As leading auditors for SME businesses involved in natural resource exploration—including those listed on AIM and AQSE—we frequently provide guidance on the correct application of IFRS. The standard that governs this area is IFRS 6, but confusion often arises regarding its applicability and the proper application of its rules in specific scenarios.
In this article, Joseph Brewer, a partner in our listed audit team, offers a refresher on six key considerations when accounting for natural resource exploration.
- Identifying When IFRS 6 Applies
IFRS 6 applies only once an entity has acquired the legal rights to explore a specific location, typically through exploration rights. Any prospecting expenses incurred before obtaining these rights are not covered under IFRS 6 and are typically expensed as incurred.
- Making an Accounting Policy Choice
Upon securing exploration rights, IFRS 6 offers an accounting policy choice: either expense all exploration costs or capitalise them. This policy must be applied consistently and disclosed in the financial statements. In exploration companies, this choice can significantly impact how the financial statements appear over the life of the project.
- Identifying Exploration Expenditures to Capitalise
If the policy is to capitalise costs, careful judgment is required to identify which expenditures fall within the scope of IFRS 6. Examples include:
- Acquisition costs of exploration rights
- Geological and geochemical studies
- Exploratory drilling, trenching, and sampling
- Costs of evaluating exploration results and assessing the technical and commercial viability of the project
Entities must carefully assess how to categorise costs related to exploration activities, such as determining whether employees are solely engaged in exploration or have mixed functions. Depreciation of assets used in exploration may also be capitalised.
- Decommissioning Obligations
Under IAS 37, if an entity has an obligation to remove exploration assets or, for instance, plug an exploratory well, a provision must be created to reflect the expected future cost. The accounting for this provision should align with the chosen policy for exploration costs—whether they are expensed or capitalised.
- Impairment Testing
When exploration costs are capitalised, impairment testing is required if there are indications that the carrying amount might exceed the recoverable amount. In exploration projects, this determination can be challenging, especially when assessments like a Preliminary Economic Assessment (PEA) have not yet been completed. IFRS 6 outlines specific indicators for when impairment testing may be necessary:
- Imminent expiry of exploration rights with little chance of renewal
- Lack of budgeted or planned expenditure for the project
- A decision to discontinue exploration has been taken, where this is not yet a successful resource discovery
- Data suggesting the discovery is unlikely to be commercially viable
For audit purposes, management should formally document their assessment of each significant exploration asset, considering these tests and other impairment factors. In some cases, reversing an earlier impairment may be permissible, for instance, when further exploration yields better results or exploration rights are unexpectedly extended.
- Identifying When IFRS 6 No Longer Applies
Once the technical feasibility and commercial viability of extracting a mineral resource are established, IFRS 6 ceases to apply, as the asset is no longer in the exploration phase. At this stage, the asset should be reclassified as either an intangible or tangible asset, as determined by the nature of the exploration asset, under the appropriate IFRS standards.
What next?
While IFRS 6 may seem straightforward, its practical application can present challenges. For further assistance, please contact Joseph Brewer, an audit partner in our London office.
