Depletion of Mineral Resources 207 | Chapter 17 Depletion of Mineral Resources Related standard: PFRS 6 Exploration for and Evaluation of Mineral Resources Learning Objectives 1, Account for the costs of exploration for and evaluation of mineral resources. 2._Account for the depletion of a natural resource. Introduction PFRS 6 addresses the accounting for expenditures on exploration for and evaluation of mineral resources. » Exploration for and evaluation of mineral resources is “the search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained legal rights to explore in a specific area, as well as the determination of the technical feasibility and commercial viability of extracting the mineral resource.” (PFRS 6.Appendix A) > Exploration and evaluation expenditures - are “expenditures incurred by an entity in connection with the exploration for and evaluation of mineral resources before the technical feasibility and commeicial viability of extracting a mineral resource are demonstrable.” (PFRS 6.Appendix A) PERS 6 applies to expenditures incurred after the entity has obtained legal rights to explore in a specific area (it is illegal to &xplore for mineral resources without obtaining first an authorization from the government) but before the existence of | Mineral reserves is in fact established and the technical feasibility and commercial viability of extracting mineral resources are Scanned with CamScanner208 demonstrable. Expenditures incurred after technical feasibility and commercial viability are demonstrable are called developmen, costs. Development costs are accounted for under other applicable Standards. after legal rights are obtained but before technical feasibility after technical feasibity before legal rights to and commercial viability are and commercial viability explore are obtained demonstrable are demonstrable c Exemption from Hierarchy of reporting standards under PAS 8 % Hierarchy of reporting standards (PAS 8) 1, PFRSs 2. Judgment ‘When making the judgment: > management sha// consider the following: a. Requirements in other PFRSs dealing with similar transactions b. Conceptual Framework > management may consider the following: a. Pronouncements issued by other standard-setting bodies b. Other accounting literature and industry practices PERS 6 temporarily exempts an entity from applying the hierarchy above. PFRS 6 permits entities to develop their own accounting policy for exploration and evaluation assets that results in relevant and reliable information based entirely on management's judgment and without the need to consider the hierarchy of standards in PAS 8. Accordingly, an entity may recognize exploration and evaluation expenditures as expenses or assets depending on its chosen accounting policy (which is developed based entirely on management's judgment). In making the judgment, an entity considers the degree to which the expenditure can be associated with finding specific mineral resources. Scanned with CamScannerDepletion of Minera 209 _Depletion of Mineral Initial measurement Exploration and evaluation assets are initially measured at cost. > Exploration and evaluation assets — are “exploration and evaluation expenditures recognized as assets in accordance with the entity’s accounting policy.” (PFRS6.Appendix A) Examples of expenditures that might be included in the initial measurement of exploration and evaluation assets: a. Acquisition of rights to explore b. Topographical, geological, geochemical and geophysical studies Exploratory drilling Trenching Sampling Activities in relation to evaluating the technical feasibility and commercial viability of extracting a mineral resource. (PFRS 6.9) mepao The initial measurement also includes the present value of any decommissioning and restoration costs for which the entity has incurred an obligation as a consequence of having undertaken the exploration and evaluation activities. Expenditures related to the development of mineral resources are not recognized as exploration and evaluation assets. Subsequent measurement Exploration and evaluation assets are subsequently measured using either the cost model or the revaluation model. Changes in accounting policies An entity may change its accounting policy for exploration and evaluation expenditures if the change results in more relevant and no less reliable, or more reliable and no less relevant, information. Hint entity judges relevance and reliability using the criteria in 8. i is ; Scanned with CamScanner210 Chapter 17 Classification of exploration and evaluation assets Exploration and evaluation assets are initially classified ag a separate class of assets and considered as tangible (e.g. vehicles and drilling rigs) or intangible (e.g. drilling rights) depending on the nature of the assets. When the technical feasibility and commercial viability of extracting a mineral resource become demonstrable, the exploration and evaluation assets are reclassified in accordance with other relevant Standards. The exploration and evaluation assets are assessed first for impairment before the reclassification, Impairment Loss Exploration and evaluation assets are assessed for impairment when indication exists that their carrying amount exceeds their recoverable amount. The entity applies PAS 36 when making the assessment, except for the allocation of impairment loss on assets within cash-generating units wherein the entity is allowed to determine its own accounting policy for the allocation. Examples of indications that exploration and evaluation assets need to be assessed for impairment: a. The right to explore has expired or will expire in the near future and is not expected to be renewed. b. Expenditures for further exploration and evaluation activities are significantly higher than expected. c. The exploration and evaluation activities in a specific area have to be discontinued because no mineral resources have been discovered. d. Indication exists. that, although a specific area will be developed, the carrying amount of the exploration and evaluation asset is unlikely to be fully recovered. Natural resources Natural resources (Mineral resources), often called wasting assets, include petroleum, minerals, and timber. They have two main features: 1, The complete removal (physical consumption) of the asset and Scanned with CamScannerepletion of Mineral Resources 21 —— 2, The replacement of the asset only by an act of nature. Unlike plant and equipment, natural resources are consumed physically over the period of use and do not maintain their physical characteristics, Cost of natural resources There are three types of costs incurred in acquiring and preparing various natural resources (coal, oil, timber, etc.) for use: 1. Purchase price including direct costs and restoration costs. 2. Exploration costs - amounts paid to find the natural resource after legal right to explore has been obtained. These costs are accounted for under PFRS 6. 3. Development costs - amounts paid to prepare the resource site for mining. These include drilling costs and construction costs of tunnels, shafts and wells. Acq ion costs Acquisition cost is the price paid to obtain the property right to search and find an undiscovered natural resource. It can also be the price paid for an already discovered resource. A third type of acquisition cost can be lease payments for property containing a productive natural resource; included in these acquisition costs are royalty payments to the owner of the property. Acquisition costs of natural resources are determined similarly with the cost of PPE. * Generally, the acquisition cost of natural resources is Tecorded in an account titled “Undeveloped property.” The entity later assigns that cost to the natural resource if exploration efforts are successful. If the efforts are unsuccessful, the acquisition cost is written-off as impairment loss. Restoration costs Storation costs are costs entities incur to restore property to its natural state after extraction has occurred. Restoration costs are “apitalized as part of the cost of natural resource to the extent the entity has a present obligation to restore the property. The amount Scanned with CamScanner212 __ Chapter yy Chapter included in the depletion base is the fair value of the obligation to restore the property after extraction. Exploration costs As soon as the entity has obtained the legal right to explore the property, it often incurs exploration costs needed to find the resource. These costs are accounted for in accordance with the entity’s accounting policy developed based on management's judgment. If management judges that exploration costs should be capitalized, then such costs are capitalized. On the other hand, if management judges that exploration costs should be expensed outright, then such costs are expensed as incurred. The reason why PFRS 6 does not provide specific provisions for the accounting of exploration costs is because of varying treatments among extractive industries. Thus, instead of providing specific provisions, entities are permitted to use their judgment in developing accounting policy that would provide relevant and reliable information. Some entities capitalize exploration costs when they are substantial or material. In the oil and gas industry, where the costs of finding the resource are significant and the risks of finding the Tesource are very uncertain, most large companies expense these costs while smaller companies often capitalize them. Development Costs As soon as it is established that natural resource actually exists in a property, the entity incurs development costs to prepare the site Prior to extraction. Entities divide development costs into two parts: (1) tangible equipment costs and (2) intangible development costs. 1. Tangible equipment costs include all of the transportation and other heavy equipment needed to extract the resource and get it ready for market. These costs are not capitalized as cost of natural resource but capitalized as equipment and depreciat separately. Scanned with CamScannerpepletion of Mineral Resources Intangible development costs, on the other hand, are such items as drilling costs, tunnels, shafts, and wells. These costs have no tangible characteristics but are needed for the production of the natural resource. Intangible development costs are capitalized as part of the cost of natural resource. 2 {2 Cost of natural resource: 4. Purchase price (including direct costs and restoration costs). 2. Exploration costs (to the extent that they are capitalized in accordance with the entity’s accounting policy). Intangible development costs Depletion Depletion, like depreciation, is the systematic allocation of the depletion base of a natural resource over the period the natural resource is extracted. Depletion base is the capitalized cost of the natural resource less its residual value. The useful life of a natural resource is normally expressed as the quantity of natural resource or number of production or similar units expected to be obtained from the natural resource by an entity. Depletion of a natural resource begins when natural Tesource starts to be extracted and ceases when the natural Tesource is physically consumed or when the natural resource is derecognized such as when it is disposed of before the natural Tesource is consumed. No depletion is recognized in periods where no natural resource is extracted. Depletion is normally computed using the units-of- Production method (activity method or variable-charge method). The depletion base is divided by the total estimated units xpected to be extracted from the natural resource to obtain a depletion rate per unit. This rate is then multiplied by the actual “nits extracted during the period to compute for the depletion large, Scanned with CamScanner3 2 Pler yy oS The depletion charge for each period forms part of the Cost of inventory. This will be expensed when the inventory js sold, i.e, as part of cost of sales. Illustration: In 20x1, ABC Mining Corp. acquired the right to use 1,000 acres of land to mine for gold. The lease cost is 50,000,000. The related exploration costs on the property amounted to P10,000,000. It is the policy of ABC Mining Corp. to capitalize all costs of exploration and evaluation of mineral resources. Intangible development costs for drilling, tunnels, shafts, and wells incurred before opening the mine amounted to P85,000,000. A law requires ABC to restore the site at the end of the mine’s economic useful life. The estimated restoration costs have a fair value of P5,000,000, ABC estimates that the mine will provide approximately 100,000,000 ounces of gold. ABC extracted 300,000 ounces of gold in 20x2. Requirement: Compute for the depletion charge in 20x2. Solution: Total cost of natural resource is computed as follows: Acquisition cost 50,000,000 Exploration costs (capitalized per ABC’s accounting policy) 10,000,000 Intangible development costs 85,000,000 Restoration costs (fair value) 5,000,000 Total cost of natural resource 150,000,000 The compound entry to record the cost of natural resource in 20x1 is as follows: 20x1 | Resource deposit - gold mine 150,000,000 : Cash 145,000,000 Asset retirement obligation 5,000,000 Scanned with CamScannerDepletion of Mineral Resources 215 Depletion in 20x2 is computed as follows: Depletion rate per unit = Depletion base + Total estimated deposits Depletion rate per unit = 150,000,000 + 100,000,000 Depletion rate per unit = 1.50 Depletion = Depletion rate per unit x Actual units extracted Depletion = 1.50 x 300,000 Depletion = 450,000 Alternative solution: (P150M x 300K actual ounces/ 100M estimated ounces) = 450,000 The entry to record the depletion in 20x2 is as follows: Dec.31, | Work-in-process (Inventory) 450,000 nd Accumulated depletion 450,000 No depletion is recognized in 20x1 because no units were extracted. The depletion forms part of the cost of inventory and recognized as expense (i.e., cost of goods sold) when the inventory is sold. The accumulated depletion is treated as a contra-asset account to the wasting asset to derive its carrying amount. Resource deposit - gold mine, at cost 150,000,000 Accumulated depletion (450,000 Carrying amount 149,550,000 Additional requirement: Assuming that of the 300,000 ounces of gold extracted in 20x2, 80,000 ounces were sold and 20,000 ounces remain in inventory. How much depletion is recognized in the (a) statement of profit or ss and other comprehensive income and (b) statement of financial position? Scanned with CamScanner216 _ Chapter jy Answers: a (a) Statement of profit or loss and other comprehensive income (280,000 x 1.5 depletion rate) = 420,000 (as part of cost of sales) (b) Statement of financial position (20,000 x 1.5) = 30,000 (as part of the cost of unsold inventory) Changes in estimates The estimates of recoverable reserves from the natural resource and any residual value are reviewed at least at each year-end. Any revisions are accounted for as change in accounting estimate and treated prospectively under PAS 8. Illustration 1: Change in estimate In 20x1, ABC Co. acquired land for a total cost of P10,000,000 to be used to quarry marble, limestone, and construction aggregates. Expenditures incurred in the exploration for and evaluation of mineral resources before technical feasibility and commercial viability of extracting a mineral resource are demonstrable totaled 5,000,000. Intangible development costs of drilling, tunnels, shafts, and wells before the actual production totaled P5,000,000. ABC Co. estimated total recoverable reserves of 100,000,000 units. Furthermore, ABC Co. expects to sell the land for P1,200,000 after the resource is depleted. However, no buyer will pay this price unless the mine is drained, filled and leveled — a process that costs 200,000. It is ABC’s policy to capitalize all exploration costs. Actual units quarried in 20x1 through 20x4 totaled 30,000,000 units. On January 1, 20x5, ABC Co. estimated that the remaining recoverable reserves are only 25,000,000 units and after the Teserves are exhausted, the land will be sold for 800,000. Costs of disposal are estimated at P300,000. Actual units quarried in 205 totaled 6,000,000 units. Requirements: Compute for the following: Scanned with CamScanner217 Depletion of M Depletion charge in 20.5. a Carrying amount of the wasting asset as of December 31, 20x5. b. Solutions: The total cost of natural resource is computed as follows: Acquisition cost 10,000,000 Exploration costs 5,000,000 Intangible development costs 5,000,000 20,000,000 Total cost of natural resource Residual value (1.2M -.2M *) (1,000,000) Depletion base — 20x1 19,000,000 «Notice that the disposal cost is deducted from the residual value. Depletion rate per unit = Depletion base + Total estimated deposits Depletion rate per unit = 0.19 (P19,000,000 + 100,000,000) The accumulated depletion as of Jan. 1, 20x5 is computed as follows: Accumulated depletion = Total units extracted x Depletion rate per unit = (30,000,000 x P0.19) = 5,700,000 Cost of natural resource 20,000,000 Accumulated depletion (5,700,000) Carrying amount - Jan. 1, 20x5 14,300,000 Revised residual value (.8M — .3M) (__500,000) Depletion base — 20x5 13,800,000 Divide by revised recoverable reserves 25,000,000 Depletion rate per unit — 20x5 0,552 Requirement (a): Depletion for 20x5: pePletion = Depletion rate per unit x Actual units extracted Pletion = (0.552 x 6,000,000) = 3,322,000 Scanned with CamScanner218 - Chapter 17 Alternative solution: (14.3M - 500K) x 6M/ 25M = 3,312,000 The entry to record the depletion in 20x5 is follows: Dec. 31, | Work-in-process (Inventory) 3,312,000 | 20x5 Accumulated depletion 3,312,000 Requirement (b): Carrying amt. of wasting asset as of 12/31/20x5 Resource deposit — quarry, at cost 20,000,000 Accumulated depletion (5.7M + 3.312M) 9,012,000) Carrying amount, Dec. 31, 20x5 10,988,000 Illustration 2: Change in estimate In 20x1, ABC Co. acquired land to be used to mine coal. Total costs of acquisition, exploration, and intangible development amounted to P10,000,000. It was estimated that total recoverable reserves is 50,000,000 units. Total units extracted from 20x1 through 20x4 totaled 30,000,000 units. In 20x5, after extracting 5,000,000 units, it was estimated that the remaining recoverable reserves is 20,000,000 units. Requirement: Compute for the depletion charge in 20x5. Solution: The carrying amount of the mine as of Jan. 1, 20x5 is computed as follows: Historical cost | 10,000,000 Multiply by: 20M/50M Carrying amount - Jan. 1, 20x5 4,000,000 *(50M original estimate - 30M actual units quarried = 20M) Total remaining recoverable reserves in 20x5 is computed follows: Scanned with CamScannerepletion of Mineral Resources 219 Units extracted during 20x5 5,000,000 Units remaining at the end of 20x5 20,000,000 Total units remaining at the beginning of 20x5 Note that the change is accounted for as at the beginning of the period of change (i.e., Jan. 1, 20x5). Alternatively, the total units remaining at the beginning of 20x5 may also be computed as follows: , _ (squeeze) Total units remaining at the beginning of 20x5 25,000,000 Units extracted during 20x5 (5,000,000) Units remaining at the end of 20x5 20,000,000. (start) The depletion for 20x5 is computed as follows: Carrying amount - Jan. 1, 20x5 4,000,000 Multiply by: 5M/25M Depletion - 20x5 800,000 Depreciation of mining equipment Again, development costs are classified as (1) tangible equipment costs and (2) intangible development costs. Only. intangible development costs form part of the depletion base of the natural resource. Tangible equipment costs are depreciated separately. Tangible equipment costs, such as transportation equipment, heavy machinery, drilling rig foundation, and other equipment are identified as either movable or immovable. Movable tangible equipment includes those that can be used from one extracting site to another (eg, heavy equipment, ttansportation equipment). Movable tangible equipment has alternative use even after the natural resource is fully depleted. Thus, movable tangible equipment is depreciated over its useful life using regular depreciation policy. Scanned with CamScannerChapte 220 hapten iy Tam S ing, sites after the reserves in one si be used in other extracting sites afler the reserve: Me site are fully depleted (c.g. drilling rig foundation). Immovable tangible equipment has no further use after the ane resource is fully depleted. Thus, immovable tangible equipment is depreciated over its useful life or the life of the resource, whichever is shorter, Depreciating the immovable tangible equipment over the shorter life is necessary in order to fully allocate its cost over the periods its economic benefits are consumed. When the useful life of immovable tangible equipment is shorter than the economic useful life of the natural resource, the immovable equipment is depreciated using the straight line method (or any other depreciation method). When the useful life of immovable tangible equipment is longer than the economic useful life of the natural resource, the immovable equipment is depreciated using the units-of- production method. This way, when the natural’ resource is depleted, the cost of the equipment is also fully depreciated. However, when the immovable tangible equipment is depreciated using the units-of-production method and no extraction activities were made in a period, the equipment is depreciated using the straight line method. When extraction activities resume, the equipment is depreciated using again the units-of-production method. ovable tangible equipment includes those that cannot Scanned with CamScannerDepletion of Mineral Resources a1 (21 Development costs: 1. Intangible development = Forms part of the cost of the costs natural resource and included in its depletion. Tangible development costs @ Recognized and depreciated separately a. Movable - Depreciated over its own useful life using any depreciation method b. Immovable - Depreciated over the shorter of the equipment’s useful life and the mine's useful life. i, Ifequipment's life is shorter, use straight line method. ii, If equipment's life is longer, use units-of production method. Illustration 1: Immovable tangible equipment Fact pattern In 20x1, ABC Co. purchased real estate containing copper for P16,000,000. Exploration costs amounted to P1,000,000 and intangible development costs of drilling, tunnels, shafts, and wells totaled P4,000,000. Movable tangible equipment costs for heavy equipment totaled P8,000,000 and immovable tangible equipment costs for drilling rig foundation totaled P6,000,000. Estimated recoverable reserves from the mine are 2,100,000 units. It is estimated that 300,000 units will be extracted each year. The heavy equipment has a useful life of 10 years. Actual units extracted during 20x1 are 320,000 units. Case #1: Life of immovable tangible equipment is shorter The drilling rig foundation has an estimated useful life of 5 years. Requirements: Scanned with CamScanner22 Chapter ty Be Chater a. Compute for the depletion on the natural resource. b. Compute for the depreciation on the movable tangibje equipment. c. Compute for the depreciation on the immovable tangible equipment. Solutions: Requirement (a): Depletion on natural resource Acquisition cost 16,000,000 Exploration costs 1,000,000 Intangible development costs 4,000,000 Total cost of natural resource 21,000,000 Depletion rate per unit = Depletion base + Total estimated deposits Depletion rate per unit = (21M + 2.1M) = 10 Depletion = Depletion rate per unit x Actual units extracted Depletion = (10 x 320,000) = 3,200,000 Alternative solution: Depletion = 21M x 320K/2.1M = 3,200,000 Requirement (b): Depreciation on movable tangible equipment Cost of heavy equipment (movable) 8,000,000 Divide by: Useful life of drilling rig foundation 10 Straight line depreciation 800,000 — Requirement (c): Depreciation on immovable tangible equipment The shorter between (a) the life of the immovable tangible equipment and (b) the life of the mine expressed in years is determined as follows: > Life of immovable tangible equipment = 5 years > Life of mine in years = Total estimated deposits + Expected annual extraction = (2.1M units + 300,000 units per year) = Zyears Scanned with CamScannerepletion of Mineral Resources 223 w The life of the immovable tangible equipment is shorter than the life of the mine. Therefore, the immovable tangible equipment will be depreciated over its useful life using the straight line method. Cost of drilling rig foundation (immovable) 6,000,000 Divide by: Useful life of drilling rig foundation 5 Straight line depreciation 1,200,000 Case #2: Life of immovable tangible equipment is longer The drilling rig foundation has an estimated useful life of 8 years. Requirement: Compute for depreciation on the immovable tangible equipment. Solution: > Life of immovable tangible equipment = 8 years > Life of mine in years = Total estimated deposits + Expected annual extraction = (2.1M units + 300,000 units per year) = Zyears * The life of the immovable tangible equipment is longer than . the life of the mine. Therefore, the immovable tangible equipment will be depreciated over the useful life of the mine using the units-of-production method. = of drilling tig foundation (immovable) 6,000,000 ide by: Total estimated deposits 2,100,000 preciation rate per unit 2.86 ——_ Depress: ePreciation = Depreciation rate per unit x Actual units extracted Preciation = (2.86 x 320,000) = 915,200 Scanned with CamScanner224 —— ——Geptery Illustration 2: No production in a period In 20x1, ABC Co. purchased real estate containing copper for P10,000,000. Immovable tangible equipment costs for drilling rig foundation totaled P5,000,000. Estimated recoverable Teserves from the mine are 1,000,000 units. It is estimated that 100,000 units will be extracted each year; therefore, the life of the mine in years is 10 years. The drilling rig foundation has an estimated useful life of 15 years. Actual units extracted from 20x1 through 20x3 totaled 340,000 units. No units were extracted during 20x4 due to an employee strike. Extraction resumed in 20x5 and total units extracted during that year was 80,000 units. Requirements: Compute for the following: a, Depreciation charge on the immovable tangible equipment in 20x4. b. Depreciation charge on the immovable tangible equipment in 20x5. Solutions: Requirement (a) The life of the immovable tangible equipment is longer than the life of the mine (i.e., 15 yrs. vs. 10 yrs.). Therefore, the immovable tangible equipment will be depreciated over the useful life of the mine using the units-of-production method. Cost of drilling rig foundation 5,000,000 Divide by: Total estimated deposits 1,000,000 Depreciation rate per unit 5 et The carrying amount of the immovable tangible equipment as of January 1, 20x4 is determined as follows: Cost of drilling rig foundation 5,000,000 Accumulated depreciation (340,000 units x 5) (2,700,000) Carrying amount - Jan. 1, 20x4 3,300,000. — Scanned with CamScannerDepreciation in 20x4 using straight line method is computed as follows: Carrying amount ~ Jan. 1, 20x4 3,300,000 Divide by: Remaining life of equipment in years (15-3) 12 Depreciation - 20x4 275,000 Note: Although the equipment is continued to be depreciated in 20x4, the wasting asset (i.e., the mine) is not depleted during this period. Requirement (b): The carrying amount of the immovable tangible equipment as of January 1, 20x5 is determined as follows: Cost of drilling rig foundation 5,000,000 Accumulated depreciation (1.7M + 275K) (1,975,000) Carrying amount ~ Jan. 1, 20x5 3,025,000 825,000 The remaining reserve deposits as of January 1, 20x5 is computed as follows: Total estimated deposits - Jan. 1, 20x1 1,000,000 Deposits extracted from 20x1 to 20x3 (340,000) Remaining deposits — Jan. 1, 20x5 660,000 —_—_—— ees Depreciation in 20x5 using units-of-production method is Computed as follows: Carrying amount - Jan. 1, 20x5 . 3,025,000 Divide by: Remaining deposits — Jan. 1, 20x5 660,000 Depreciation rate per unit Oe he Multiply by: Units extracted in 20x5 80,000 epreciation — 20x5 ___ 366,400 386,400 Scanned with CamScanner226 Chay ter 17 gna aNaE a Liquidating dividends Dividends are normally declared out of the balance of UNTestricteg retained earnings. Dividends declared in excess of retained Camings are called liquidating dividends. . Entities normally cannot declare dividends out of its legal capital because of the trust fund doctrine. Under this doctrine, g corporation's legal capital is considered a trust fund for the protection of its creditors. Accordingly, no part of the legal capital can be distributed to the owners unless the corporation js dissolved or liquidated. However, for wasting asset corporations (those engaged in the extraction of mineral resources), the wasting asset doctrine applies rather than the trust fund doctrine. Under the wasting asset doctrine, due to the irreplaceable nature of the corporation’ assets, dividends can be declared not only from unrestricted retained earnings but also from the balance of accumulated depletion to the extent that it is already realized but not yet liquidated. Depletion is realized when the inventory to which it was charged is sold to unrelated Parties. Depletion is not yet liquidated if it has not yet been declared as dividends in prior periods. The maximum amount of dividends that a wasting asset corporation can declare is computed as follows: Unrestricted retained earnings xx Add: Accumulated depletion xx Total xx Less: Depletion in ending inventory Xx Capital liquidated xx xx Maximum amount of dividend xx Illustration: ABC Co. has the following balances in its accounts as of December 31, 20x1: ‘ Resource deposit - coal mine 10,000,000 Accumulated depletion 4,000,000 Ordinary share capital 20,000,000 Scanned with CamScannerDepletion of Mi ineral Resources 227 Capital liquidated 2,000,000 Unappropriated retained earnings 5,000,000 Inventory (600,000 units) 7,000,000 Depletion rate per unit 1.50 per unit Requirement: Compute for the maximum amount that can be declared as dividends. Solution: Unrestricted retained earnings . 5,000,000 Add: Accumulated depletion 4,000,000 Total 9,000,000 Less: Depletion in ending inventory (600,000 units x P1.50 per unit) 900,000 Capital liquidated 2,000,000 _2,900,000 Maximum amount of dividend 6,100,000 Assuming the maximum amount is declared as dividends, the entry is as follows: Dee Retained earnings - unappropriated | 5,000,000 sui, | Capital liquidated 1,100,000 Dividends payable 6,100,000 The “Capital liquidated” account represents the liquidating dividends, i., the excess of dividends declared over unrestricted retained earnings. Capital liquidated account is a Contra-equity account, i.e., a deduction in shareholders’ equity. Accounting for decommissioning and restoration costs Decommissioning and restoration costs are capitalized only if the Sntity has incurred a present obligation for such costs. Present obligation arises from either legal obligation (e.g,, law or contract) °t constructive obligation. Scanned with CamScanner228 Chapter q7 Examples: a. An existing asset needs to be dismantled in the future When replacing it with a new asset. » There is no present obligation. The dismantling costs will be expensed when incurred. b. An existing asset needs to be dismantled and repaired before it can be sold in the future at its residual value. » There is no present obligation. The estimated dismantling and repair costs are treated as a deduction to the asset's residual value. c. A contract of lease (e.g., land lease) requires an entity to dismantle a structure built on the leased asset and to restore the site at the end of the lease term. » There is present obligation. The dismantling costs are capitalized as cost of the structure built. A corresponding provision (liability) is recognized. d. A law requires a mining company to restore the mining site when the mineral resources are depleted. This includes dismantling any structure built on the site, decontamination, making landfills, and planting of trees and other vegetation to restore the site into its previous prairie state. _» There is present obligation. The restoration costs are capitalized as cost of the mine. A corresponding provision (liability) is recognized. Present obligation also arises from constructive obligation, such as when an entity is neither required by law nor contract to decommission or restore properties but is expected to do so because of past practices. Scanned with CamScannerepletion of Mineral Resources 229 Initial measurement Decommissioning and restoration costs are initially measured at fair value. Fair value is the amount that the entity would pay in an active market to settle the obligation. While active markets do not exist for many obligations for decommissioning and restoration, entities should estimate fair value based on the best information available. Such information could include market prices of similar liabilities, if available. Fair value can also be measured using present value techniques. This requires the use of a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the liability. The discount rate does not reflect risks for which future cash flow estimates have already been adjusted. Recording the provision The fair value of decommissioning and restoration costs for which the entity has incurred a present obligation is recorded: a. as part of the cost of the related asset (e.g., equipment, building, natural resource etc.); and b. as a provision or liability, commonly described as “Asset retirement obligation” (ARO). . Decommissioning and restoration costs are recorded as Part of the related asset because they are tied to operating the asset. Decommissioning and restoration costs are not recorded in 4 separate asset account because no economic benefits can be associated with them alone. Subsequent measurement lated asset ase missioning and restoration costs are included in the related fl Set’s depreciable amount or depletion base and allocated over © asset's useful life as depreciation or depletion charge. Scanned with CamScanner230 Chapter Provision (Liability) . The corresponding liability is subsequently measureg at amortized cost. The periodic unwinding of the discount on the liability is recognized in profit or loss as a finance cost. (epic » Capitalization under PAS 23 Borrowing Cost is not permitted, Decommissioning and restoration costs on non-depreciabje asset If decommissioning and restoration costs are capitalized as cost of land, that portion of the land is depreciated over the period of benefits obtained by incurring those costs. In some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that reflects the benefits to be derived from it. (PAs 16) Changes in estimates Subsequent changes in the estimate of decommissioning and restoration costs or in the discount rate applied to those costs are accounted for prospectively under PAS 8. The change is adjusted to both the carrying amount of the related asset and the corresponding liability. After the change, the revised carrying amount of the related asset is depreciated or depleted over its remaining useful life. The periodic unwinding of discount on the revised liability is recognized in profit or loss. If the change results to a decrease in the asset below its carrying amount, the asset’s carrying amount is reduced to zero and the excess is charged as loss. Illustration 1: Wasting asset Z In 20x1, ABC Mining Corp. acquired a gold mine for P50,000,000- Exploration costs and intangible development costs totaled P10,000,000. An environmental law requires ABC to restore the site after 5 years. The estimated restoration costs are P5,000,000: The current market-based discount rate is 12%. The estimate’ Tesource deposit is 13,000,000 ounces. Actual ounces extracted i* 20x1 and 20x2 were 2,700,000 and 2,600,000, respectively. Requirement: Provide the journal entries in 20x1 and 20x2. Scanned with CamScannerapletion of Mineral Resources 231 Solution: The fair value of the restoration costs is determined as follows: Undiscounted cash outflow for restoration cost 5,000,000 Multiply by: PV of P1 @12%, n=5 0.567427 Present value of restoration costs 2,837,135 The total cost of the natural resource is computed as follows: Acquisition cost 50,000,000 Exploration and Intangible development costs 10,000,000 Present value of restoration costs 2,837,135 Total cost of natural resource 62,837,135 The entry to record the cost of natural resource is as follows: 2011 | Resource deposit - gold mine 62,837,135 Cash 60,000,000 Asset retirement obligation 2,837,135 The Jump sum amortization table for the liability is prepared as follows: Interest expense | Present value (a)=()x12%_|__(W) =(b)+ (a) Jan. 1, 20x1 | 2,837,135 Dec. 31, 20x1 340,456 | 3,177,591 Dec. 31, 20%2 381,311 | 3,558,902 Dec. 31, 20%3 427,068 | 3,985,970 Dec. 31, 20x4 478,316 | 4,464,286 Dec. 31, 20%5 535,714 | _5,000,000 Depletion in 20x1 is computed as follows: pletion rate per unit = (62,837;135 + 13,000,000) = 4.83 Depletion for 20x1 = (4.83 x 2,700,000) = 13,041,000 Scanned with CamScannerThe simple entries on December 31, 20x11 are as follows: Dec. | Work-in-process (Inventory) 13,041,000 eo Accumulated depletion 13,041 9 09 i to record the depletion for 20x1 Dec. | Interest expense 340,456 3 Asset retirement obligation 20x: to record the winding up of discount on the asset retirement obligation Depletion in 20x2 is computed as follows: Depletion for 20x2 = (4.83 x 2,600,000) = 12,558,000 The compound entry on December 31, 20x2 is as follows: Dec. | Work-in-process (Inventory) 12,558,000 Suty_ | Interest expense 381,311 Accumulated depletion 12,558,000 Asset retirement obligation 381,311 Additional requirement: Assume that the actual cash outflow for restoration costs on December 31, 20x5 is P5,500,000. Provide the journal entry. The entry is as follows: Dec. 31, | Asset retirement obligation 5,000,000 | 20x5 | Loss on settlement of ARO 500,000 Cash 5,500,000 Note that the deficiency is accounted for prospectively, ie., charged as expense in 2085 Illustration 2: Equipment On January 1, 20x1, ABC Co. acquired an oil rig for P100,000,000- Installation and other necessary costs in bringing the equipment t its intended condition for use totaled P20,000,000. ABC Co. uses the straight line depreciation method. A law requires ABC '© dismantle the equipment and restore the installation site at the end of the equipment’s 20-year useful life. The estima! decommissioning and restoration costs are ?10,000,000. The imputed rate of interest is 12%, Scanned with CamScannerDepletion of Mineral ces Requirement: Provide the journal entries in 20x1 and 20x2. Solutions: The cost of the equipment is computed as follows: Purchase price 100,000,000 Necessary direct costs 20,000,000 PV of decommissioning and restoration costs (10M x PV of 1 @12%, n=20) = (10M x 0.1036668) 1,036,668 Cost of equipment 121,036,668 The entry to record the acquisition of the equipment is as follows: Jan. 1, | Equipment 121,036,668 20x Cash 120,000,000 Asset retirement obligation 1,036,668 A partial lump sum amortization table is shown below. Interest expense | Present value (a) = (b) x 12% (b) = (b) + (a) Jan. 1, 20x1 1,036,668 Dec. 31, 20x1 124,400 | 1,161,068 D3, 202 | 139908 | 1.800396 The simple entries on December 31, 20x1 are as follows: fee Depreciation expense (121,036,668+20) | 6,051,833, 20x1 Accumulated depreciation 6,051,833 7 to record the depreciation for 20x1 a Interest expense 124,400 2x1 Asset retirement obligation 124,400 to record the winding up of discount on asset retirement obligation The compound entry on December 31, 20x2 is as follows: Scanned with CamScannerChapter 1 ation expense (121,036,008 20) | 6,051,833 139,328 st expense Accumulated depreciation 6,051,833, Asset retirement obligation | Notice in the illustrations above that the “unwinding” (amortization) of the discount on the liability does not affect the depletion and depreciation charges. Illustration 3: Estimating the fair value of ARO On January 1, 20x1, ABC Mining Company purchased a quartz mine for P10,000,000 that it intends to work for the next 10 years, According to environmental laws, ABC must restore the mine site to its original natural prairie state after it ceases mining operations. There is no active market for retirement obligations such as these but ABC has been able to develop cash flow estimates based on its prior experience in mining-site restoration. It will take 3 years to restore the mine site when mining operations cease in 10 years. Each estimated cash outflow reflects an annual payment at the end of each year of the 3-year restoration period. The current market-based rate is 12%. Restoration estimated cash outflow _ Probability assessment 2,000,000 , 10% 3,500,000. 15% 4,000,000 50% 4,200,000 i 25%. 100% Requirement: Compute for the initial cost of the mine. Solution: Scanned with CamScannerpepletion of Mineral Resources 235 ote ee . The “expected value” of the provision for restoration costs is computed as follows: Estimated cash outflow Probability jected value (a) (b) (c) = (a) x (b) 2,000,000 10% 200,000, 3,500,000 15% 525,000 4,000,000 50% 2,000,000 4,200,000. 25% 1,050,000 Expected value-of annual payment 775,000 The present value of the annual restoration costs is computed as follows: Date Annual Present payments PV of P1 factors values Dec. 31, 2x11 3,775,000 PVofP1@12%,n=11 0.287476 1,085,222 Dec. 31, 2x12 3,775,000 PV ofP1@12%,n=12 0.256675 968,948 Dec. 31, 2x13 3,775,000 PV of P1@12%,n=13 0.229174 865,132 Total 11,325,000 2,919,302 The cost of the mine is computed as follows: Purchase price 10,000,000 | PV of asset retirement obligation 2,919,302 | Cost of the mine 12,919,302 —= The entry on January 1, 20x1 is as follows: | ae Resource deposit — quartz mine 12,919,302 PT Cash 10,000,000 | Asset retirement obligation 2,919,302 Amortization table - installment Interest ins Jan. 1, 20x1 2,919,302 Dec. 31, 20x1 - 350,316 350,316 3,269,618 °C. 31, 20x2 e 392,354 392,354 | 3,661,972 Dec. 31, 20x3 2 439,437 439,437 4,101,409 Dec. 31, 204 i E 492,169 492,169 4,593,578 Scanned with CamScanner236 Chapter yy Dec. 31, 20x5 - | 551,229 551,229 | 5,144,807 Dec. 31, 20x6 - | 617,377 617,377 | 5,762,184 Dec. 31, 20x7 - | 691,462. 691,462 | 6,453,646 Dec. 31, 20x8 - | 774,438 74,438 | 7,228,084 Dec. 31, 20x9 - | 867,370, 867,370 8,095,454 Dec. 31, 2x10 - | 971454 | 971,454 9,066,908 Dec. 31, 2x11 | 3,775,000 | 1,088,029, 2,686,971 6,379,937 Dec. 31, 2x12 | 3,775,000 765,592 30408 | 3,370,529 Dec. 31, 2x13_| 3,775,000 | 404,463 | __3,370,537 (gy "The difference is due to rounding-offs. During the deferral periods, the amortization is added to the present value. During the 3-year restoration period where cash flows are made, the amortization is deducted from the present value. The entry on December 31, 2x11 to record the first annual __ payment of restoration cost is as follows: Dec. 31, | Interest expense 1,088,030 2x11 | Asset retirement obligation 2,686,970 Cash 3,775,000 Illustration 4: Changes in estimates On January 1, 20x1, ABC Co. acquired a quarry for P100,000,000. A law requires ABC Co. to. restore the site after 5 years, The estimated restoration costs are P10,000,000. The imputed rate of interest is 12%. On January 1, 20x4, estimated that the restoration costs should be P12,000,000 and the imputed rate of interest is 10%. Requirement: Provide the journal entry on January 1, 20x4 to effect the change in the estimate of restoration costs. Solution: The present value of the initial estimate of ARO is computed as follows: Scanned with CamScannerepletion of Mineral Resources oan pv of ARO ~ Jan. 1, 20x1 = Restoration cost x PV of 1 @ 12%, n=5 pV of ARO - Jan. 1, 20x1 = 10,000,000 x 0.567427 pv or ARO - Jan. 1, 20x1 = 5,674,269 Initial amortization table Initial amortization tare Date Interest expense Present value Jan. 1, 20x1 5,674,269 Dec. 31, 20x1 680,912 6,355,181 Dec. 31, 20x2 762,622 7,117,802 Dec. 31, 20x3 854,136 7,971,939 Dec. 31, 20x4 956,633 8,928,571 Dec. 31, 20x5 1,071,429 10,000,000 The present value of the revised estimate of ARO is computed as follows: PV of ARO - Jan. 1, 20x4 = Restoration cost x PV of 1 @ 10%, n=2 PV of ARO - Jan. 1, 20x4 = 12,000,000 x 0.826446 PV or ARO —Jan. 1, 20x4 = 9,917,355 Revised amortization table “Date Interest expense Present value Jan. 1, 20x4 9,917,355 Dec. 31, 20x5 991,736 10,909,091 Dec. 31, 20x6 1,090,909 12,000,000 The change in ARO is determined as follows: . ARO - Jan. 1, 20x4 before change in estimate 7,971,939 ARO - Jan. 1, 20x4 after change in estimate 9,917,355 Increase in ARO 1,945,416 — ae Ian. 1,T Resource deposit - quarry 1,945,416 The "| on January 1, 20x4 to adjust the ARO is as follows: 20x4 . sree tt Asset retirement obligation 1,945,416 The revised carrying amount of the quarry will be depleted over its remaining economic life. Scanned with CamScanner238 Chapter 17 Chapter 17: Summary Exploration and evaluation expenditures start to be incurred after the legal right to explore an area is obtained and ceases when the existence of reserves is in fact established. Exploration and evaluation expenditures are either recognized as asset or expense depending on the entity’s chosen accounting policy — which is based entirely on management's judgment. If the entity chooses to recognize exploration and evaluation expenditures as asset, it shall initially measure the asset at cost and subsequently measure it using either the cost model or the revaluation model. An entity may subsequently change its accounting policy if the change makes the financial statements more relevant and no less reliable, or more reliable and no less relevant. Exploration and evaluation assets are initially recognized as a separate class of assets. When the existence of mineral resources is established, the exploration and evaluation assets are reclassified to other assets (e.g., as part of the cost of the mine). The cost of a natural resource includes: (a) purchase cost, direct costs, and decommissioning and restoration costs for which the entity has incurred a present obligation, (b) exploration and evaluation costs to the extent that ‘they are capitaljzed in accordance with the entity’ accomnting policy, and (c) intangible development costs. Depletion is computed using the units-of-production method. Tangible development costs are not included as cost of a*natural resource but rather capitalized as equipment and depreciated separately. Liquidating dividends are those declared in excess of the balance of retained earnings. Liquidating dividends are return of capital rather than return on capital. Scanned with CamScannerpepleti on of Mineral Resources pROBLEMS: pROBLEM 1: TRUE OR FALSE 1. 1 Ss Exploration for and evaluation of mineral resources is the search for mineral resources before the entity has obtained legal tights to explore in a specific area. PFRS 6 temporarily exempts an entity from applying the hierarchy of reporting standards under PAS 8. At initial recognition, exploration and evaluation assets are measured at cost. PFRS 6 requires an entity to capitalize exploration and evaluation costs. After initial recognition, exploration and evaluation assets are measured using either the cost model or the revaluation model. . According to PFRS 6, an entity shall classify exploration and evaluation assets as tangible or intangible according to the nature of the assets acquired and apply the classification consistently. . Intangible development costs form part of the cost of a natural resource, subject to depletion. . Restoration costs are capitalized as part of the cost of natural Tesource to the extent the entity has a present obligation to restore the property. The amount included in the depletion base is the fair value of the obligation to restore the property after extraction. In accounting parlance, depletion means the decrease in the €conomic life or value of a wasting asset due to extraction of mineral resources. Entity x acquires a mine for PIM. Entity X éstimates that the mine contains 1,000 units of extractable mineral resources. During the period, Entity X extracts 100 units of mineral Tesources. The depletion for the period is computed as P1M x 100/1,000. Scanned with CamScanner240 Chapter 17 PROBLEM 2: FOR CLASSROOM DISCUSSION Exploration and evaluation expenditures 1. PFRS 6 applies to expenditures incurred a. d. when searching for an area that may warrant detaileg exploration, even though the entity has not yet obtained the legal rights to explore a specific area. when the legal rights to explore a specific area have been obtained, but the technical feasibility and commercial viability of extracting a mineral resource is not yet demonstrable. when a specific area is being developed and preparations for commercial extraction are being made. in extracting mineral resources and processing the resource to make it marketable or transportable. (Adapted) 2. Does PFRS 6 require an entity to recognize exploration and evaluation expenditure as assets? a. Yes, but only to the extent such expenditure is recoverable in future periods. b. Yes, but only to the extent the technical feasibility and commercial viability of extracting the associated mineral resource have been demonstrated. c. Yes, but only to the extent required by the entity's accounting policy for recognizing exploration and evaluation assets. d. No, such expenditure is always expensed in profit or loss as incurred. (Adapted) 3. What is an entity required to consider in developing accounting policies for exploration and evaluation activities? a. b, The requirements and guidance in Standards and Interpretations dealing with similar and related issues. The definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. Scanned with CamScanner |