Accounting for Mining (#261)
/In this podcast episode, we discuss some aspects of the accounting for mining. Key points made are noted below.
Mine Exploration Activities
One issue with the accounting for mining is that a mine operator first has to engage in exploration activities in order to even figure out where to develop a mine. Then it has to decide whether it would be economical to build the mine, and only then can it begin developing the property. In these early stages, there isn’t necessarily any prospect of having a viable business, so all of the expenses incurred have to be charged to expense as incurred.
Mine Development
The situation changes when you actually start to develop the mine. At this point, management has decided that commercially recoverable mineral reserves actually exist, and so has decided to proceed with construction. There can be a lot of development costs, such as building roads to get to the mine site, and sinking shafts, and removing something called overburden, which is the rock or soil that lies on top of a mineral deposit. All of these costs are capitalized during the development stage.
Sustainable Production Phase
That development stage ends when sustainable production begins. At that point, you can start amortizing the costs that were capitalized during the development stage. The amortization method used is the units of production method, which is not used all that much elsewhere. Under this approach, you estimate the total output expected from the mine, and then amortize the proportion of the total output actually mined.
So, if the capitalized amount of development costs is $1 million, and the mine has just produced 2% of the total amount of expected ore, then you can charge 2% of that $1 million to expense in the current reporting period. If there’s no production from the mine, then there’s no amortization.
Inventory Valuation
The next phase in the life of a mine is the production phase, which should last a fairly long time. The most unique accounting issue in this phase is inventory valuation, because it isn’t necessarily all that precise. For example, a mine could engage in something called heap leaching. This means the company has laid out some sort of impermeable pad and dumped a massive amount of low-grade ore onto it.
Then it drizzles some fairly nasty chemicals onto the heap, like sulfuric acid or cyanide, which dissolves out the metals being mined. The dissolved metals are then collected and subjected to further treatment in a processing plant. The accountant recognizes an inventory asset from the ore stacked on the pad by measuring the size of the heap and then factoring in the proportion of expected metal recovery. Or, a mine could simply pile up its output into a stockpile. For example, coal from a coal mine could be heaped up into a stockpile. If so, the accountant needs to measure the pile to determine the amount of inventory to recognize.
Royalty Payments
Yet another inventory issue is that the mine might very well have to pay a royalty to the owner of the land. If so, the cost of the royalty should be capitalized into inventory, so that it gets charged to expense when the inventory is sold.
Asset Retirement Obligations
And the final unique accounting issue for a mine is the costs that arise towards the end of its useful life. There are two of them. One is any asset retirement obligations, should as landscaping an open pit mine after it’s been closed. This can be a massive cost, running well into the millions of dollars. The mine needs to accrue for a liability for this cost as soon as it has a reasonable understanding of the amounts involved. This number is likely to change, as the closure date of the mine approaches and the company clarifies just how much it’ll need to spend; so the related liability will also change. The accountant may find that this is the largest liability on the balance sheet, so it pays to keep close track of the amount of the liability, and how it’s been calculated.
Environmental Obligations
The other cost that can come up later in the life of a mine is environmental obligations. If there’re any environmentally hazardous conditions at a mine site, the mining company may be seriously liable under a bunch of federal laws. If so, it may be responsible for things like feasibility studies, cleanup costs, legal fees, and restoration costs. The accountant needs to accrue for an environmental obligation if it appears that the business bears some responsibility for a past event, and it’s probable that the outcome will be unfavorable for the business.
It’s not that easy to figure out the amount of this cost, because the mining company might end up sharing responsibility for the obligation with other parties. For example, a mining company buys a mine from another mine operator, and then the Environmental Protection Agency declares the area a Superfund site. In this case, both the current and former owners share responsibility for the cleanup.
In this case, you need to estimate the likelihood that the other party will pay its fair share of the liability, because if it doesn’t then your company may be tagged with the full amount of the cleanup. Consequently, the amount of the environmental cleanup obligation will vary not just based on the latest cost estimate, but also on the ability of the other responsible parties to pay for their shares of the bill. This is a moving target for the accountant, who can expect to issue revisions to this accrued liability on a very regular basis.