Emerging Issues Task Force. EITF Agenda Committee Report Supplement. Mining Industry Issues November 5, 2003

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1 1103RPTMNG Emerging Issues Task Force Agenda Committee Report Supplement Mining Industry Issues November 5, 2003 Potential New Issues Page(s) 1. Whether Mining Rights are Tangible or Intangible Assets Mineral Assets Business Combinations and Impairment Allocation of Goodwill to Reporting Units for a Mining Enterprise Accounting for Deferred Stripping Costs in the Mining Industry Application of FASB Statement No. 142, Goodwill and Other Intangible Assets, to Certain Assets of Oil and Gas Companies Subject to FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies 19 EITF Agenda Committee Report Supplement Table of Contents

2 Potential New Issues 1. Whether mineral rights are tangible or intangible assets Background FASB Statement No. 141, Business Combinations, requires the acquirer in a business combination to allocate the cost of the acquisition to the acquired assets and liabilities. Paragraph 37 of Statement 141 lists assets and liabilities that an acquirer should consider in its allocation of purchase price. Natural resources are listed as an example of other assets and are separated from intangible assets in the list. Appendix A of Statement 141 provides examples of intangible assets. These examples include mineral rights as an example of an intangible asset that should be recognized apart from goodwill. Accounting Issues Issue 1 Whether mineral rights are tangible or intangible assets. Mining entities generally did not change their practice of accounting for mineral rights as tangible assets upon adoption of Statement 141 and Statement 142. In mid-2003, the SEC staff concluded based on paragraphs 39 and A14 of Statement 141 that entities that are outside the scope of FASB Statement No. 19 Financial Accounting and Reporting by Oil and Gas Producing Companies, should account for mineral rights as intangible assets in accordance with Statement 142. As a result of that conclusion, some mining entities have changed their classification and amortization of mineral rights, including the method of amortization, useful life, and salvage value. The National Mining Association (NMA) and others disagree with the SEC staff's conclusion that mineral rights are intangible assets. They believe that there is an inconsistency in Statement 141 that requires resolution (that is, the perceived inconsistency that mineral rights and natural resources are economically similar but one is viewed as an intangible asset and one is viewed as a tangible asset). Further, they believe that the intent of the FASB in listing the examples of intangible assets was to require the recognition of assets apart from goodwill, not to reclassify Agenda Committee Meeting (Potential New Issues) p. 1

3 assets that were already recognized and subject to depreciation. NMA also supports its position that mineral rights are tangible property through mineral case law. For example, most U.S. states treat mineral leases as interests in real property and apply real property law to interpret the leases. As such, the NMA argues that there is no legal basis to distinguish between real estate ownership that includes mineral rights and mineral rights that do not include real estate ownership. In each case, the owner of the mineral rights has the right to extract a tangible natural resource. Some Working Group members believe that the EITF cannot conclude that all mineral rights are tangible assets without an amendment to Statement 141 that removes mineral rights as an example of an intangible asset. Accordingly, the Working Group requests that the EITF develop a model that is based on the substance of the mining rights for determining when mineral rights are tangible assets and intangible assets. Any model needs to be comprehensive enough to evaluate mineral rights under both U.S. law and the laws of other countries. The Working Group acknowledges that any conclusion on when mineral rights are tangible assets and intangible assets may have implications on other "use rights" including drilling and timber cutting rights. Issue 2 If certain mineral rights are intangible assets that are subject to amortization, the appropriate basis for amortization of the intangible asset. If the EITF concludes that certain (or all) mineral rights are intangible assets, the Working Group identified a number of potential issues related to the amortization of the mineral rights. Mining entities generally amortize mineral rights on a units-of-production method based on the estimated total proven and probable reserves. Amortization of mineral rights typically starts when production begins. Before production, the mineral rights are not amortized, but are evaluated for impairment. Period of Amortization Statement 142 requires an entity to amortize finite-lived intangible assets over the best estimate of its useful life with a method that reflects the pattern in which the economic benefits of the intangible assets are consumed. Some believe that mining entities should amortize unproven Agenda Committee Meeting (Potential New Issues) p. 2

4 mineral rights on a straight-line method over the period required to convert, develop, or further explore the mineral rights. Others believe that unproven mineral rights should be amortized on a straight-line method over the life of the mineral rights or over management's best estimate of the life of the mine. At the point that the mineral reserves are proven, the entity should determine whether a units-of-production or a straight-line method of amortization best reflects the pattern in which the economic benefits of the mineral rights are consumed. Others argue that until production begins, the economic benefits of minerals rights are not consumed, and, accordingly, they believe that mineral rights should not be amortized until production begins. Residual Value Statement 142 requires an entity to amortize an intangible asset to its residual value. The residual value of an intangible asset is assumed to be zero unless at the end of its useful life to the reporting entity the asset is expected to have a useful life to another entity and (a) the reporting entity has a commitment from a third party to purchase the asset or (b) the residual value can be determined by reference to an exchange transaction in an existing market for that asset and that market is expected to exist at the end of the asset's useful life. Some believe that the residual value of mineral rights should always be assumed to be zero unless there is a commitment from a third-party to purchase the asset at the end of its useful life to the reporting entity. That is, they believe that mineral rights are unique assets for which a market does not exist. Others argue that a market for mineral rights exists and is evidenced by the frequent buying and selling of mineral rights. Issue 3 If mineral rights are intangible assets, whether those assets should be presented together with the related property, plant, and equipment on an entity's balance sheet. Mining entities generally present mineral rights as property, plant and equipment on their balance sheets. If the EITF concludes that certain mineral rights are intangible assets, the Working Group believes that there is an inconsistency in the authoritative literature associated with the balance sheet presentation of mineral rights. Agenda Committee Meeting (Potential New Issues) p. 3

5 Statement 142 requires an entity to present intangible assets aggregated in a separate line item (or in separate line items for each intangible asset) in its statement of financial position. In contrast, Statement 141 provides an example in which an entity is not precluded from presenting a license to operate a nuclear plant (an intangible asset) and the associated power plant as a single asset for financial reporting purposes. Some members of the Working Group believe that this example is analogous to mineral rights and capitalized mine development costs. Therefore, they believe that entities should always present mineral rights with the associated tangible assets. Others believe that the Statement 141 example is a narrow exception to which entities should not analogize. Issue 4 The appropriate impairment test for assets relating to unproven mineral rights. The Working Group identified a number of issues related to testing unproven mineral properties for impairment. Some mining entities test unproven mineral rights for impairment using a method that is similar to the method required by Statement 19 for unproven oil and gas reserves. That is, many mining entities test unproven mineral reserves periodically for impairment when indicators of impairment exist, such as unsuccessful exploration activities or approaching lease expiration. If impairment indicators exist, the mining entity typically will record a valuation allowance based on the fair value of the mineral rights. For proven reserves, mining entities typically follow the provisions of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Statement 142 requires that an entity review an intangible asset that is subject to amortization in accordance with Statement 144. Although unproven oil and gas properties are not subject to the provisions of Statement 144, there is not a similar scope exception for other mineral rights. Accordingly, the Working Group believes that mining entities should apply the provisions of Statement 144, regardless of how the EITF concludes on whether mineral rights are tangible or intangible assets. The Working Group requests that the EITF clarify that proven and unproven mineral rights of mining entities should be evaluated for impairment in accordance with Statement 144 (or Statement 142 if the EITF concludes that mineral rights are intangible assets Agenda Committee Meeting (Potential New Issues) p. 4

6 and the specific mineral right has an indefinite life) and that Statement 19 should not be used to evaluate mineral reserves for impairment by entities that are outside of its scope Refer to Proposed Issue 2, "Mineral Rights: Business Combinations and Impairment," for additional issues regarding the impairment of mineral rights. Issue 5 Impairment testing for royalty interests. A common type of interest in the mining industry is a royalty interest. Royalty interest holders are entitled to receive a share of future production from a mining property, which may be settleable in cash, by actual production ("royalty in kind"), or by a combination of both. Some believe that a royalty interest is a form of mineral right and they note that Statement 19 includes royalty interests in its definition of mineral properties for oil and gas companies. Others believe that a royalty interest is a financial instrument. As a result, diversity in practice exists on the evaluation of royalty interests for impairment. The Working Group believes that the first step is to determine the nature of the asset; mineral right, financial instrument, or intangible asset. The Working Group also believes that the nature of the asset should be determined based on the specific terms of the royalty interest. Accordingly, developing a list of factors for an entity to consider may be the most appropriate approach. Agenda Committee Decision: The Agenda Committee decided to add this Issue to the EITF's agenda. The Agenda Committee agreed with the Working Group's observation that a decision by the Task Force that all mineral rights are tangible assets would necessitate an amendment to Statement 141. An FASB Board member of the Agenda Committee indicated that the Board would consider any new information that may impact the Board's view as to the classification of mineral rights as tangible assets or intangible assets. The Agenda Committee also noted that the Issue should specifically address the possibility that "mineral rights" may contain multiple rights that may need to be bifurcated into separate assets. The Agenda Agenda Committee Meeting (Potential New Issues) p. 5

7 Committee agreed with the Working Group's recommendation that the scope of this Issue should exclude those rights that are covered by Statement 19. Agenda Committee Meeting (Potential New Issues) p. 6

8 2. Mineral Assets: Impairment and Business Combinations Background Reserve Definitions Securities Act Industry Guide No. 7, Description of Property by Issuers Engaged or to be Engaged in Significant Mining Operations (Industry Guide 7), defines proven and probable reserves as follows: (1) Proven Reserves. Reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well-established. (2) Probable Reserves. Reserves for which quantity and grade and/or quality are computed from information similar to that used for proven (measured) reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven (measured) reserves, is high enough to assume continuity between points of observation. Industry Guide 7 prohibits disclosure of estimates of any reserves that are not proven or probable. "Possible" reserves are estimated reserves that are less well established than proven and probable reserves. FASB Statement No. 89, Financial Reporting and Changing Prices, provides less specific definitions of proven and probable reserves. The Working Group acknowledges that there is a mining industry initiative to develop more comprehensive definitions of reserves for public reporting purposes than the definitions in Industry Guide 7. Accounting Issues Some mining entities disregard "possible" mineral reserves and future market prices of minerals when testing proven mineral rights and properties (mineral assets) for impairment. Because some mining entities exclude those factors from cash flows used for impairment testing, they also exclude those factors when allocating the purchase price of a business combination to acquired mineral assets. The primary concern is that the acquired asset would be subject to a Agenda Committee Meeting (Potential New Issues) p. 7

9 day-two impairment charge if "possible" reserves (including exploration potential) and future market price increases were included in the fair value of the asset for the purchase price allocation and subsequently excluded for the impairment test. However, the fair value of a mineral asset (that is, the amount buyers agree to pay) generally includes both "possible" mineral reserves and an estimate of future market prices, which often represents the potential upside of the asset. Typically, buyers pay a premium over the existing proven reserves for this potential upside. As a result, amounts paid in a business combination for "possible" reserves and anticipated increases in market prices of minerals may have been included in goodwill. Further, entities are required to assign goodwill to reporting units to test the goodwill for impairment. A number of issues have arisen for mining entities about the goodwill impairment test. Issue 1 Whether the value associated with "possible" mineral reserves and anticipated fluctuations in the future market price of minerals should be included in the valuation of mineral assets when those assets are tested for impairment. Possible mineral reserves Statement 144 requires an entity to recognize an impairment loss only when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Estimates of future cash flows used to test recoverability of a long-lived asset should incorporate management's own assumptions about its use. In developing those estimates, management should consider internal budgets and projections, and information that is communicated to others. If alternative courses of action are possible or if a range is estimated for the future cash flows associated with the likely course of action, the likelihood of those possible outcomes should be considered. Additionally, estimates for assets that are in use (for example, operating mines) should be based on the existing service potential of the asset. An entity should exclude cash flows associated with future capital expenditures that would increase the existing service potential of a long-lived asset. Agenda Committee Meeting (Potential New Issues) p. 8

10 Some believe that the existing service potential of a mineral asset is the proven and probable reserves and, accordingly, the cash flow assumptions used by management to evaluate a mineral asset are restricted to the cash flows from these reserves. Additionally, the development of "possible" reserves often requires substantial capital investment and Statement 144 requires that an entity exclude from its impairment analysis cash flows associated with expenditures that increase the service potential of an asset. Others argue that "possible" reserves should be included in the existing service potential of a mineral asset and the restrictions in Statement 144 about service potential do not contemplate "possible" mineral reserves. Further, they argue that Statement 144 permits the use of a probability-weighted cash flow method to incorporate estimates of future outcomes and they believe that this method should be used to incorporate the potential cash flows from "possible" reserves into an impairment analysis. Industry Guide 7 only prohibits disclosure of possible reserves; it does not restrict a mining entity from using possible reserves for impairment testing or purchase price allocations. However, some believe that the restrictions on disclosing possible reserves also prohibit the use of possible reserves when testing mineral assets for impairment. Some believe that these views have been supported by discussions with the SEC staff. Others, including the SEC Observer, disagree that Industry Guide 7 provides guidance on the accounting for possible mineral reserves. Further, they reference the SEC staff position in II.F.5 of the Division of Corporation Finance: Frequently Requested Accounting and Financial Reporting Interpretations and Guidance March 31, 2001, which supports the use of a probability-weighted cash flows to test unproven oil and gas properties for impairment. Future market prices Similar to "possible" reserves, some believe that discussions with the SEC staff have resulted in an industry practice of using the average historical price of minerals to estimate the future cash flows for impairment testing. Further, they believe that this practice is supported by analogy to oil and gas accounting. Specifically, SEC Regulation S X limits capitalized costs under the full cost method to the present value of future cash flows from proved properties based on current prices. Additionally, FASB Statement No. 69, Disclosures about Oil and Gas Producing Activities, requires entities to disclose the future net cash flows of proven oil and gas Agenda Committee Meeting (Potential New Issues) p. 9

11 reserves generally using the year end oil and gas prices. Others, including the SEC Observer, argue that mining entities should not analogize to this oil and gas accounting guidance and that Statement 144 requires entities to use their best estimates of future cash flows including their estimates of future prices. Issue 2 Whether the value associated with "possible" mineral reserves and anticipated fluctuations in the future market price of minerals should be included in the valuation of mineral assets when those assets are recognized in a purchase business combination Statement 141 requires an acquiring entity to allocate the cost of an acquired entity to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. Mineral reserves and properties generally are the primary assets in an acquisition of a mining company. The Working Group believes that an acquirer should consider the estimates and analysis that it used to develop the purchase price when it allocates the purchase price to the acquired assets and liabilities. However, some mining entities exclude the value paid for "possible" mineral reserves (including exploration potential) and anticipated fluctuations in mineral prices (both increases and decreases) from the amount that is allocated to mineral assets. The Working Group believes that this industry practice is inconsistent with the concept of fair value and the requirements of Statement 141. The Working Group recommends that the EITF provide guidance to the mining industry on the treatment of "possible" reserves and anticipated fluctuations in mineral prices in a purchase price allocation. If the EITF concludes that the value of "possible" mineral reserves should be allocated to mineral assets in a purchase price allocation, the EITF should consider whether it wants to provide guidance on the treatment of "possible" reserves in the application of the unitsof-production depreciation method. Agenda Committee Decision: The Agenda Committee decided to add this Issue to the EITF's agenda. Agenda Committee Meeting (Potential New Issues) p. 10

12 3. Allocation of Goodwill to Reporting Units for a Mining Enterprise Background An acquisition of a mining company may result in a significant amount of goodwill. For example, gold mining companies typically trade at 1.5 to 3 times their net asset values. Some believe that the premium over the net asset value (that is, the goodwill) reflects the expectation that the mining company can create long-term stability and growth through the acquired exploration and development activities. They believe that goodwill does not result from the cash flows of individual operating mines, which are valued in a business combination based on their reserves. Statement 142 requires an entity to test goodwill for impairment at the reporting unit level. A reporting unit is an operating segment under FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, or one level below an operating segment. Statement 131, paragraph 10, defines an operating segment as a component of an enterprise: a. That engages in business activities from which it may earn revenues and incur expenses, b. Whose operating results are regularly reviewed by the enterprise's chief operating decision maker to make decisions about resources to be allocated, and c. For which discrete financial information is available. Since adopting Statement 131, many mining entities have reported the operations of individual mines as operating segments. For these entities, the operating mines meet the definition of an operating segment because the chief operating decision maker receives discrete financial information for the individual mines. These mines often are not aggregated for financial reporting purposes because each mine may have significantly different cost structures and gross margins. However, an individual operating mine is not a typical "going-concern" business because it has a finite life based on the life of its reserves. That is, an operating mine is a depleting asset with little or no value beyond its mineral reserves. Agenda Committee Meeting (Potential New Issues) p. 11

13 Many believe that Statement 142 requires an entity to assign goodwill in a business combination to individual operating mines that are reporting units. Some argue that assigning goodwill to an operating mine results in a day-two impairment of the goodwill. That is, the fair value of reporting unit only consists of the fair value of the operating mine and, accordingly, there is no additional fair value in the reporting unit to support the recognition of the goodwill. Others acknowledge that any goodwill assigned to an operating mine ultimately will be impaired because an operating mine is a wasting asset. Others believe that goodwill represents the premium for the exploration and development activities and, therefore, an entity should not assign goodwill to individual operating mines. The Working Group acknowledges that diversity in practice exists and that the application of Statement 142 raises a number of questions. The majority of the Working Group believes that the EITF should address the mining industry issues regarding the goodwill impairment test that is required by Statement 142. Other Working Group members believe that the application of Statement 142 requires judgment based on specific facts and circumstances, and that many of these issues are not unique to the mining industry. Accordingly, a minority of the Working Group believes that the EITF should not address those issues. Accounting Issue Issue Whether an entity in the mining industry should assign goodwill to a reporting unit that consists of an individual operating mine. Agenda Committee Decision: The Agenda Committee decided to add this Issue to the EITF's agenda. Agenda Committee Meeting (Potential New Issues) p. 12

14 4. The accounting for certain costs in the mining industry including deferred stripping costs Background In June 2003, the EITF Agenda Committee considered an issue on the accounting for deferred stripping costs in the mining industry. The issue description is provided below. The Agenda Committee acknowledged that other issues that are unique to the mining industry exist. Accordingly, the Agenda Committee requested that the FASB staff form a working group to identify and deliberate mining industry issues. The Working Group considered the deferred stripping costs issue and acknowledged that existing authoritative literature does not address this issue and diversity in practice exists. Accordingly, the Working Group requests that the EITF provide guidance on this issue. Further, the Working Group believes that the deferred stripping cost issue is complex due to (1) the diversity in practice resulting from the diversity in the types of mines and (2) costs that are incurred in the development and production phases of the mine. For example, an entity that mines coal may defer stripping costs as inventory/work-in-process for several months based on its cycle for removing and replacing overburden. In contrast, an entity that mines precious metals may defer stripping costs for years based on the long-term benefits that the removal of the overburden is deemed to provide. The Working Group believes that the question and views provided in the issue description, which was previously provided to the Agenda Committee, do not address the fundamental issue. The Working Group believes that the fundamental issue underlying the deferred stripping cost question is how to determine whether costs that increase the future capacity or production of the mine can be capitalized when such costs are incurred during the production phase of the mine. Therefore, this issue is broader than deferred stripping costs and includes all costs incurred during production that may benefit future periods. For example, if an entity that operates an underground mine constructs a tunnel before the mine is in production, the costs are capitalized. If that entity constructs a tunnel while the mine is in production and the tunnel will benefit production both in the current period and in the future, how should the entity determine whether Agenda Committee Meeting (Potential New Issues) p. 13

15 to capitalize or expense those costs? Current practice is diverse. Similarly, mining entities drill to define an ore body and to gain access to the ore body. Diversity in practice exists as to whether these costs are expensed as exploration costs or capitalized as development costs. Contributing to the issue is the lack of authoritative accounting guidance for the mining industry. There is no specific authoritative literature to assist a mining entity in its assessment of whether a cost should be expensed or capitalized. In contrast, the FASB has provided guidance to oil and gas entities in Statement 19. Industry practice that has developed is based roughly on the Statement 19 guidance. The Working Group believes that the an effective approach to address the deferred stripping cost issue, and the broader issue of capitalizing costs during the production stage of a mine, is to develop a framework for analyzing these costs. Providing a framework to address these costs is similar to other existing authoritative guidance including Statement 19 and FASB Statement No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. The Working Group recommends that the EITF define and provide guidance for the following types of costs: 1. Exploration 2. Development 3. Production 4. Closure. The Working Group acknowledges that this approach is similar to AcSEC's proposed Statement of Position, Accounting for Certain Costs and Activities Related to Property, Plant and Equipment. However, the Working Group believes that the proposed SOP is not sufficient to address the unique nature of an extractive industry. The FASB staff acknowledges that defining the stages of mining operations and providing the accounting for the costs incurred during each phase of the mining operation is consistent with a recommendation made by the IASC in its publication, An Issues Paper Issued for Comment by the IASC Steering Committee on Extractive Industries. Agenda Committee Meeting (Potential New Issues) p. 14

16 The Working Group believes that developing a framework for these activities is the first step in developing comprehensive guidance for the mining industry. Further, some questioned whether developing comprehensive guidance for the mining industry, including this first step, is outside the charter of the EITF. However, the Working Group strongly believes that it is an area that needs to be addressed. If the EITF does not address the broader issue of capitalizing costs during production, the Working Group believes that the EITF should, at a minimum, address the deferred stripping cost issue. The following is the description of the stripping cost issue that previously was considered by the EITF Agenda Committee. Accounting for Deferred Stripping Costs in the Mining Industry Introduction In the mining industry, companies that use open pit mining methods are required to remove overburden and other waste materials to access mineral deposits. The costs of removing waste materials are referred to as 'stripping costs.' During the development of a mine, before production commences, it is generally accepted that stripping costs are capitalized as part of the depreciable cost of building and constructing the mine. The mining company must continue to remove waste materials as it mines the mineral deposits during the production stage of the mine. In practice, many mining companies estimate what the total post-production stripping costs will be throughout the mine's production life. The companies then develop a "life of mine stripping ratio" or a "stripping ratio" calculated as estimated total post-production stripping costs divided by the estimated total proven and probable reserves. This ratio is then used to calculate the current period production cost charged against earnings by multiplying the stripping ratio times the reserves mined during the period. Because the concentration of the mineral deposits is not evenly distributed throughout the mine, there are periods during the life of the mine in which the company is mining richer (or better quality) reserves as the waste is removed. Of course, there are also periods during the life of the mine in which the company is mining lesser (or lower quality) reserves as the waste is removed. As a result, the amount that is charged against earnings in the current period (based on the Agenda Committee Meeting (Potential New Issues) p. 15

17 stripping ratio) will not, necessarily, equate to the actual production costs during the period. As a result, the company must record a deferred stripping cost asset (when the actual costs incurred to date exceed the normalized costs to date) or a deferred stripping cost liability (when the normalized costs to date exceed the actual costs incurred to date). Because a mine's life can range anywhere from 5 to greater than 50 years, this deferred stripping cost asset or liability can be a significant component of mining companies' balance sheets. Accounting Issues and Alternatives 1 Issue: Whether stripping costs incurred after production commences (that is, post-production), and that do not increase a mine's production capacity as contemplated by a mine plan, should be expensed as incurred as a production cost or deferred and amortized over the estimated economic life of the mine. View A: Post-production stripping costs that do not increase a mine's production capacity should be expensed as incurred because they do not meet the definition of an asset. Proponents of View A believe that once mine production begins, all subsequent costs to remove materials from the mine are production costs unless they represent post-production development, as contemplated in the mine plan, or extend the size and life of the mine and increase the amount of proven and probable reserves beyond the original mine plan. Proponents of this view do not believe that production costs incurred in this period create a probable future benefit (asset) or impose a probable future sacrifice (liability) on the company. They believe that production costs, though a necessary cost of extracting the unrefined product from the mine, provide no future economic benefits to be obtained or controlled by an entity and, therefore, do not meet the definition of an asset or liability as contemplated by FASB Concepts Statement No. 6, Elements of Financial Statements. They point out that it is often the case that mineral deposits are not uniform throughout the geographic location being mined, and it is an expected part of the mining plan that there will be periods in which more minerals or fewer minerals are produced. Furthermore, the use of a deferred stripping ratio to measure postproduction stripping and waste removal costs results in the financial statements capturing and reporting a life-of-mine budgeted or standard cost rather than the operational events that occurred during the period(s) covered by the financial statements. Furthermore, proponents of View A are concerned that deferring production stripping costs and recognizing the production costs at a uniform rate per quantity of mineral reserve over the life of the mine results in smoothing of earnings such that the financial statements do not accurately reflect economic reality. If costs are incurred unevenly, then the financial statements should reflect that economic Agenda Committee Meeting (Potential New Issues) p. 16

18 reality, rather than production costs that have been smoothed through the use of an artificial matching methodology. It should also be noted that the determination of the production stripping ratio by which the production costs are assigned to results of operations is subject to significant subjectivity because of the need to estimate both production costs and proven and probable reserves over such long periods of time. Because the ratio needs to be adjusted as additional data becomes available, the use of the production-stripping ratio also creates opportunities for manipulation of earnings that could cause investors and others to call into question the reliability of financial reporting in this industry. Proponents of this view believe the need to estimate future stripping costs over the life of the mine introduces an unnecessary and subjective element into the financial accounting and reporting process, and, in support, they point to paragraph 211 of FASB Statement No. 19 Financial Accounting and Reporting by Oil and Gas Producing Companies, in which the Board rejected the use of estimated future development costs in determining amortization of capitalized costs for oil and gas companies. They note that "matching" of revenues and expenses is no longer a consideration in determining how costs should be recognized. View B: Post-production stripping costs that do not increase a mine's production capacity should be deferred and amortized over the life of the mine on a basis consistent with pre-production stripping costs. Proponents of View B believe that stripping costs should be capitalized over the life of the mine regardless of whether they are incurred during the mine development or production phase. They note that it is expected that the quantity and/or quality of the product being mined will vary over the life of the mine because the mineral deposits are often not uniformly distributed throughout the property being mined. They also note that production-stripping costs are necessary costs that will be continually incurred over the life of the mine. They believe that production-stripping activities represent the continuous development of the mine because they allow access to other proven and probable reserves as products are mined. They note that deferral of production stripping costs is a long-standing industry practice, and they believe it more appropriately portrays the long-run cost of producing the products being mined. They believe that expensing stripping costs once production has begun results in unnecessary volatility in reported production costs and earnings as the products being mined are produced from sections of the mine where ore concentrations may be more or less than the expected average over the life of the mine. They believe investors would be confused by widely varying production costs from period to period, and that comparability of operating results between companies would be impaired if stripping costs were not deferred after production began. Agenda Committee Meeting (Potential New Issues) p. 17

19 Related Issues If the Task Force were to reach a consensus that post-production stripping costs should be deferred, additional issues arise regarding the classification of those costs on the balance sheet, how they should be evaluated for impairment, and the classification of the related cash flows in the statement of cash flows. 1 The issues and alternative views may be revised and/or additional alternative views may be identified during the development of the Issue Summary. Agenda Committee Decision: The Agenda Committee decided to add this Issue to the EITF's agenda. One agenda committee member expressed a concern about the possibility of nonmining enterprises attempting to analogize to the guidance developed in this issue as a basis for deferring various other "costs to obtain access to sources of revenue," and recommended that the issue be narrowly scoped to deal only with those types of costs unique to the mining industry. However, the Agenda Committee also agreed that the Issue should attempt to identify characteristics of costs that should be capitalized because they will provide future benefit rather than prescribing the accounting for costs that are commonly referred to in a certain manner. One agenda committee member also noted that the Board's Revenue Recognition project, under the "broad performance view," would address the questions raised in this Issue. However, given the extended timetable for completion of that project and the fact that the Board has not yet decided to pursue the "broad performance view," the committee decided that it is appropriate for the EITF to consider this Issue in the interim. Agenda Committee Meeting (Potential New Issues) p. 18

20 5. Application of FASB Statement No. 142, Goodwill and Other Intangible Assets, to Certain Assets of Oil and Gas Companies Subject to FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies Background Paragraph 8 of Statement 142 states that it does not change the accounting that is prescribed in Statement 19. Accordingly, some believe that Statement 142, including its classification and disclosure requirements, does not apply to oil and gas companies. Others argue that Statement 19 does not provide guidance as to whether assets are tangible and intangible assets, and the accounting for intangible assets. Accordingly, they believe that the classification and disclosure requirements of Statement 142 apply to oil and gas companies. Further, they believe that paragraph A14(d)(7) of Statement 141 requires oil and gas entities to account for oil and gas drilling rights as intangible assets. A third group believes that classification of oil and gas drilling rights is an accounting issue that is outside the scope of Statement 142; however, they believe that oil and gas companies are required to provide the Statement 142 disclosures. Accounting Issue Issue If oil and gas drilling rights are intangible assets, whether those assets are subject to the classification and disclosure provisions of Statement 142. Agenda Committee Decision: The Agenda Committee decided to add this issue to the agenda but indicated that the consideration of whether oil and gas drilling rights are intangible assets should be consistent with the approach taken with regard to mineral rights related to mining enterprises. Agenda Committee Meeting (Potential New Issues) p. 19