Decommissioning liabilities in a business combination – unholy mismatch!

Here’s an issue discussed a while ago in Viewpoints: Applying IFRS in the Mining Industry – Accounting for Decommissioning Liabilities Assumed in a Business Combination, a document issued by the Mining Industry Task Force on IFRSs of CPA Canada and the Prospectors & Developers Association of Canada:

  • “Mining entities often acquire projects directly or through the acquisition of shares of another mining entity. Among other things, the acquisition of such projects may include the assumption of decommissioning, restoration and similar liabilities (“decommissioning liabilities”).
  • If the acquired project constitutes a business and the acquirer obtains control of that business, the transaction is considered a business combination within the scope of IFRS 3 Business Combinations. Under IFRS 3, a business combination is accounted for using the “acquisition method”, which requires assets acquired and liabilities (including provisions for decommissioning liabilities) assumed to be measured at their acquisition date fair values, subject to certain exceptions. IFRS 13 Fair Value Measurement provides guidance on how to measure fair value.
  • In accordance with IFRS 3, in general, an acquirer subsequently measures and accounts for assets acquired and liabilities assumed in accordance with other applicable IFRSs for those items. In the case of assumed provisions for decommissioning liabilities, such provisions are subsequently measured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Under IAS 37, a provision is measured at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities provides more prescriptive guidance in accounting for certain changes to decommissioning liabilities.
  • A decommissioning liability measured at fair value in accordance with IFRS 13 can potentially differ materially from a best estimate amount calculated under IAS 37. Among other things a decommissioning provision measured at fair value, under IFRS 3 and IFRS 13, is based on market participant assumptions and typically includes a profit element and an adjustment for credit risk (as part of non-performance risk). Under IAS 37, such a provision is measured at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. This is considered to be more of an entity specific measurement than a market participant measurement. If, for example, a mining entity plans to perform remediation work itself, it would measure such a provision at management’s best estimate which, among other things, would exclude a profit element and be discounted at an appropriate rate.”

As the document discusses, the mismatch between standards could result in an entity having to significantly remeasure such a liability immediately after the acquisition, even though nothing has changed in substance. Based on the task force’s experience, the most common approach to this is to apply the concepts in IFRIC 1, and to add or deduct the amount of the change in the liability from the carrying value of the related asset. Some though don’t see IFRIC 1 as applicable, because it only sets out to deal with measurement changes resulting from changes in the estimated amount or timing of the underlying outflows, not with this kind of technical issue. This would seem to leave no alternative to recognizing the amount of the change in profit or loss.

No doubt wisely, the task force doesn’t acknowledge the other tempting option – of making the problem go away by bending the rules, most obviously by applying IAS 37 to this aspect of the business combination in the first place. And yet, it’s hard to look kindly on accounting headaches of this kind when they seem to reflect nothing more than imperfections in the IASB’s work. In an earlier post, I cited IASB Hans Hoogervorst’s discussion of how the IASB’s proposals to amend the conceptual framework deal with measurement: he concludes: “I think the IASB was wise not to express a general preference for either historical cost on the one hand or for current measurement, or more specifically, fair value on the other hand. Instead, we acknowledge that in many cases mixed measurement is the expected outcome of our standard-setting.” But surely this wisdom, if that’s what it is, should work to anticipate and address all the ways in which mixed measurement causes bumps and potholes in the accounting road.

At the time it issued its document, the task force speculated that this issue might get some traction as part of the IASB’s post-implementation review of IFRS 3, which I wrote about here. This doesn’t really seem to have happened – the nearest thing to it in the summary of findings is this: “Some participants suggested investigating whether the accounting for contingent consideration and contingent liabilities could be reconsidered in order to enhance relevance and faithful representation.” Even then, it provides no greater commitment than this: “Depending on the feedback received from the 2015 Agenda Consultation, we could start working on this issue.” It seems then that for the foreseeable future we’ll be left with the task force’s inevitable conclusion: “preparers are encouraged to exercise judgment in subsequently accounting for decommissioning liabilities assumed in a business combination. Mining entities should consider consulting their professional advisors and auditors when undertaking such analysis.”

The opinions expressed are solely those of the author

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