., excluding future capital expenditures that will improve or enhance the asset s performance. In the mining industry however, significant capital expenditures are often required to access mineral reserves and resources in future periods. These capital expenditures can be included in a mine s FVLCS determined using a discounted cash flow model which also includes the cash inflows resulting from accessing mineral reserves and resources in future periods and the related capital expenditures based on a market participant s view. Accordingly, during a mine s life, a CGU s FVLCS may exceed its VIU because FVLCS includes the capital expenditures over the entire life of the mine and the additional cash flows generated by the additional resources whereas, VIU only includes near term capital expenditures to sustain current production. However, FVLCS may no longer exceed a CGU s VIU near the end of a mine s life when mineral reserves are nearing depletion and there are no significant capital expenditures requiring approval in the future to develop mineral resources. it is difficult to identify a market price for the asset. Accordingly the most common technique used to determine FVLCS in the mining industry is a discounted cash flow model. In that case, the assumptions used to determine fair value are consistent with those a market participant would make. Typically for mining companies, cash flow projections in a discounted cash flow model are based on an operation s mine plan, since that is the information a market participant would consider to determine the fair value of a mining operation. The cash flows extend over the entire estimated life of the mine based on the production levels and the amount of mineral reserves and resources at the mine. The amount of confidence in mineral reserves and resources would impact the value assigned to them by a market participant and accordingly, should be taken into account in the discounted cash flow model. Techniques sometimes include applying a factor to mineral resources that reflects the estimated conversion ratio to reserves, or applying a higher discount rate to mineral resources. In accordance with IAS 36, companies are required to make extensive disclosures about the estimates used to measure the recoverable amount of a CGU for which the carrying amount of goodwill allocated to that unit is significant in comparison to the entity s total carrying amount of goodwill. The required disclosures include the basis on which a CGU s recoverable amount has been determined, a description of key assumptions to which the recoverable amount is most sensitive, and a description of management s approach to determine the values assigned to each key assumption. When an entity records a material impairment loss, it must also provide extensive disclosures, including a description of the events and circumstances that led to the recognition of the impairment loss and the basis for the recoverable amount. In situations other than those quoted above, entities are also encouraged to disclose the assumptions used to determine the recoverable amount. The best evidence of fair value is a binding sale agreement, or failing that, a price derived from an active market or recent transaction for similar assets. If there is no binding sale agreement and no active market, then fair value can be determined based on valuation techniques that use the best information available to reflect the amount that a company could obtain at the reporting date from the disposal of the asset in an arm s length transaction between knowledgeable, willing parties. In our experience, given the significant differences among mines, 1. Source: Hudbay Minerals Inc., Annual Financial Statements 2011, p. 17.