IFRS 15 Mining Revenue recognised properly and complete

IFRS 15 Mining Revenue

Revenue recognition in the mining industry might appear to be simple. Revenue is generated through the supply of commodities in exchange for consideration.

Complexities can arise, however, from certain types of contractual arrangements that are common to the industry, including partnerships with other entities and arrangements for which the consideration is based on future production.

Agency arrangements, transportation services, provisionally-priced commodity sales contracts and long-term take-or-pay arrangements might also be impacted by IFRS 15. The complexities in these areas can make the decision of when to recognise revenue under IFRS 15 and how to measure it more challenging.

This narrative focuses on how the standard impacts entities in the mining industry under IFRS and U.S. GAAP.

Mining entities need to use judgement as they evaluate whether or not the parties in the transaction have a vendor-IFRS 15 Miningcustomer relationship, and therefore fall within the scope of IFRS 15 or ASC 606.

Definition of a customer

A customer is a party that contracts with an entity to obtain goods or services that are the output of that entity’s ordinary activities. The scope includes transactions with collaborators or partners if the collaborator or partner obtains goods or services that are the output of the entity’s ordinary activities. It excludes transactions arising from arrangements where the parties are participating in an activity together and share the risks and benefits of that activity.

Production sharing arrangements

Governments are increasingly using production sharing arrangements (PSAs) to facilitate the exploration and production of their country’s mineral resources by using the expertise of a commercial mining entity. In such arrangements, it might be challenging to determine whether the government is a customer, and therefore whether the arrangement is within the scope of IFRS 15. Under a typical PSA, a mining entity will be responsible for all of the exploration costs, as well as some or all of the development and production costs associated with the mineral interest.

In return, the mining entity is usually entitled to a share of the production, which will allow the recovery of specifiedIFRS 15 Mining costs plus an agreed profit margin.

PSAs, including royalty agreements, are becoming more complex and the terms might vary even within the same jurisdiction. Governments often write specific legislation or regulations for each significant new field. Each PSA should be evaluated and accounted for in accordance with the substance of the arrangement to determine whether the government meets the definition of a customer and is within the scope of the standard:

  • A PSA in which the government is not a customer is outside the scope of IFRS 15. The mining entity would recognise the construction of its own tangible assets and would apply other relevant guidance including guidance on property plant and equipment, intangible assets and exploration. Revenue would be recognised when the mining entity delivers its share of production to its customers. The cost of the share of production delivered to the government would be an operating cost.
  • A PSA in which the government is a customer is in the scope of IFRS 15. The proposed guidance requires the operator to recognise revenue for the delivery of services, which might include exploration or construction services, in exchange for future production. The future production would be variable non-cash consideration and would affect the measurement of revenue.

Forward-selling contracts to finance development

Mineral exploration and development is a capital intensive process. Mining entities use different financing methods including structured transactions which involve selling future production from specified properties to a third-party “investor” for cash. This cash is used to fund the development of a promising prospect. Such structures come in many different forms (for example, silver streaming) and each needs to be carefully analysed to determine the appropriate accounting.

Product exchanges

Mining companies often exchange mineral products, such as coal, with other mining companies to achieve operational objectives. A common term used to describe this is a “Buy-sell arrangement.” The objective of these arrangements is often to save transportation costs by exchanging product A in location X for product A in location Y.

IFRS 15 scopes out non-monetary exchanges, specifically “non-monetary exchanges between entities in the same line of business to facilitate sales to customers other than the parties to the exchange (for example an exchange of coal to fulfil demand on a timely basis in a specified location).” Non-monetary exchanges should be accounted for based on other guidance.

IFRS 15 is different than the guidance under previous IFRS. Non-monetary exchanges between entities in the same line of business that are not the end customer but are rather to facilitate sales to the end customer are outside the scope of the guidance, even if the exchange is of dissimilar products. This might widen the scope of transactions accounted for outside the scope of the standard.

IFRS 15 also requires that there be a contract with a customer before revenue is recognised. A contract only exists if there is commercial substance (that is, the entity’s future cash flows are expected to change as a result of the contract). Judgement will be required to determine whether the contract has commercial substance. If there is no commercial substance to the exchange, the transaction is outside the scope of the standard and revenue should not likely be recorded.

Interaction with other standards

Contracts that are within the scope of other guidance under IFRS or U.S. GAAP, such as leases or financial instruments, are outside the scope of IFRS 15. The standard provides application guidance for evaluating contracts with repurchase agreements that assist mining entities in determining whether the arrangement is a sale to a customer, a financing arrangement or a lease. This may impact some tolling agreements with smelters or refiners.

Agency relationships

Mining entities often engage in other activities in addition to selling extracted ore, such as providing transportation of IFRS 15 Miningproduct. It is important to identify whether a mining entity is acting as a principal or an agent in transactions as it is only when the entity is acting as a principal that they are able to recognise revenue based on the gross amount received or receivable in respect of its performance under a sales contract.

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Entities acting as agents do not recognise revenue for any amounts received from a customer to be paid to the principal. Revenue is recognised for the commission or fee earned for facilitating the transfer of goods and services. Whether the entity is acting as agent or principal depends on the facts of the relationship, which can require significant judgement.

Principal versus agent considerations

An entity is the principal in an arrangement if it obtains control of the goods or services of another party in advance of transferring control of those goods or services to the customer.

Obtaining title momentarily before transferring a good or service to a customer does not necessarily constitute control.

An entity is an agent if its performance obligation is to arrange for another party to provide the goods or services.

Indicators that the entity is an agent include:

  • the other party is primarily responsible for fulfilment of the contract;
  • the entity does not have inventory risk;
  • the entity does not have latitude in establishing prices;
  • the entity does not have customer credit risk; and
  • the entity’s consideration is in the form of a commission.

An agent recognises revenue for the commission or fee earned for facilitating the transfer of goods or services. Its consideration is the ‘net’ amount retained after paying the principal for the goods or services that were provided to the customer.

Delivery – CIF contracts or FOB contracts

An entity recognises revenue when (or as) a good or service is transferred to the customer and the customer obtains control of that good or service. Control of an asset refers to an entity’s ability to direct the use of and obtain substantially all of the remaining benefits (that is, the potential cash inflows or savings in outflows) from the asset.

Resources are often extracted from remote locations and require transportation over great distances. Transportation by truck instead of railway can be a significant cost. There are two main variants of contracts that address future shipping costs – cost, insurance and freight (CIF) or free on board (FOB).

CIF contracts mean that the selling entity has the responsibility to pay the costs, insurance and freight until the goods reach a final destination, such as a refinery or an end user. FOB contracts mean that the selling entity delivers the goods when the goods are delivered to an independent carrier. The buyer has to bear all costs and risk of loss to the goods from that point.

In both approaches, contractual terms mean that risk and title and therefore control of the commodity normally pass at the ship’s rail, although the timing of revenue recognition could change under IFRS 15, depending on the terms of trade. The difference between the shipping terms affects which party is responsible for freight costs.

Cost insurance and freight (CIF contracts)

Identifying separate performance obligations IFRS 15 requires an entity to account for each distinct good or service as a separate performance obligation. Freight services may meet the definition of a distinct service.

IFRS 15 Mining

Satisfaction of performance obligations

An entity recognises revenue when it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when the customer obtains control of that good or service. IFRS 15 lists indicators of control transferring, including an unconditional obligation to pay, legal title, physical possession, transfer of risk and rewards and customer acceptance.

Sales of goods: Revenue is recognised at the point when control transfers to the customer. This generally follows the terms of the contract and is usually when the goods pass the rail on a vessel selected by the buyer, at which point the buyer will control the goods.

Transportation: A performance obligation for transportation generally meets the criteria for a performance obligation that is settled over a period of time, and revenue is recognised over the period of transfer to the customer. If it does not meet the criteria, the performance obligation would be settled at a point in time, and revenue would likely be recognised when the customer receives the goods.

Example – Timing of revenue recognition in a CIF arrangement

Facts: The entity’s revenue contracts are on a CIF basis. Copper concentrate is transported by rail from an offshore operation to the port where it is loaded on ship to be sent to a refinery in Asia. The refiner is the customer.

The entity receives a provisional payment of 90% of the invoice raised 10 days after the concentrate has been unloaded from the ship into the destination port. The contracts contain a clause that states that the title of the copper concentrate passes on unloading the goods at the purchaser’s facility.

Consideration

The revenue contract is on CIF terms; the seller therefore has to pay the costs, freight and insurance associated with shipping. There is also a specific clause that states that risk and title, and therefore control of the concentrate, only passes on unloading at the destination port.

Something else -   Performance obligation

Revenue would be recognised at the date of unloading. This illustrates the importance of understanding the terms of trade in the contract, as this is what determines the accounting. Shipping is not a separate performance obligation when an entity controls the goods until they are unloaded.

Free on board (FOB contracts)

FOB 1

Satisfaction of performance obligations

An entity recognises revenue when it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when the customer obtains control of that good or service.

IFRS 15 lists indicators of control transferring, including an unconditional obligation to pay, legal title, physical possession, transfer of risk and rewards and customer acceptance.

Example – Timing of revenue recognition in a FOB arrangement

Facts: The entity’s revenue contracts are on FOB basis. Copper concentrate is transported by rail from an offshore operation to the port, where it is loaded on a ship to be sent to a refinery in Asia. The refiner is the customer.

The entity receives a provisional payment of 90% of the invoice raised 10 days after the concentrate has been unloaded from the ship into the destination port. The customer’s obligation to pay arises when the goods pass the rail.

Consideration
The revenue contract is on FOB terms; the control of the goods transfer at the moment that the product passes the ship’s rail, demonstrated by title, physical possession and an obligation to pay, passing to the buyer. As a result, revenue would be recognised upon delivery to the carrier.

Provisional pricing arrangements

Sales contracts for commodities often incorporate provisional pricing. Provisional pricing might arise for a variety of reasons:

  • The time taken to transport the product might mean that the customer wishes to pay the market price at the date of eventual delivery at the final destination – in those situations, a provisional price is charged on the date control of the product initially transfers. The final price is generally an average market price for a particular future period or a final assayed amount.
  • The product is being transported in concentrate form and the final quality and volume of component commodities will not be known until further processing at its final destination.

Satisfaction of performance obligations

The sales contract would be in the scope of IFRS 15. There is a single performance obligation, being the delivery of the promised product. Revenue is recognised when the performance obligation is satisfied, which is when the customer obtains control of the product.

Determining the transaction price

The entity needs to determine the transaction price, which is the amount of consideration it expects to be entitled to in the transaction.

Management should first consider whether provisionally priced contracts include embedded derivatives that are in the scope of IFRS 9 Financial instruments. A mining entity applies the separation and/or measurement guidance in other standards first, and then applies the guidance in the revenue standard to the remaining portion of the contract.

The transaction price might be variable or contingent on the outcome of future events, which would include provisional pricing arrangements.

Variable consideration is subject to a constraint. The objective of the constraint is that an entity should recognise revenue as performance obligations are satisfied to the extent that a significant revenue reversal is not “probable” (U.S. GAAP) or “highly probable” (IFRS), in future periods.

Such a reversal would occur if there is a significant downward adjustment of the cumulative amount of revenue recognised for that performance obligation.

Judgment will be required to determine if the amount to be recognised is subject to a significant reversal. IFRS 15 has a list of factors that could increase the likelihood or magnitude of a revenue reversal.

Management’s estimate of the transaction price is reassessed each reporting period.

Example – Provisional pricing

Facts: An entity enters into a contract to sell 1,000 tons of copper concentrate to a customer on 1 December 20X4. The final price will be based on the London Metal Exchange (“LME”) copper price three months from the date of delivery.

Delivery takes place on 31 December 20X4 and control of the copper concentrate is transferred to the customer on that date. Final invoicing will take place on 31 March 20X5. The entity has a 31 December year-end.The three-month forward copper price on 31 December is CU6,500 per ton. On 31 March 20X5 the copper price amounts to CU6,750 per ton.

Consideration
At contract inception (1 December 20X4), the entity will need to determine whether the provisional pricing mechanism represents an embedded derivative that needs to be separated from the host sales contract. Revenue is recognised on 31 December 20X4, the date when control of the copper is transferred to the customer and the performance obligation is satisfied. Judgement will be required to identify the point at which the consideration becomes unconditional, and is then a financial asset within the scope of IFRS 9.

If the entity concludes that the provisional pricing is variable consideration and not a financial asset within the scope of IFRS 9/IAS 39, the entity would need to apply judgement in:

  • estimating the variable sales price at 31 December 20X4; and
  • determining whether the estimate meets the “probable” (U.S. GAAP)/“highly probable” (IFRS) test regarding the likelihood of significant reversal.
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It should be probable/highly probable that the revenue would not be subject to a significant revenue reversal between 31 December 20X4 and 31 March 20X5. To the extent the entity were to report results on 31 January 20X5, before the final invoicing on 31 March 20X5, the estimate of the transaction price and revenue constraint would need to be reassessed.

Take-or-pay and similar long-term supply agreements

Long-term sales contracts are common in the mining industry. Producers and buyers may enter into sales contracts that are often a year or longer in duration to secure supply and reasonable pricing arrangements. Such contracts are often fundamental to supporting the business case or to finance, develop or continue activity at a particular mine.

Contracts typically stipulate the sale of a set volume of product over the period at an agreed price. There are often clauses within the contract relating to price adjustment or escalation over the course of the contract to protect the producer and/or the seller from significant changes to the underlying assumptions in place at the time the contract was signed. Long-term commodity contracts frequently offer the counterparty flexibility and options in relation to the quantity of the commodity to be delivered under the contract.

Mining entities should continue to first assess whether these arrangements represents financial instruments or contain embedded derivatives that should be accounted for under the financial instruments standards (e.g., whether a contract with volume flexibility contains a written option that can be settled net in cash or another financial instrument). In addition, mining entities should continue to evaluate whether such arrangements convey the right to use a specific asset, and therefore constitute a lease under the leasing standards.

Identifying the contract

In relation to take-or-pay contracts, only the minimum amount specified would generally be considered a contract, as this is the only enforceable part of the agreement. Options in the contract to acquire additional volumes are likely to be considered a separate contract at the time the customer exercises the option, unless such options provide the customer with a material right (e.g., an incremental discount).

Where there is a material right, the option should be accounted for as a separate performance obligation in the original contract.

It is likely that each unit of product is considered a separate performance obligation (e.g., tonne of coal). This requires the total transaction price to be allocated to the separate performance obligations using stand-alone selling prices.

Breakage

Customers may not exercise all of their contractual rights to receive a good or service in the future. Unexercised rights are often referred to as breakage.

An entity should recognise estimated breakage as revenue in proportion to the pattern of exercised rights.

Management might not be able to conclude whether there will be any breakage, or the extent of such breakage. In this case, they should consider the constraint on variable consideration, including the need to record any minimum amounts of breakage. Breakage that is not expected to occur should be recognised as revenue when the likelihood of the customer exercising its remaining rights becomes remote. The assessment should be updated at each reporting period.

In take-or-pay arrangements, this may mean that an entity may be able to recognise revenue in relation to breakage amounts in a period earlier than when the breakage occurs, provided that it can demonstrate it is expects that the customer will not exercise these rights. Given the nature of these arrangements and the inherent uncertainty in being able to predict a customer’s behaviour, it may be difficult to satisfy this requirement.

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