1

THE UNIVERSITY OF
NEW SOUTH WALES


SchoolofAccounting

ACCT3563:IssuesinFinancialReportingandAnalysis

Session1,2014

Week5Tutorial

Accountingforassetsintheextractiveindustry










Website:http://telt.unsw.edu.au


2
TopicsandLearningObjectives

Topics:

Accountingfortheextractiveindustry
o Exploration and evaluation of expenditures and the area of interest
method
o Developmentandconstructioncosts
o Amortisationofcapitalisedcosts
o Inventories
o Revenuesfromsaleofproduct
o Restorationcosts

Thistopicslearningobjectivesaretounderstandandexplain:

1. Therecognitionofexplorationandevaluationcostsintheextractive
industriesusingtheareaofinterestmethod
2. Theimpairmenttoexplorationandevaluationassets
3. Themeasurementofinventoryintheextractiveindustries
4. Accountingpolicychoicesorjudgmentsmadebymanagementinrespectof
explorationandevaluationcostsbyreferencetoagencytheoryorpolitical
costs
5. Howaccountingforexplorationandevaluationassetsalignswiththe
conceptualframework


Readings

RequiredReadings:

DeeganChapter20
Accountingstandards:AASB6




3
BasicConcepts

RevisionofAccountingforExtractiveIndustry

Phaseofoperation/transaction
orevent
RelevantStandards
Activitiesthatprecede
explorationforandevaluation
ofmineralresources
AASBFramework
AASB116Property,PlantandEquipment
AASB 138IntangibleAssets
Explorationandevaluation
expenditures
AASB6Explorationforand Evaluationof
MineralResources
AASB136Impairment
AASB114SegmentReporting
Developmentandconstruction
costs
AASB 116Property,PlantandEquipment
AASB 138IntangibleAssets
Depreciationoramortisationof
capitalisedcosts
AASB 116Property,PlantandEquipment
AASB 138IntangibleAssets
Inventories AASB 102Inventories
Revenuerecognition AASB 118Revenue
Restorationcosts AASB 137Provisions,ContingentLiabilities
andContingentAssets
AASB 116Property,PlantandEquipment

PracticeQuestions:Textbookquestions

DeeganChapter20:
Reviewquestions3,4,7,11,13,14


Deegan20.3
What method of accounting for exploration and evaluation expenditures would
mostly likely be used if the AASB Conceptual Framework were the overriding
regulation?

Interestingly, paragraph 7 of AASB 6 exempts an entity from having to consider the
Framework when setting its accounting policies for the recognition and
measurement of exploration and evaluation assets. Is this an example where the
conceptual framework loses out to the vested interests of the oil and gas lobby
groupandthepoliticalmachinationsofstandardsetting?

Recall that pursuant to the AASB Framework, an asset shall be recognised in the
financialstatementswhen,andonlywhen:

(a) it is probable that the future economic benefits embodied in the asset will
eventuate;and
(b) theassetpossessesacostorothervaluethatcanbemeasuredreliably.

4
Apartfrompermittingcoststobecarriedforwardwheresuchcostsareexpectedto
be recouped through successful development and exploitation of the area of
interest,AASB6alsostatesthatwhereexplorationand/orevaluationactivitiesinthe
areaofinteresthavenotyetreachedastagewhichpermitsareasonableassessment
of the existence or otherwise of economically recoverable reserves, and active and
significant operations in, or in relation to, the area are continuing, then such costs
may be carried forward. The ability to carry forward such costs in the absence of
assessing that economic benefits are probable would not directly seem to pass the
probabletestoftheAASBFramework.However,itmaybearguedthatasthework
is ongoing then management must consider it probable that future benefits will
eventuate.

The costswrittenoffandreinstated method would seem to be consistent with the

requirements of the AASB Framework. This method would require that all
explorationandevaluationcostsinitiallybewrittenoffduetothelowprobabilityof
success,butbereinstatedifeconomicallyrecoverableresourcesareproventoexist.
TheAASBFrameworkpermitsassetstobereinstatedwheretherelatedexpenditure
waspreviouslyexpensed.

AdditionalComments
Exploration and evaluation costs that were tangible assets might pass the test of
probable future economic benefits on the basis that they can be used or sold but
exploration and evaluation costs that relate to staff costs and other costs of an
intangiblenaturethatgotodiscoveringwhatisinthegroundorfieldwouldnot.

Also note that exploration and evaluation costs that create internally generated
intangiblese.g.mapsandstudieswouldnotbecapitalisedifAASB138heldsway.

Deegan20.4
AccordingtotheUSexperience,whatwouldhavemotivatedfirmstolobbyagainst
theabolitionofthefullcostmethod?

Firstly, there may have been an efficiency argument in which it was argued that
thosefirmsthatusedthefullcostmethoddidsobecausetheybelievedthatitmost
reliablyreflectedtheirperformance,relativetootheraccountingchoices.Eliminating
the fullcost method from their portfolio of accounting methods may have then
necessitatedthemusingamethodthatdidnotefficientlyreflecttheirperformance.
The counterargument is that none of the methods reflect the financial position of
sayagoldminingcompanywherethekeydataistheamountofgoldintheground
andratherthanthecostsincurredonfindinganddevelopingamine.

The elimination of the fullcost method would have required the fullcosters to
reducetheirassetsandtheirownersequity,asaresultoftherequirementtowrite
offexpensesassociatedwithexpenditurescarriedforwardinrelationtounsuccessful
areas.Thiswouldhaveadverseeffectsongearingratiosandinterestcoverageratios.
To the extent that such ratios were included within contracts that were already in
place, such adverse movements may have motivated the management of the full


5
costfirmstolobbyagainstthestandard.Further,thefullcostmethodminimisesthe
volatility of earnings relative to other methods. Low volatility of earnings would
typicallybepreferredbymanagement,especiallyiftheirsalariesarepartlybasedon
reportedearnings.

To the extent that management bonuses were tied to reported earnings, this may
also have motivated management to lobby for the fullcost method. This would
assume,of course,thatthemeasureofprofit usedinthe compensationplandoes
notadjustforthemethodusedtoaccountforpreproductionexpenditures.
ThediagramonthenextpageexplainswhyUSfirmsthatchangedfromFCtoSEmay
have experienced a negative share price reaction. It illustrates how economic
consequences and share price reactions can flow from a change in accounting
method.

CHANGEFROMFCTOSE

Accounting
impact

FCFIRMSWOULDEXPERIENCEDECREASE
INEXPECTEDREPORTEDEARNINGS

MANAGERIALCOMPENSATIONAFUNCTION
OFREPORTEDEARNINGS*

Economic
impact

DRILLINGACTIVITYDECREASETOCOMPENSATE
FOREFFECTOFSESWITCH**
EXPECTEDFUTURECASHFLOWSDECREASE

NEGATIVEMARKETREACTIONFORFCFIRMS

AFFECTSABILITYOFFIRMSTORAISE
FUNDSINCAPITALMARKET

* Assumes bonus component of management compensation plan is more important

thanstockoptioncomponent.

** This behaviour is an example of management altering its investment behaviour to

counteracttheeffectonreportedearningofthechangeinaccountingmethod.

Deegan20.7
Generally speaking, what costs should be included in the cost of inventory of an
entityinvolvedintheextractiveindustries?Explainyouranswer.

The cost of inventories should include all the expenses necessarily incurred to get
theinventoryintotheconditionandpositionatthepointofsale.Thiswillnecessarily
requireamountsattributedto:
amortisation of preproduction costs (either on a production or time basis)
including exploration and evaluation expenditures and development costs
incurredinestablishingaccesstothedepositorfield
production costs including depreciation of plant used in production and any
depreciation of any construction costs incurred in establishing necessary
infrastructure

Under the areaofinterest method, the cost of inventories would not include
expenses relating to operations in other areas of interest, some of which may have
beenabandoned.

Anotherinterestingissueconcernsthesubsequentmeasurementofexplorationand
evaluationcostsusingtherevaluationmodelseeparagraph12ofAASB6.Justlike
property, plant and equipment there is a choice between the cost model and the
revaluation model for subsequent measurement of exploration and evaluation
assets.Inpracticethecostmodeltendstobepreferredtotherevaluationmodelfor
exploration and evaluation assets because of the difficulty and cost of ongoing
assessmentoffairvalue.

Itshouldalsobenotedthatinventorymeasurementmustbeatthelowerofcostand
net realisable value. Therefore it is not possible to amortise anything greater than
thecostofexplorationandevaluationassetsintothecostofinventory.

Deegan20.11
Would it be permissible for a company operating in the extractive industries to
write off all exploration and evaluation expenditures, regardless of the ultimate
successofasite?

AASB6ExplorationsforandEvaluationofMineralResourcesstatesthat:

Aus7.1 An entitys accounting policy for the treatment of its exploration and
evaluation expenditures shall be in accordance with the following
requirements. For each area of interest, expenditures incurred in the
explorationforandevaluationofmineralresourcesshallbe:

(a) expensedasincurred;or

7
(b) partially or fully capitalised, and recognised as an exploration and
evaluationassetiftherequirementsofparagraphAus7.2aresatisfied.

Anentityshallmakethisdecisionseparatelyforeachareaofinterest.

Aus7.2 An exploration and evaluation asset shall only be recognised in relation to

anareaofinterestifthefollowingconditionsaresatisfied:

(a) therightstotenureoftheareaofinterestarecurrent;and

(b) atleastoneofthefollowingconditionsisalsomet:

(i) the exploration and evaluation expenditures are expected to be

recouped through successful development and exploitation of the
areaofinterest,oralternatively,byitssale;and

(ii) explorationandevaluationactivitiesintheareaofinteresthavenot
at the reporting date reached a stage which permits a reasonable
assessment of the existence or otherwise of economically
recoverable reserves, and active and significant operations in, or in
relationto,theareaofinterestarecontinuing.

Anaccountingpolicydecisionisrequiredforeachareaofinterest.

Onepolicychoiceistoexpenseevaluationandexplorationexpendituresasincurred.

Thesecondpolicychoiceistocapitalise(carriedforward)thecostsbuttodosothe
rights to tenure of the AOI must be current and there must be a reasonable
probabilityofeconomicreturnfromtheAOIormanagementmuststillbeassessing
theexistenceofeconomicallyrecoverablereservesoftheAOI.

Whether or not management prefer capitalisation over expensing is an empirical

question.Whatdoestheorysuggest?

Deegan20.13
Extracto Ltd commences operations on 1 January 2013. During 2013 Extracto Ltd
exploresthreeareasandincursthefollowingcosts:

Explorationandevaluationexpenditure
$m
GoodSite 23
BadSite 16
IndifferentSite 25

In 2014 oil is discovered at Good Site. Bad Site is abandoned. Indifferent Site has
not yet reached a stage that permits a reasonable assessment of the existence or
otherwise of economically recoverable reserves, and active and significant


8
operationsintheareaofinterestarecontinuing.Inrelationtotheexplorationand
evaluation expenditures incurred at Good Site and Indifferent Site, 80 per cent of
the expenditures relate to property, plant and equipment, and the balance (20%)
to intangible assets. (The question says nothing about PPE versus intangibles for
theBadSite,sowewillassumethat100%ofexpenditureintheBadSiterelatesto
intangibleassets.)

In 2014 development costs of $27million are incurred at Good Site (to be written
offonaproductionbasis).$20millionofthisexpenditurerelatestopropertyplant
andequipmentandthebalance($7million)relatestointangibleassets.GoodSite
is estimated to have 15 000 000 barrels. The current sale price is $30 per barrel.
Three million barrels are extracted at a production cost of $4 million and 1.9
millionbarrelsaresold.

Providethenecessaryjournalsusing:
(a) theareaofinterestmethod
(b) allcostswrittenoffmethod(Note:thequestionsasksforthefullcostmethod
in part (b), but since the all costs written off method can be used under
AASB6,wewilllookatthatmethodinsteadofFullcost.TheFullcostmethod
isnotpermittedinAustralia).

(a) Areaofinterestmethod

2013
$m $m
Dr Explorationandevaluationassets(Good)PPE 18.4
Dr Explorationandevaluationassets(Good)Intangible 4.6
Cr Cash

23
(Recognitionofexplorationandevaluationassetsinrespectof
GoodSiteclassified80%asPPE)

Note: The asset is Exploration and evaluation costs (Good). The appendages PPE
and Intangible refer to subsidiary ledger accounts wherein the breakdown of the
$23mintotangibleandintangiblecomponentsisrecorded.
$m $m
Dr Explorationandevaluationassets(Indifferent)PPE 20
Dr Explorationandevaluationassets(Indifferent)Intangible 5
Cr Cash

25
(Recognitionofexplorationandevaluationassetsinrespectof
IndifferentSiteclassified80%asPPE)

Note: The asset is Exploration and evaluation costs (Indifferent). The appendages
PPEandIntangiblerefertosubsidiaryledgeraccountswhereinthebreakdownofthe
$25mintotangibleandintangiblecomponentsisrecorded.

$m $m


9
Dr Explorationandevaluationassets(Bad)Intangible 16
Cr Cash

16
(RecognitionofexplorationandevaluationassetsinrespectofBad
Siteclassified0%asPPE)

Note: The asset is Exploration and evaluation costs (Bad). The appendage
Intangiblereferstothesubsidiaryledgeraccountwhereinthe$16misrecorded.

2014
$m $m
Dr Impairmentloss 16
Cr Exploration and evaluation assets
(Bad)Intangible

16
(Recognitionofimpairmentlossinrespectofexploration
andevaluationassetforBadsiteabandonedduring2011)

$m $m
Dr OilfielddevelopmentassetPPE 18.4
Dr OilfielddevelopmentassetIntangible 4.6
Cr Exploration and evaluation assets
(Good)PPE
18.4
Cr Exploration and evaluation assets
(Good)Intangible
4.6

(Reclassificationofexplorationandevaluationassetsfor
Goodsitetooilfielddevelopmentasset)

Note:TheassetisOilfielddevelopmentasset.TheappendagesPPEandIntangible
refertosubsidiaryledgeraccountswhereinthebreakdownofthe$23mintotangible
andintangiblecomponentsisrecorded.
$m $m
Dr OilfielddevelopmentassetPPE 20
Dr OilfielddevelopmentassetIntangible 7
Cr Cash

27
(RecognitionofdevelopmentcostsinrespectofGoodsite
inaccordancewiththeAASBFramework)

Note:TheassetisOilfielddevelopmentasset.TheappendagesPPEandIntangible
refertosubsidiaryledgeraccountswhereinthebreakdownofthe$27mintotangible
andintangiblecomponentsisrecorded.
$m $m
Dr OilfieldproductiveassetPPE 38.4
Dr OilfieldproductiveassetIntangible 11.6
Cr OilfielddevelopmentassetPPE 38.4
Cr Oil field development asset
Intangible
11.6


10
(Reclassificationofoilfielddevelopmentassettooilfield
productiveassetforGoodsite)

Note:TheassetisOilfieldproductiveasset.TheappendagesPPEandIntangible
refertosubsidiaryledgeraccountswhereinthebreakdownofthe$50mintotangible
andintangiblecomponentsisrecorded.
$m $m
Dr Inventoryofcrudeoil 14
Cr Cash 4
Cr Oil field productive asset
Accumulateddepn/amortisation*

10
(Recognition of direct and indirect costs of oil barrels
producedduringthe2011year)

Note: Use production units method to depreciate oil field productive asset 50m
costsx3m/15mbarrels=10m
$m $m
Dr Cash/receivables* 57
Cr Salesrevenue 57
(Recognitionofsalesfortheyear)

*(1.9m$30perbarrel)
$m $m
Dr Costofgoodssold* 8.9
Cr Inventoryofcrudeoil 8.9
(Recognitionofcostofbarrelssoldfortheyear)

*14mcostofinventory1.9m/3mbarrels=8.9m

Note: There has been no expenditure incurred on the Indifferent Site for 2011. A
good auditor would ask management to confirm that management are still actively
reviewingtheprospectsofthatsite.

ExtractfromBalanceSheets
2011 2010
$m $m
Explorationandevaluationassets 25* 64
Oilfieldproductiveasset 40**
Inventory 5.1***
70.1 64

*64m16m(bad:impairment)23m(good:reclassified)=25m(indifferent)
**50m10m=40m(good)
***14m(costofoilbarrelsproduced)8.9m(costofoilbarrelssold)

11
ExtractfromIncomeStatements
2011 2010
$m $m
Salesrevenue 57
Less:CostofSales (8.9)
Less:Impairmentloss (16)
32.1
(b) Costswrittenoffmethod

2013
$m $m
Dr Explorationandevaluationexpenses 64
Cr Cash 64
(Recognitionofexplorationandevaluationexpenseforall
costsincurredduring2010)

Note: This journal assumes that none of the PPE associated with exploration and
evaluationactivitiesiscapableofbeingseparatedforotheruseorsale.

2014
$m $m
Dr OilfielddevelopmentassetPPE 20
Dr OilfielddevelopmentassetIntangible 7
Cr Cash 27
(RecognitionofdevelopmentcostsinrespectofGoodsite
inaccordancewiththeAASBFramework)

Note:TheassetisOilfielddevelopmentasset.TheappendagesPPEandIntangible
refertosubsidiaryledgeraccountswhereinthebreakdownofthe$27mintotangible
andintangiblecomponentsisrecorded.
$m $m
Dr OilfieldproductiveassetPPE 20
Dr OilfieldproductiveassetIntangible 7
Cr OilfielddevelopmentassetPPE 20
Cr Oil field development asset
Intangible
7
(Reclassificationofoilfielddevelopmentassettooilfield
productiveassetforGoodsite)

Note: The asset is Oil field productive asset. The appendages PPE and Intangible
refertosubsidiaryledgeraccountswhereinthebreakdownofthe$27mintotangible
andintangiblecomponentsisrecorded.
$m $m
Dr Inventoryofcrudeoil 9.4
Cr Cash 4
Cr Oil field productive asset
Accumulateddepn/amortisation*
5.4


12
(Recognition of direct and indirect costs of inventory
producedduringtheyear)

* Use production units method to depreciate oil field productive asset

$27mcostsx3m/15mbarrels=5.4m

$m $m
Dr Cash/receivables 57
Cr Salesrevenue 57
(Recognitionofsalesfortheyear)
$m $m
Dr Costofgoodssold* 6
Cr Inventoryofcrudeoil 6
(Recognitionofcostofbarrelssoldfortheyear)

*9.4mcostofinventory1.9m/3mbarrels=6m

ExtractfromBalanceSheets
2010 2011
$m $m
Oilfieldproductiveasset* 21.6
Inventory** 3.4
25

*27mdevelopmentcostsaccumulateddepn/amortisation5.4m
*9.4(costofoilbarrelsproduced)6m(costofoilbarrelssold)

ExtractfromIncomeStatements
2010 2011
$m $m
Salesrevenue 57
Less:CostofSales (6)
Less:Explorationandevaluationexpenses (64)
51 (64)

Compare the impact on the balance sheet and income statement of (a) area of
interestmethodand(b)costswrittenoffmethod.

WhichmethoddoyouthinkmostAustralianoilandgasexplorerswillprefertousein
practiceandwhy?

13

Deegan20.14
Surfcity Mining Ltd incurs the following exploration and evaluation costs at two
sites,IanandEddie,overtheyearsindicated:

Ian Eddie
2013 $1500 $2000
2014 $2000 $3000
2015 $3000 $4000

Inrelationtotheaboveexpenditure,ineachyear20percentrelatestointangible
assets and the balance (80%) of the expenditure relates to property, plant and
equipment. At the end of 2015, oil of an economically recoverable nature is
discoveredatIan,butEddieisabandoned.

Following the discovery of oil at Ian, roads and other infrastructure of a fixed
natureareconstructedin2016atacostof$2000.Portablebuildingswithalifeof
10yearsarealsoputinplace.Thesebuildingscost$500.

Production at Ian begins in 2016. It is envisaged that the Ian site would contain 1
500barrels.Thesalepriceofeachbarrelis$25.Theincrementalproductioncosts
associated with each barrel are $5. During 2016, 400 barrels are extracted, of
which250sold.

Assets are amortised or depreciated using the productionoutput method, except

where such assets can be redeployed elsewhere, in which case their individual
usefullifeisused.

Providethejournalentriesfor2013to2016usingtheareaofinterestmethod.

2013
$ $
Dr Explorationandevaluationassets(Ian)PPE 1200
Dr Explorationandevaluationassets(Ian)Intangible 300
Cr Cash 1500
(Recognitionofexplorationandevaluationassetsinrespectof
areaofinterest,Ian$1500.)

Note:TheassetisExplorationandevaluationcosts(Ian).TheappendagesPPEand
Intangible refer to subsidiary ledger accounts wherein the breakdown of the $1500
intotangibleandintangiblecomponentsisrecorded.
$ $
Dr Explorationandevaluationassets(Eddie)PPE 1600
Dr Explorationandevaluationassets(Eddie)Intangible 400
Cr Cash 2000


14
(Recognitionofexplorationandevaluationassetsinrespectof
Areaofinterest,Eddie$2000.)

Note: The asset is Exploration and evaluation costs (Eddie). The appendages PPE
and Intangible refer to subsidiary ledger accounts wherein the breakdown of the
$2000intotangibleandintangiblecomponentsisrecorded.

2014
$ $
Dr Explorationandevaluationassets(Ian)PPE 1600

Dr Explorationandevaluationassets(Ian)Intangible 400
Cr Cash 2000
(Recognitionofexplorationandevaluationassetsinrespectof
areaofinterest,Ian$2000.)

Note:TheassetisExplorationandevaluationcosts(Ian).TheappendagesPPEand
Intangible refer to subsidiary ledger accounts wherein the breakdown of the $2000
intotangibleandintangiblecomponentsisrecorded.

$ $
Dr Explorationandevaluationassets(Eddie)PPE 2400
Dr Explorationandevaluationassets(Eddie)Intangible 600
Cr Cash 3000
(Recognitionofexplorationandevaluationassetsinrespectof
Areaofinterest,Eddie$3000.)

Note: The asset is Exploration and evaluation costs (Eddie). The appendages PPE
and Intangible refer to subsidiary ledger accounts wherein the breakdown of the
$2000intotangibleandintangiblecomponentsisrecorded.

2015
$ $
Dr Explorationandevaluationassets(Ian)PPE 2400
Dr Explorationandevaluationassets(Ian)Intangible 600
Cr Cash 3000
(Recognitionofexplorationandevaluationassetsinrespectof
areaofinterest,Ian$3000.)

Note:TheassetisExplorationandevaluationcosts(Ian).TheappendagesPPEand
Intangible refer to subsidiary ledger accounts wherein the breakdown of the $3000
intotangibleandintangiblecomponentsisrecorded.
$ $
Dr Explorationandevaluationassets(Eddie)PPE 3200
Dr Explorationandevaluationassets(Eddie)Intangible 800


15
Cr Cash 4000
(Recognitionofexplorationandevaluationassetsinrespectof
Areaofinterest,Eddie$4000.)

Note: The asset is Exploration and evaluation costs (Eddie). The appendages PPE
and Intangible refer to subsidiary ledger accounts wherein the breakdown of the
$4000intotangibleandintangiblecomponentsisrecorded.
$ $
Dr Impairmentloss* 9000
Cr Explorationandevaluationassets(Eddie)PPE 7200
Cr Exploration and evaluation assets (Eddie)
Intangible
1800

(Recognitionofimpairmentlossinrespectofexplorationandevaluationasset
forEddiesiteabandonedattheendof2009,i.e.$2000+$3000+$4000)

* This journal entry assumes that none of the PPE associated with the Eddie site is
capableofbeingseparatedfromthesiteforotheruseorsale.
$ $
Dr OilfielddevelopmentassetPPE 5200
Dr OilfielddevelopmentassetIntangible 1300
Cr Exploration and evaluation assets
(Ian)PPE
5200
Cr Exploration and evaluation assets
(Ian)Intangible
1300
(Reclassificationofexplorationandevaluationassetstodevelopment
assetfortheIanSitefoundtobecommerciallyviableatendof2009,
i.e.$1500+$2000+$3000)

Note:TheassetisOilfielddevelopmentasset.TheappendagesPPEandIntangible
refer to subsidiary ledger accounts wherein the breakdown of the $6500 from the
Iansiteintotangibleandintangiblecomponentsisrecorded.

2015
$ $
Dr OilfielddevelopmentassetPPE 2500
Cr Cash

2500
(Recognitionofassetsfordevelopmentcostsincluding
buildingsinrespectofIansite,i.e.$2000+$500)

$ $
Dr OilfieldproductiveassetPPE 7700
Dr OilfieldproductiveassetIntangible 1300
Cr OilfielddevelopmentassetPPE 7700
Cr Oil field development asset
Intangible
1300


16
(Reclassificationofdevelopmentassettoproductionassetwhenthe
IanSiteisfoundtobecommerciallyviableatendof2009,i.e.$6,500
Ex,Ev+$2,500Dev)

Note: The asset is Oil field productive asset. The appendages PPE and Intangible
refer to subsidiary ledger accounts wherein the breakdown of the $9000 into
tangibleandintangiblecomponentsisrecorded.
$ $
Dr Inventoryofcrudeoil 4317
Cr Cash* 2000
Cr Oil field productive asset
Accumulateddepn/amortisation**
2317
(Recognitionofdirectandindirectcostsofinventoryproducedduring
theyear)

*400barrelsproducedx$5directproductioncosts
** Depreciation/amortisation on portable building + other costs carriedforward for
theoilfieldproductiveasset=$50+$2,267=$2,317

NotethebuildingshaveausefullifethatisindependentofproductionfromtheIan
oilfieldandmustbedepreciatedseparatelyonatimebasisof10years.

Assume buildings were acquired beginning of the year. Depreciation on buildings

$500x1/10years=$50

Depreciation/amortisationonotheroilfieldcostscarriedforward$8,500x
400/1,500barrels=$2,267
$ $
Dr Cash/receivables 6250
Cr Salesrevenue* 6250
(Recognitionofsalesfortheyear)

*250barrels$25perbarrel

$ $
Dr Costofgoodssold* 2698
Cr Inventoryofcrudeoil 2698
(Recognitionofcostofbarrelssoldfortheyear)

*$4317x250/400barrels=$2698

17
PracticeQuestions:Pastexamquestions

1. Explorationandevaluationcosts
On 1 July 20X5, Reef Mining NL commenced the search for oil around the fringe of
the Great Barrier Reef. During 20X6 Reef Mining NL carried out exploratory drilling
and evaluation at four individual geological locations known as Dunk, Hayman,
Herron and Lizard. In its financial statements for 30 June 20X6 Reef Mining NL
recognisedallexpenditureinrelationtotheexploratorydrillingandevaluationasan
asset. The financial statements are now being prepared for the year ended 30 June
20X7andthefollowinginformationisavailableinrespectofthefourlocations.
Dunkhasfailedtoshowthepresenceofanypromisinggeologicalformationsbut
further testing will be carried out before any decision to abandon the area is
taken.
Hayman shows promising geological formations and is expected to be
successfullydevelopedinthenottoodistantfuture.
Herron has been assessed as a commercially viable well and oil production
commenced on 1 July 20X6. Herron is expected to yield 40 million barrels of oil
over a tenyear useful life. 5 million barrels of oil have already been extracted
fromHerronby30June20X7and1millionofthesearestillonhandatyearend.
All sales for the year were at $9 per barrel. The plant and buildings installed at
Herronwillbescrappedwhendrillingceasesatthesite.
Lizard was abandoned on 1 June 20X7 after an environmental impact study
indicatedthatsitedevelopmentmightleadtotheextinctionofcertainspeciesof
marinebiology.

Thefollowinginformationisavailableontheexpenditureincurredinrelationtoeach
ofthefourlocationsfortheyearsended30June20X6and30June20X7.

20X7 20X6
Dunk
Exploration&Evaluation 270,000 30,000
Hayman
Exploration&Evaluation 250,000 100,000
Herron
Exploration&Evaluation 300,000
Development 500,000
FixedAssetsBuildings 400,000
FixedAssetsPlant 600,000
ProductionCosts 2,250,000
Lizard
Exploration&Evaluation 200,000 80,000

Preparethejournalentriesfor20X7usingtheareaofinterestmethod.

18
2. PATandEthicsQuestion
High Hopes Mining Company Ltd begins exploring for oil in outback Australia on 1
July 2012. It spends $80,000,000 on exploration and evaluation (E&E) in the year
ended 30 June 2013 in one area of interest. At June 30 2013 no economically
recoverableoildepositshavebeenfoundbuttheareaofinterestisstillcurrentand
explorationworkisongoingsoadecisionhasnotyetbeenmadeabouttheultimate
economic viability of the area of interest. However, the companys geologists and
engineersinformthecompanythattheoutlookforsuccessinthisareaofinterestis
not good, and that it is not probable that the company will find economically
recoverable oil reserves. High Hopes must decide how it will account for the
$80,000,000 E&E expenditure. The facts in the next paragraph are about the
companys financial situation before it decides how to account for this $80,000,000
E&Eexpenditure.

The company has other successful oil wells that have produced a net profit of
$50,000,000 for the year ended 30 June 2013. On this day, the company has total
assetsof$920,000,000(beforedecidinghowtoaccountforthe$80minexploration
and evaluation) and total liabilities of $590,000,000. The company has a debt
contract in place with lenders that prohibits the companys total liabilities/total
assetsratiofromexceeding60%;otherwisethecompanywillbeindefault.

The companys accounting choices for the $80,000,000 E&E expenditure are (a)
immediate writeoff to P&L or (b) capitalisation of $80m and carry forward as an
asset.Whatshouldthecompanydo?

(i) AccordingtoAASB6
(ii) AccordingtotheConceptualFramework
(iii) FromaPATperspective;
(iv) FromtheperspectiveofanAristotelian