PwC IFRS blog

Digging around for an accounting solution

After 10 years of debate, discussion, and backroom musing, last month the IASB published its initial proposals on financial reporting for mining and oil & gas companies. Well, sort of. The IASB seems to be hedging its bets: it took an unusual step of issuing a draft discussion paper – prepared by the national standard-setters of Australia, Canada, Norway and South Africa – and releasing it deep within its website without any fanfare or formal public comment period. The formal release is scheduled for the first quarter of next year. It’s certainly quiet beginnings for an ambitious new accounting standard.

Even still, the draft proposals haven’t gone unnoticed in the energy and resources sector. Based on the conversations my colleagues and I have had with resources companies, after a decade of trying to get accounting for extractive industries on the ‘immediate’ agenda, they’re now nonplussed with where the IASB appears to be heading.

The IASB is proposing a new standard for accounting for extractive assets, which would replace the current guidance in IFRS 6, ‘Exploration for and evaluation of mineral resources’. It would strip out many of the accounting choices currently allowed in IFRS 6, in an attempt to create uniform accounting practice globally.

The draft discussion paper makes five key recommendations (albeit tentatively).

• A single financial reporting model should be available for all mining and oil & gas activities. This sounds logical and it seems to be supported by industry.
• Reserves and resources definitions for financial reporting should be consistent and developed by an overarching industry body. Again, this seems to be supported by industry, and it would make obvious inroads into achieving global consistency and comparability.
• Mineral and oil & gas assets should be recognised when an entity has acquired the legal right to explore. Under this approach, there would be more capitalisation of expenses, which would increase the risk of asset impairment. But unlike the impairment rules in IAS 36, ‘Impairment of assets’, entities would need to assess their assets for impairment whenever evidence suggests that full recovery of the carrying amount of an exploration asset is unlikely. Unsurprisingly, most entities don’t support this proposal. Many are questioning the merit in being ‘forced’ to capitalise something in one year, only to have to write it off at a later date.
• Mineral and oil & gas assets should continue to be measured at historical cost, supplemented by disclosure of the volume and current value of reserves.
• Significantly more detailed disclosures are proposed. By far the most contentious of them is the requirement to disclose information about either the current value or fair value measurement of proved and probable reserves, by major geographical region. This would present resources entities with significant disclosure challenges and may not substantially enhance comparability between entities. Other disclosures proposed relate to monies paid to governments, split by country. Many of the companies I’ve spoken to have questioned why such a burden should be imposed only on one industry.

Time will tell where the IASB ends up with this project. Its current plans involve issuing a formal discussion paper next year, but there has been no communicated timetable from that point on. Given accounting for the extractive industries has been a contested issue for as long as many can remember, I doubt it will be all smooth sailing from here.

As always, I would be interested in your thoughts, either by commenting here or by email.

What exactly is ‘other comprehensive income’?

 

Many companies with December year ends have by now completed their half-year reporting cycle and are more familiar with the new presentation requirements introduced in IAS 1 (Revised). In many cases, the changes have been cosmetic – an extra line item here and an additional disclosure there – but we have to remember that this is only a step in the IASB’s financial statement presentation journey.

 

One of the new concepts introduced this year is the notion of other comprehensive income (OCI). This might appear in a separate statement (looking rather similar to its predecessor – the statement of recognised income and expense) or towards the bottom of a single performance statement – a statement of comprehensive income.

 

What is OCI? This is an extremely difficult question to answer. The following are examples of items that IFRS either permits or requires to be presented as OCI:

 

• Foreign currency translation adjustments on foreign subsidiaries
• Changes in the fair value of available-for-sale financial assets
• Actuarial gains and losses arising on a defined benefit pension plan
• Revaluations of property, plant and equipment
• Changes in the fair value of a financial instrument in a cash flow hedge

 

There is no obvious principle that drives these gains and losses out of earnings and into OCI. They all reflect re-measurements as a result of movements in a price or valuation, but so do some items that are unquestionably included within earnings (such as fair value gains and losses on traded derivatives and investment properties). There is also the question of recycling.

 

Some of these items (such as foreign currency translation adjustments and changes in the fair value of available-for-sale financial assets) are recognised in OCI but are then recognised again in earnings when the underlying item (that is, the foreign subsidiary or available-for-sale financial asset) is sold or realised. In other cases (such as actuarial gains and losses and revaluations of property, plant and equipment) there is no recycling.

 

Items that historically have been recorded outside of earnings have largely been addressed piecemeal in order to resolve specific issues. A recent example has been the proposed treatment of equity investments in July’s exposure draft on financial instruments classification and measurement. However, in that particular case the IASB highlighted the complexity of the issue when it commented that “it would be difficult, and perhaps impossible, to develop a clear and robust principle that would identify investments that are different enough in nature to justify a different presentation requirement”.

 

This might explain why the IASB has not, in its financial statement presentation project or separately, addressed the following fundamental questions: What is the purpose of OCI and its separation from earnings? Which gains and losses on re-measurement to fair value should be reported in earnings and which in OCI? Which items, if any, should be recycled?

 

Is pragmatism the right approach, or should the IASB initiate a separate project to address these issues as a matter of priority? As always, I would be interested in your thoughts, either by commenting here or by email.