Here’s another issue recently discussed by CPA Canada’s IFRS Discussion Group
- In Canada, the government generally owns all minerals and rights over those minerals beneath the ground, while individuals and entities own freehold ownership interests over the surface of the land. In mining and oil and gas industries, an entity may acquire from the government a licence to drill, mine or explore for minerals, on property that a third party owns. To access such minerals, the entity would need to enter into a separate contractual arrangement with the land owner, which grants the entity the right to access the surface of the land which contains the minerals (commonly called “land access agreement”).
- Paragraph 3(a) of IFRS 16 Leases states that “an entity shall apply this Standard to all leases, including leases of right-of-use assets in a sublease, except for leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources.”
- The Group considered the following rights to determine whether they would be in scope of the leases standard.
- Fact Pattern
- Right #1 – Right to explore. Entity A obtains a permit from the government that provides it with the right to explore for oil within a tract of Land Y for 20 years. Entity A pays an annual fee to the government for the permit to explore for the oil.
- Right #2 – Agreement with private landowner for right to access land. To explore for the oil contained within Land Y, Entity A also obtains the right to access the surface of Land Y from a private owner of the land that contains the resources.
- Right #3 – Right to use equipment to explore and extract. To extract the oil from Land Y, Entity A enters into a lease for drilling equipment. The drilling equipment will be used exclusively in the extraction of the oil on Land Y throughout the entire lease term
The group identified various possibilities. You might think the scope exemption applies only to #1, because that’s the only fact pattern that seems confined to exploring for oil (and nothing else). You might alternatively think it applies to #2 as well, regardless that the lease provides a broader right than just that to explore for oil. Or you might think more expansively still, concluding that “Any lease of equipment used in the extraction process falls within the scope exemption because it is required to explore for or use the minerals.” The IFRS 16 basis for conclusions doesn’t provide much detail, beyond observing that the “IASB decided that the scope of IFRS 16 should be based on the scope of the leases requirements in IAS 17.”
Most members of the group supported applying the scope exemption just to #1 and #2. As we’ve noted before, IFRS 6 allows issuers some concessions in how an entity develops its accounting policies for recognizing and measuring exploration and evaluation assets – it labels this as a “temporary exemption” from aspects of IAS 8 (an exemption now in its fifteenth year with no end in sight). It noted at the time, among other things, that “many aspects of accounting for extractive activities are interrelated with aspects that will not be considered until the Board completes its comprehensive review of accounting for extractive activities.” Until that (again, not seemingly imminent) day, it seems that this interrelation may sometimes work to shield these activities from the impact of other standards. There’s no reason though why this should apply to a lease for drilling equipment – regardless of the use to which the equipment is put, the application of IFRS 16 is as clear as for any other piece of equipment used in any other industry (or at least, no less clear).
Anyway, in this case it appears that “both the right to explore for the mineral and the right to access the surface of the land that contains the mineral are required to carry out the extractive work,” supporting a broad application of the scope exemption. The group did briefly discuss “an example of a single arrangement that encompassed both an equipment lease and the right to access the land,” with some members commenting “that the various components embedded in a single arrangement should be bifurcated and evaluated separately against the scope exemption.” Perhaps if the fact pattern were altered so that #2 also allowed the right to do something else on the land (build a gift shop or whatnot), such bifurcation would be appropriate here as well.
One last point: the group observed that “some diversity in practice may exist in the Canadian oil and gas industry in applying the scope exemption related to surface rights beyond those highlighted in the fact pattern. An example would be surface rights related to certain activities to process the resource into a condition necessary for it to be transported, and whether the scope exemption should be applied separately to such surface rights to use land beyond accessing the minerals.” It didn’t comment further on how this diversity should be resolved. Note that the scope exemption applies to “leases to explore for or use” minerals, oil and so forth. While the meaning of “explore for” may be relatively clear, there may be a further discussion to be had on the use of “use”…
The opinions expressed are solely those of the author