Will the “temporary exemption” allowed by IFRS 6 ever actually be lifted?

The choice allowed by IFRS 6 in the area of exploration and evaluation expenses is well-known to those involved in the extractive industries; or, put another way, to any Canadian practitioner who works with smaller entities. Many Canadian entities used the transition to IFRS to move (in oil and gas terminology) from a “full cost” to a “successful” efforts basis of accounting, or more broadly to a policy of expensing exploration and evaluation expenses they previously capitalized (a handful of entities went in the opposite direction, to start capitalizing costs they previously expensed). Different entities would no doubt explain the motivation for this in different ways, but one common explanation would perhaps be that the accumulated asset balances just weren’t very relevant to assessing the ultimate value of the economic opportunity, serving mainly to clutter up the balance sheet. Others might argue a policy of capitalizing virtually everything as incurred doesn’t really lend itself to the best internal practice: expensing early-stage costs may provide a better focus on monitoring and controlling them.

Recalling the discussion paper

Although IFRS 6 inherently promotes inconsistency, I don’t know if it’s a significant impediment to decision-making in practice. Still, the IASB never meant this as a permanent approach – it based IFRS 6 on a “temporary exemption” from the usual requirements of IAS 8. The April 2010 Extractive Industries discussion paper proposed removing this exemption and imposing a single approach in this area – the approach of capitalizing all exploration and evaluation costs. It says: “The information gained from these activities generates a better understanding of whether a minerals or oil and gas deposit exists and, if so, the characteristics of that deposit and the prospects for economically extracting minerals or oil and gas from the deposit. Over time, exploration and evaluation will provide more information, thereby reducing geological and economic uncertainty. Information that is generated during development and production will reduce this uncertainty further. Thus, the information attribute of the legal rights asset will continue to be modified.”

The paper takes the view that this “information” satisfies the asset recognition criteria (although I’m not sure it really explains why), and acknowledges “Recognizing information as part of the minerals or oil and gas property— particularly during the exploration and evaluation phases—would lead to a change in existing accounting policies for many minerals entities that recognize all exploration costs as expenses when incurred and for those oil and gas entities that use successful efforts accounting.”

Paused project

Such a change would be especially irritating, one imagines, for Canadian companies that only in the last few years moved in the opposite direction to adopt their current policy. Still, there’s no particular reason to start anticipating this change. The project is currently “paused,” and it’s hard to predict whether or when the IASB might pick it up again. Even if they do, there’s no reason to think the project would come to the same conclusion as the discussion paper. The staff summary of responses to the discussion paper says this: “a significant majority disagreed with the project team’s view that the subsequent exploration and evaluation activities undertaken would always represent an enhancement of the property (at least at the time that information is obtained).” Many of the respondents “suggested that the project team’s analysis of the treatment of those exploration and evaluation activities was inconsistent with the asset recognition criteria in the Framework because the information obtained may not have any probable future economic benefit.”

It’s rather amusing that the discussion paper consistently refers to the cost of exploration and evaluation activities as “information” – given how little relevance those costs have to the prospects for future success, you might as well label them “misinformation.” Of course, a rational investment decision – particularly for early-stage entities – should be unaffected by whether the costs are capitalized or not. But that being the case, I’d agree with commentators who argued the discussion paper “does not adequately make the case for changing existing accounting policies that are being consistently applied and that are well understood by user of financial statements.” I suspect the IASB will agree with that too.

The Discussion Paper, by the way, is over 180 pages long (I’m not claiming I’ve read all, or even most of those pages), so there’s obviously much more to it than the one item I’ve focused on. For example, it also proposed disclosing information on proved reserves and on proved and probable reserves within the notes to the financial statements. Unsurprisingly, many users and consultants argued that “auditing reserve disclosures would impose a significant cost, be time intensive and would divert geological and engineering expertise away from business functions and towards compliance functions. Furthermore, most users consulted by the project team agreed that the costs of auditing reserves disclosure would outweigh the benefits they would obtain from that assurance process.” I suspect the IASB will agree with that too. On the whole, despite the Board’s presumed reluctance to let a “temporary” exemption become effectively permanent, it wouldn’t surprise me at all if they decide to write off the exploration costs on this project, and to never proceed to the development stage.

The opinions expressed are solely those of the author.