​ ​ ​ ​ ​ ​ ​ DEPLETION OF MINERAL RESOURCES

​ ​ Lecture

Depletion of Mineral Resources (PFRS 6)

PFRS 6 Exploration for and Evaluation of Mineral Resources

Learning Competencies
●​ Explain the accounting for costs of exploration for and evaluation of mineral resources.
●​ Identify the cost of a natural resource.
●​ Account for the depletion of a natural resource.

1. Definition/ Introduction (D)

Natural resources (aka. Wasting Assets) such as oil, gas, gold, copper, and coal are extremely
valuable assets. Unlike buildings or machinery, however, these resources get depleted (consumed)
as they are extracted. Once the ore has been dug, or the oil pumped, the resource is gone forever.

This unique nature requires a special accounting treatment so that financial statements reflect the
true cost and value of these assets.

To address this, the Philippine Financial Reporting Standard (PFRS) 6 – Exploration for and
Evaluation of Mineral Resources provides guidelines for how companies should account for costs
and activities related to mining and oil & gas exploration.

Note: PFRS 6 allows companies engaged in mining, oil, and gas exploration to capitalize certain
costs and provides flexibility in accounting policies before commercial feasibility is established.

a) Exploration and Evaluation of Mineral

Resources
-​ is the search for mineral resources,
including minerals, oil, natural gas and
similar non-regenerative resources after the
entity has obtained legal rights to explore in
a specific area, as well as the determination
of the technical feasibility and commercial
viability of extracting the mineral resource.
-​ The process of searching for mineral
deposits and assessing whether it is
technically feasible (we can dig it up) and
commercially viable (we can make money
from it) to extract them.

Example: Drilling test wells to check for oil,

conducting geological surveys, or sampling rock formations for gold content.

b) Exploration and Evaluation Expenditures

-​ expenditures incurred by an entity in connection with the exploration for and evaluation of
mineral resources before the technical feasibility and commercial viability of extracting a
mineral resources are demonstrable.
-​ The costs incurred in connection with exploring for and evaluating mineral resources.

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Examples:
●​ Acquisition of rights to explore (permits/licenses)
●​ Topographical, geological, geochemical and geophysical studies.
●​ Exploratory drilling costs
●​ Trenching
●​ Sampling and testing
●​ Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource.
●​ General and administrative costs directly attributable to exploration and evaluation
activities.

Applicability of PFRS 6

PFRS 6 applies only to expenditures incurred in the exploration and evaluation phase. The
applicability depends on the stage:

a) Before legal rights to explore are obtained

●​ Costs are normally expensed immediately.
●​ Example: Initial desktop research or general area surveys without government permits.

b) After legal rights are obtained but before technical feasibility and commercial viability are
demonstrable
●​ PFRS 6 applies.
●​ Companies may capitalize exploration and evaluation expenditures as assets.
●​ Example: A mining company acquires a license to explore a mountain. Drilling and sampling
costs can be recognized as exploration assets.

c) After technical feasibility and commercial viability are demonstrable

●​ PFRS 6 no longer applies.
●​ Expenditures are accounted for under other standards, such as:
○​ PAS 16 (Property, Plant, and Equipment) – for development of mine sites and related
facilities.
○​ PAS 38 (Intangible Assets) – if expenditure relates to intangible rights.

2. Recognition (R)

Accounting for exploration and evaluation expenditures

PFRS 6 permits entities to develop their own accounting policy for exploration and evaluation of assets which
results in relevant and reliable information based entirely on management’s judgment and without the
need to consider the hierarchy of standards in PAS 8.

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This means that the entity may recognize exploration and evaluation expenditures either as expense or asset
depending on the entity’s own accounting policy.

Exploration and evaluation assets are recognized when:

●​ The company has legal rights to explore a specific area.
●​ Costs are directly attributable to exploration and evaluation activities.​

✔ Examples of recognized costs:

●​ Fees for exploration rights
●​ Topographical and geological studies
●​ Exploratory drilling and trenching
●​ Costs of technical feasibility studies​

❌ ●​CostsGeneral
not recognized:
administrative costs
●​ Initial prospecting costs before legal rights are obtained

3. Measurement (Me)
Initial Measurement
●​ Exploration and evaluation assets are measured at cost.​

Subsequent Measurement
●​ Entities may use either the:
○​ Cost Model (Carrying Amount), or
○​ Revaluation Model (Recoverable Amount).

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Note: If the entity opts to capitalize exploration and evaluation expenditures as assets, it shall measure them at
cost.
Subsequent to recognition, the exploration and evaluation assets shall be measured using the cost model or
the revaluation model.

4. Presentation (Pre)
●​ Exploration and evaluation assets are presented as a separate line item in the Statement of
Financial Position (Balance Sheet) as Non-Current Asset.
●​ They are not mixed with PPE or intangible assets until feasibility is proven.

5. Derecognition (De)
Exploration and evaluation assets are derecognized when:
●​ They are disposed of, or
●​ No further economic benefits are expected from them (e.g., site is abandoned because no
minerals were found).​

The difference between disposal proceeds and carrying amount is recognized in profit or loss.

6. Disclosure (Dis)
Companies must disclose:
●​ Their accounting policies for exploration and
evaluation assets
●​ The amounts of assets, liabilities, income, and
expenses arising from exploration and evaluation
●​ Any impairment losses recognized
●​ Judgments and estimates used in determining feasibility and viability​

Real-Life Example (Philippines):​

Philex Mining and Nickel Asia disclose in their annual reports the capitalized exploration costs and
whether projects are still in the evaluation stage or moved to development stage.

Example Problem:​
ABC Mining Inc. acquired rights to explore a site for ₱10,000,000. Geological surveys cost
₱2,000,000 and exploratory drilling cost ₱3,000,000. The company estimates recoverable reserves of
5,000,000 tons of ore. Restoration costs (present value) are ₱1,000,000. Residual land value is
₱500,000. In the first year, the company extracted 600,000 tons of ore.
Required: Compute the depletion expense for the first year.

Solution
1.​ Determine Depletable Base
=Acquisition cost+Exploration cost+Restoration cost–Residual value
=10,000,000+2,000,000+3,000,000+1,000,000–500,000​
=₱15,500,000

2.​ Compute Depletion Rate per Ton

15,500,000 / 5,000,000 tons=₱3.10 per ton

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3.​ Compute Depletion Expense (Year 1)

3.10 × 600,000 = ₱1,860,000

Depletion expense for Year 1 = ₱1,860,000

7. Natural Resources (Wasting Assets) - nonrenewable

-​ Assets such as mines, oil fields, and gas reserves that are physically consumed once
extracted.
-​ Natural resources, often called wasting assets, include petroleum, minerals, and timber. They
have two main features:
a.​ The complete removal (physical consumption) of the asset, and
b.​ The replacement of the asset only by an act of nature.

Think of a box of chocolates—every piece eaten reduces the total available. Unlike machinery
(which can be repaired or replaced), once the minerals are gone, the resource no longer exists.

Cost of natural resources

a.​ Acquisition Cost
-​ price paid to obtain property right to search and find undiscovered natural resources
-​ initial cost of the wasting asset

b.​ Exploration and evaluation costs – to the extent that they are capitalized in accordance with
the entity’s accounting policy.

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c.​ Development costs – amounts paid to prepare the resource site for mining. These include
drilling costs and costs of construction of tunnels, shafts and wells.

d.​ Restoration Cost

8. Depletion
-​ The process of allocating the cost of a natural resource over the units extracted.
-​ Depletion is the systematic allocation of the depletion base of a natural resource over the
period the natural resource is extracted.
-​ Depletion base is the capitalized cost of the natural resource less its residual value.
-​ Depletion is normally computed using the units-of-production method (activity method or
variable-charge method).

Formula:
Depletion per unit = (Cost – Residual value) / Total estimated recoverable units​
Depletion expense = Depletion per unit × Units extracted in the period
​
Comparison between Depreciation and Depletion:
●​ Depreciation = buildings & equipment lose value through use.
●​ Depletion = natural resources lose value as they are extracted.

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9. Changes in Accounting Policies

●​ Entities can change policies if the new policy makes FS more relevant and reliable.
●​ Example: From full-cost method to successful efforts method.

10. Classification of Exploration and Evaluation Assets

●​ Tangible: e.g., drilling rigs, vehicles used in exploration.
●​ Intangible: e.g., acquired rights to explore, geological information.
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Note: When technical feasibility and commercial viability of extracting a mineral resource become
demonstrable, the Exploration and Evaluation Assets are reclassified in accordance with other
relevant Standards (eg. PAS 16 and PAS 38). The assets are assessed first for impairment before the
reclassification.

11. Impairment Loss

●​ Recognize impairment if carrying amount exceeds recoverable amount.
●​ Tested at cash-generating unit level (CGU).​

12. Depreciation of Mining Equipment

●​ Mining equipment (e.g., drills, trucks) is depreciated separately under PAS 16.
●​ Often depreciated using the units of production method linked to extracted output.

a.​ Movable tangible equipment includes those that can be used from one extracting site to
another (e.g., heavy equipment, transportation equipment). Movable tangible equipment is
depreciated separately over its useful life using normal depreciation policy.

b.​ Immovable tangible equipment includes those that cannot be used in other extracting sites
after the reserves in one site are fully depleted (e.g., drilling rig foundation). Immovable
tangible equipment is depreciated separately over its useful life or the life of the resource,
whichever is shorter.

Note:
-​ When the useful life of immovable tangible equipment is shorter than the economic
useful life of the natural resource, the immovable equipment is depreciated using the
straight line method.
-​ When the useful life of immovable tangible equipment is longer than the economic useful
life of the natural resource, the immovable equipment is depreciated using the
units-of-production method.

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13. Liquidating Dividends

●​ Dividends declared from depletion (return of capital, not profit).
●​ Must disclose that part of the dividend represents a return of invested capital.
​

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-​ Normal dividends are declared from unrestricted retained earnings.

-​ Liquidating dividends occur when dividends exceed retained earnings.
-​ Under the trust fund doctrine, corporations cannot declare dividends from legal capital
(equity invested by owners), as it is reserved to protect creditors, unless the corporation is
dissolved or liquidated.
-​ Exception – Wasting Asset Corporations (e.g., mining companies):
●​ Follow the wasting asset doctrine instead.
●​ Can declare dividends from both:
○​ Unrestricted retained earnings, and
○​ Accumulated depletion, but only if:
■​ It is realized (i.e., related inventory has been sold to outsiders), and
■​ It is not yet liquidated (i.e., hasn't been paid out as dividends yet)

14. Decommissioning and Restoration Costs

-​ expenses associated with dismantling, removing or restoring long-lived assets to original state
as the end of their useful life
-​ capitalized only if the entity has incurred present obligation

Initial Measurement
●​ Initially measure at fair value using the present value
●​
Recording the Provision
●​ Recognize provision for decommissioning liability and add to cost of asset.
●​ Asset Retirement Obligation (ARO) — recognized when a legal obligation exists to retire a
long-lived asset and can reasonably estimated

Subsequent Measurement
●​ Related asset is subsequently measured as an expense in the income statement, while the
provision is subsequently measured at amortized cost
●​ Liability increased with unwinding of discount (interest).
●​ Adjustments in estimates affect the asset’s carrying amount.​

Special Case: Non-Depreciable Asset (e.g., land)

●​ If restoration improves land condition, recognize it separately as asset.

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PRACTICE EXERCISE:

PROBLEM 1:
At the beginning of the current year. Vorst Company purchased a mineral mine for P26,400,000 with
removable ore estimated at 1,200,000 tons. After it has extracted all the ore, the entity will be
required by law to restore the land to its original condition at an estimated cost of P2,100,000. The
present value of the estimated restoration cost is P1,800,000.

The entity believed that it would be able to sell the property afterwards for P3,000,000. During the
current year, the entity incurred P3,600,000 of development cost preparing the mine for production,
removed 80,000 tons of ore and sold 60,000 tons.

A. What total amount of depletion should be recorded for the current year? _______________
B. What amount of depletion should be included in the cost of goods sold for the current
year? _______________

PROBLEM 2:
On March 31, 2018, Mariel Company purchased the right to remove gravel from an old rock quarry.
The gravel is to be sold as roadbed for highway construction. The cost of the quarry right was
P1,640,000 with estimated salable rock of 200,000 tons. During 2018, the entity loaded and sold
40,000 tons of rock.

On January 1, 2019, the entity estimated that 200,000 tons still remained. During 2029, the entity
loaded and sold 80,000 tons.

A. What is the depletion for 2018? _______________

B. What is the depletion for 2019? _______________

PROBLEM 3:
On July 1, 2018, Lam Company, a calendar Year corporation, purchased the rights to a mine. The
total purchase price was P16,400,000, of which P2,000,000 was allotable to the land. Estimated
reserves were 1,800,000 tons. The entity expected to extract and sell 25,000 tons per month.

The entity purchased new equipment on July 1, 2018 for P7.500,000. The equipment had a useful life
of 3 years. However, after all the resources are removed, the equipment would be of no use and
could be sold for P300,000.

A. What amount should be recorded as depletion for 2018_______________

B. What amount should be recorded as depreciation of the mining equipment for 2018?
_______________

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