Deck 19: Accounting for Extractive Industry

Question 1

Describe the activities involved in the pre-production phase in the production of minerals,oil and gas and the accounting treatments that might be allowed for costs arising from this phase.

Answer 1

The pre-production phase encompasses four types of activities.They comprise exploration of areas that are leased for this purpose,the evaluation of exploration results,the development of the deposit for exploitation,and the possible construction of facilities for extraction,treatment and transportation from the deposit or field.EXPLORATION This phase of operations includes the topographical,geological,geochemical and geophysical studies that are usually made over a wide area in order to obtain information that will lead to the acquisition of exploration rights in the most promising areas.EVALUATION After the property rights have been acquired,work is undertaken to determine the technical feasibility and commercial viability of the prospect.The aim of this investigation is to find a commercial deposit.The costs of this phase include salaries and wages,supplies,transport,depreciation or rental of equipment,and other expenditure.DEVELOPMENT After the commercial viability of a prospect has been established,the development phase commences.'Development' refers to the activities involved in the establishment of access to the deposit or field and other preparation for commercial production.These activities include drilling wells for the production of oil or natural gas,sinking shafts,driving tunnels,the removal of overburden,the development of access roads,and the supply of water and power.CONSTRUCTION A separate phase may be identified for construction,which includes the establishment of the facilities for extraction,treatment and transportation from the deposit or field.

Question 2

According to the Statement of Accounting Concepts and the Framework,which of the following methods of accounting for exploration and evaluation costs in the extractive industries is most consistent?

A) The expense-and-reinstate method
B) The successful-efforts method
C) The expense (costs written-off) method
D) The full-cost method

Answer 2

A

Question 3

The units-of-production method is commonly used to calculate the amount of depreciation and amortisation expense to be written-off each year from the accumulated costs of exploration and development of a mining venture.Which of the following formulae best expresses the calculation of the amortisation rate under this method?

A)
$$\frac { \begin{array} { c } \text { Accumulated } \\\text { Cost }\end{array} + \begin{array} { c } \text { Estimated } \\\text { Future Costs }\end{array} - \begin{array} { c } \text { Estimated } \\\text { Residual Value }\end{array} } { \text { Economically Recoverable Reserves } }$$
B)
$$\frac { \begin{array} { c } \text { Accumulated } \\\text { Cost }\end{array} + \begin{array} { c } \text { Estimated } \\\text { Future Costs }\end{array} - \begin{array} { c } \text { Estimated } \\\text { Residual Value }\end{array} } { \text { Economically Market Value of the Venture } }$$
C)
$\frac{\begin{array}{c}\text { Accumulated } \\\text { Cost }\end{array}+\begin{array}{c}\text { Estimated } \\\text { Future Costs }\end{array}-\begin{array}{c}\text { Estimated } \\\text { Residual Value }\end{array}}{\text { Present Value of Estimated Future Net Revenue }}$

D)
$$\frac { \begin{array} { c } \text { Accumulated } \\\text { Cost }\end{array} + \begin{array} { c } \text { Estimated } \\\text { Future Costs }\end{array} - \begin{array} { c } \text { Estimated } \\\text { Residual Value }\end{array} } { \text { Estimated Future Net Revenue } }$$

Answer 3

$$\frac { \begin{array} { c } \text { Accumulated } \\\text { Cost }\end{array} + \begin{array} { c } \text { Estimated } \\\text { Future Costs }\end{array} - \begin{array} { c } \text { Estimated } \\\text { Residual Value }\end{array} } { \text { Economically Recoverable Reserves } }$$

Question 4

Australian Accounting Standard AASB 6 Exploration for and Evaluation of Mineral Resources refers to which of the following categories of reserves of minerals,oil or gas?

A) Possible reserves
B) Economically recoverable reserves
C) Probable reserves
D) Proved reserves

Question 5

Australian Accounting Standard AASB 6 Exploration for and Evaluation of Mineral Resources identifies all of the following EXCEPT which phases in the exploitation of mineral,oil or gas deposits?

A) Production
B) Restoration
C) Construction
D) Evaluation

Question 6

Zenith Mining Ltd paid $3 million for a mineral deposit and spent a further $225 000 in developing the property prior to commencing production on 1 July 20X0.It is estimated that the deposit will produce 25 million tonnes of ore and that the land will have an eventual residual value of $25 000.In addition to the development costs,Zenith spent another $500 000 on infrastructure construction at the mine site.Its mining operations during the year ended 30 June 20X1 resulted in:
$$\begin{array} { l l } \text { Tonnes of ore mined } & 1000000 \\\text { Tonnes of ore sold } & 900000\end{array}$$
The amount to be charged as amortisation of pre-production costs for the year is:

A) $149 000
B) $148 000
C) $128 000
D) $133 200

Question 7

Under the Australian Accounting Standard AASB 6 'Exploration for and Evaluation of Mineral Resources',the area-of-interest method in accounting for pre-production costs of a mining operation is a special form of the:

A) expense-and-reinstatement method
B) successful-efforts method
C) expense (costs written-off) method
D) full-cost method

Question 8

The successful-efforts method of accounting for exploration and evaluation costs in the extractive industries:

A) requires all such costs to be recognised as expenses
B) requires all such costs to be recognised as expenses until an area is abandoned or a commercial mineral deposit is found
C) requires all such costs to be recognised as assets until an area is abandoned or a commercial mineral deposit is found
D) none of the above

Question 9

The expense (or costs written-off)method of accounting for exploration and evaluation costs in the extractive industries would seem to be the most conservative of the suggested methods of accounting for these costs.Conservatism has a long history in accounting and is often used to justify or support many accounting practices.Why then is the expense method not favoured by the Australian Accounting Standards Board? Consider both the benefits and the disadvantages arising from the use of this method.

Question 10

Describe the units-of-production method of amortizing pre-production costs that have been capitalized.

Question 11

Reasons for the AASB 6 to allow exploration and evaluation costs to be capitalised under certain circumstances includes which of the following?

A) when the costs are expected to be recouped
B) when the rights to tenure of the area of interest are current
C) when a reasonable assessment of the viability of the area of interest can be made
D) all of the above

Question 12

Examples of expenditures that might be included in the initial measurement of exploration and evaluation assets provided in paragraph 9 are which of the following:

A) topographical, geological, geochemical and geophysical studies
B) mining
C) cultiviating
D) refining

Question 13

Australian Accounting Standard AASB 6 Exploration for and Evaluation of Mineral Resources defines 'economically recoverable reserves' of minerals,oil or gas as those which can be expected to be profitably:

A) extracted and sold under current and foreseeable economic conditions
B) extracted, processed and sold under current and foreseeable economic conditions
C) extracted, processed and sold under foreseeable economic conditions
D) processed and sold under current economic conditions

Question 14

Australian Accounting Standard AASB 6 Exploration for and Evaluation of Mineral Resources states that exploration and evaluation costs of a mining operation:

A) can be recognised as expenses or carried forward as an asset depending on the circumstances of the particular operation
B) must be accounted for in accordance with Australian Accounting Standard AASB 116 'Property, Plant and Equipment'
C) must be recognised as expenses as they are incurred
D) must be carried forward as an asset until production commences

Question 15

Which of the following statements is correct? The expense (costs written-off)method of accounting for exploration and evaluation costs in the extractive industries:

A) is inconsistent with the framework of accounting
B) is likely to be accepted for income tax purposes
C) is simple and conservative
D) all of the above are correct

Question 16

AASB 6 is an activity based standard; as such it does not fully cover other areas of extractive industries.Make a list and briefly explain the other relevant standards that a mining company has to consider in producing its financial statements under the new regime.

Question 17

Ferrous Minerals Ltd paid $2 million for a mine site and has spent a further $500 000 developing the property prior to commencing production.Ferrous estimates that the mine will produce 10 million tonnes of ore and that the land will have a final residual value of $75 000 for sale and use as a waste disposal site.It is also believed that to extract the last 2 million tonnes of ore will require further drilling and excavation work at a cost of an extra $200 000.What is the amortisation rate that should be used to write-off pre-production costs in the first year of production (when it is estimated that 1 million tonnes of ore will be mined):

A) 27.0 cents per tonne
B) 26.25 cents per tonne
C) 24.25 cents per tonne
D) 21.875 cents per tonne

Question 18

The full-cost method of accounting for exploration and evaluation costs in the extractive industries:

A) requires that all such costs be recognised as expenses
B) requires that all such costs be recognised as assets
C) allows more timely disclosure of the costs of unsuccessful exploration activities
D) gives asset values closely approximating the value of mineral deposits that are discovered

Question 19

Epson Mining Ltd has economically recoverable reserves of 3 million tonnes of ore.In discovering and developing its mine it has spent $400 000 to acquire the mining site,$600 000 in geological survey costs and $300 000 in excavating an open pit mine.It has also acquired a fleet of trucks to transport the ore,at a total cost of $160 000; the trucks have an estimated life of 5 years and zero residual value.Epson has extracted 300 000 tonnes of ore in its first year of production and expects to mine the same amount each year for the life of the mine.The mine will have no value when the ore has been extracted.In its first year of production,Epson's total expense for amortisation and depreciation should be shown as:

A) $292 000
B) $130 000
C) $146 000
D) $162 000

Question 20

Extractive industries should value inventory held by businesses at:

A) lower of cost and net realisable value, including amortisation of pre-production cost
B) net realisable value less an allowance for future rehabilitation costs
C) net realisable value
D) lower of cost and net realisable value, excluding amortisation of pre-production costs

Question 21

To calculate the value of the reserves,the following data are required:

A) an estimate of the current sales price per output unit
B) a discount rate
C) an estimate of the life of the fixed assets
D) an estimate of the cost of salvage per output unit

Question 22

Bigspill Gas & Oil Ltd began operations on 1 July 20X1.During the year ended 30 June 20X2,Bigspill explored five different areas of interest and spent $200 000 in each area.The exploration results indicated that three areas were likely to be productive and Bigspill acquired leases over the three areas at costs of $400 000,$720 000 and $480 000 respectively.Under the expense method of accounting for exploration and evaluation costs in the extractive industries,Bigspill would include which of the following amounts in its statement of financial position as at 30 June 20X2 for Exploration and Evaluation Costs?

A) $2 200 000
B) $1 600 000
C) $2 600 000
D) $ Nil

Question 23

Bigspill Gas & Oil Ltd began operations on 1 July 20X1.During the year ended 30 June 20X2,Bigspill explored five different areas of interest and spent $200 000 in each area.The exploration results indicated that three areas were likely to be productive and Bigspill acquired leases over the three areas at costs of $400 000,$720 000 and $480 000 respectively.Under the successful-efforts method of accounting for exploration and evaluation costs in the extractive industries,Bigspill would include which of the following amounts in its statement of financial position as at 30 June 20X2 for Exploration and Evaluation Costs?

A) $1 600 000
B) $2 600 000
C) $2 200 000
D) $ Nil

Question 24

The accountant for a mining exploration company presents the following figures to the directors of the company as being possible values that could be assigned to its total non-current assets (comprising exploration and evaluation costs and purchases of plant and machinery to date)- $750 000,$1 600 000,or $2 350 000.Use of the figure $2 350 000 indicates that the company is probably using which of the following methods of accounting for exploration and evaluation costs?

A) Expense
B) Full-cost
C) Successful-efforts
D) Area-of-interest

Question 25

Bigspill Gas & Oil Ltd began operations on 1 July 20X1.During the year ended 30 June 20X2,Bigspill explored five different areas of interest and spent $200 000 in each area.The exploration results indicated that three areas were likely to be productive and Bigspill acquired leases over the three areas at costs of $400 000,$720 000 and $480 000 respectively.Under the full-cost method of accounting for exploration and evaluation costs in the extractive industries,Bigspill would include which of the following amounts in its statement of financial position as at 30 June 20X2 for Exploration and Evaluation Costs?

A) $2 200 000
B) $1 600 000
C) $ Nil
D) $2 600 000