The Canadian mining industry appears to have dodged concerns that some companies would be overwhelmed by having to dig into decades-old records in order to expense certain project costs after adopting International Financial Reporting Standards.
But experts warn the big test may still loom, when commodity prices inevitably plunge, citing big differences in accounting for impairment of assets between IFRS and Canadian Generally Accepted Accounting Principles.
"When times are good, you’re going to get commodity prices going up. You don’t have to worry too much about impairment. But we all know with commodity cycles [that] when you go up there’s always a down period as well," said Dean Braunsteiner, IPO leader in the partner and assurance group of PricewaterhouseCoopers LLP in Toronto.
"I think [that’s] one of the bigger issues facing the mining industry, because it’s a commodity-based industry."
Under pre-changeover Canadian GAAP, the test for impairment involved a two-step approach. Mining companies would first establish their production profile cash flows over the expected life of the mine, then compare that amount to the carrying value of the asset on the financial statements. If gross cash flows exceeded the carrying amount, no adjustment was necessary. But if those cash flows were less, the asset had to be recorded at fair value, explained Braunsteiner.
"Under IFRS, there’s no longer a two-step approach. If you identify there are impairment indicators, you’re required to do a formal impairment test. You go straight to determining what the fair value of the operating asset is, then compare that to the carrying amount.
"So under IFRS you would see impairment charges earlier than you would have under Canadian GAAP," he said. "But where it gets complicated is under IFRS, to the extent that those factors recover, companies are then required to go through and actually write up their assets again."
Under pre-changeover Canadian GAAP, "if you had a write-off, you never went back to the asset to determine whether or not that value recovered. You just booked the impairment and moved forward from that point. So this is really a new concept for Canadian companies under IFRS," he said.
David Bryson, senior vice-president and chief financial officer of Hudbay Minerals Inc., a Toronto-based diversified mining company with assets in Canada, the United States and Peru, also believes the next commodities downturn could offer significant repercussions from an accounting standpoint.
"Some of the implications of the IFRS conversion may not have been fully felt. The next time we have a downturn in metal prices, the industry will find that the triggers for impairments and results of impairments may come faster than they would have under Canadian GAAP," he predicted.
One of the key choices mining firms had to make during the IFRS changeover period involved whether to capitalize or expense their exploration and evaluation costs.
Under GAAP, firms basically had that same choice — the opportunity to retain accounting policies under GAAP with respect to exploration and evaluation costs is part of the guidance contained in IFRS 6.
Some companies, such as Stonegate Agricom Ltd., a Toronto-based exploration and development company with projects in the U.S. and Peru, made no change. "In the past [we] capitalized," said Germaine Coombs, the company’s vice-president and chief financial officer.
"With IFRS, there was suddenly the ability to take a decision on whether [to] capitalize or expense. We decided to continue with capitalization. The decision was made by management and the board together. This goes right up through to your audit committee, and requires a significant amount of discussion, because fundamentally it’s quite a different way to do your accounting."
Many other mining companies previously elected to capitalize exploration costs, but used the IFRS adoption period to change their policy. "They decided they would write off the exploration costs incurred historically, then set a policy which indicated when they would start to capitalize costs," Braunsteiner said.
International Financial Reporting Standards allow judgment in terms of when a mining company believes it is appropriate to begin capitalizing costs for a particular project it believes will become a viable production property. For example, some might decide to capitalize costs going forward after conducting a preliminary economic assessment, while others might prefer capitalization to commence after a feasibility study on the site has been completed.
Hudbay Minerals Inc. decided to use this opportunity to change its policy.
"In connection with the conversion to IFRS, we did take a closer look at our capitalization policy, and made some changes. We were trying to get somewhat more objective, and so implemented a policy whereby we needed to have reserves declared on a project, have completed a pre-feasibility, and be confident the project would be developed before we would move from the exploration and evaluation phase into the capital works and progress phase," Bryson said. "We also made a policy decision not to capitalize expenditures in the exploration and evaluation phase. IFRS was more specific in terms of distinguishing between those two phases."
Braunsteiner believes mining companies retain a significant amount of choice under IFRS.
"I think people were expecting a lot more consistency when we moved to IFRS — in particular with respect to exploration and evaluation costs and how they were being treated. But it’s really allowed companies to do what they were doing historically, or make a new policy choice. There’s no requirement in terms of saying ‘here’s what you shall do.’ And so that consistency or comparability isn’t quite there, which I think some analysts or investors were hoping to see," he said.
"But the good thing is companies have had to put quite specific guidance in their financial statements about what their policy is. And so when you’re comparing two companies you can say ‘I need to understand what their policies and judgments are,’ and that may help investors and analysts make adjustments or decisions regarding what the company’s practices are going forward."
One thing clear, however, is that after adopting IFRS, mining companies must expense costs on unsuccessful exploration projects, said Kin Lo, an accounting professor at the University of British Columbia’s Sauder School of Business in Vancouver. Thus, the IFRS changeover brought another practical concern: that the detailed components of such expensed items might be difficult, if not impossible, for some mining companies to dig up — especially for old projects.
"It’s possible that they wouldn’t have kept track of costs because [under Canadian GAAP] it could all just be aggregated and capitalized, without differentiating which site was successful and which site was not," Lo said.
Recognizing this potential difficulty, the transitional rules contained in IFRS 1 – First-time Adoption of International Reporting Standards, give companies the option to carry forward the assets for capitalized exploration costs, Lo said.
For larger mining companies, a challenging requirement came from breaking down property, plant and equipment into components when calculating amortization expenses. Under IFRS, each of those costs has to be amortized separately, Braunsteiner explained.
"In our case [identifying the components of a project that could have separate depreciable lives] was a significant amount of work, but it wasn’t as burdensome as it might have been for some others," Bryson said. "Because Hudbay had essentially been IPO’d in 2004, we only had to go back to 2004 because we were able to avail ourselves of some exemptions that allowed us to cut it off at that point in time."
In January, PwC surveyed several junior and senior mining companies to determine where their adjustments were using the March 31, 2011 financial statements — the first quarter under which publicly listed companies had to adopt IFRS, in an effort to ascertain where their big adjustments were.
"Componentization of assets really wasn’t [an area] where there were a lot of adjustments," Braunsteiner said.
"In terms of dollar value, it wasn’t a significant adjustment. They were still coming up with relatively the same result under IFRS as they would have under Canadian GAAP."
The fact many Canadian mining companies had international subsidiaries was actually a help during the adoption phase, because many of those countries had already adopted IFRS before Canada.
"If you look at the mining jurisdictions around the world, Canada is probably one of the last to adopt IFRS. The U.K., Australia, South Africa [all] have fairly sizable global mining companies, and had already converted.
"So what it’s done is made financial reporting a bit more streamlined for those companies," Braunsteiner said.