IFRS 6 Exploration for and Evaluation of Mineral Resources

IFRS 6 Exploration for and Evaluation of Mineral Resources

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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IFRS 6 was issued in December 2004 as an explicitly interim standard, a short-term solution to a problem the IASB did not have time to solve properly before the 2005 European adoption deadline. Two decades later, it is still in force, still described as interim, and still doing exactly what it was designed to do: permitting extractive companies to continue applying whatever accounting policies they were already applying, while requiring them to disclose what those policies are.

That is an unusual thing for an accounting standard to do, and it produces an unusual result. Two mining companies with identical geology, identical drilling programmes, and identical outcomes can report materially different assets and materially different profits, both in full compliance with IFRS. The standard permits it deliberately.

Understanding IFRS 6 therefore requires understanding what it does not do, as much as what it does.

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The Problem the Standard Was Solving

Extractive activity has a fundamental accounting difficulty at its centre. A company spends heavily searching for mineral resources, and most of that spending finds nothing. The question is whether the cost of unsuccessful exploration is an asset.

Two established answers exist, and both have been used for decades.

The successful efforts method capitalises only the costs of exploration that actually leads to a commercially viable discovery. Costs relating to unsuccessful exploration are expensed as incurred. The reasoning is that a dry hole produces no future economic benefit, so it is not an asset.

The full cost method capitalises all exploration costs within a defined cost pool, on the reasoning that unsuccessful exploration is a necessary and unavoidable cost of finding the successful discoveries, in the same way that testing rejects are a cost of manufacturing output. The pool is then depleted against production from within it and tested for recoverability as a whole.

Neither method is obviously wrong, both were entrenched in practice, and forcing a change would have imposed substantial cost on an industry for benefits the IASB had not yet established. IFRS 6's answer was to defer the question and permit both, while requiring disclosure of which one is used.

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Scope: Two Sharp Boundaries

IFRS 6 applies to exploration and evaluation expenditures only, meaning expenditures incurred in connection with 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, but before the technical feasibility and commercial viability of extracting the resource are demonstrable.

The two boundaries define the standard's territory precisely.

The earlier boundary: legal rights obtained. Expenditures incurred before the entity obtains the legal right to explore a specific area are outside IFRS 6's scope entirely. Pre-licence costs, regional geological studies, speculative surveys over areas the entity has no rights to, and the costs of bidding for a block are generally expensed as incurred, since there is no asset to which they attach.

The later boundary: technical feasibility and commercial viability. Expenditures incurred after the technical feasibility and commercial viability of extracting a mineral resource are demonstrable are also outside IFRS 6's scope. From that point, the asset is no longer an exploration and evaluation asset, and the ordinary standards apply: IAS 16 for tangible development assets, IAS 38 for intangible ones, IAS 2 for produced inventory.

IFRS 6 does not define when technical feasibility and commercial viability become demonstrable, which is deliberate and which makes it one of the most consequential judgments in extractive accounting.

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The Policy Exemption: IFRS 6's Defining Feature

An entity applying IFRS 6 may continue to apply the accounting policies it applied immediately before adopting the standard, without needing to satisfy the ordinary IAS 8 requirements that an accounting policy be relevant and reliable.

This is a genuine and deliberate departure from IAS 8's hierarchy. Under normal circumstances, where no IFRS specifically applies to a transaction, an entity must develop a policy by reference to IFRS dealing with similar issues and then to the Conceptual Framework. IFRS 6 suspends that requirement for exploration and evaluation expenditures.

The consequence, stated plainly by ACCA in its own technical material, is that IFRS 6 allows entities using quite different accounting policies to all claim adherence to the standard.

An entity may change its accounting policy for exploration and evaluation expenditures, but only if the change results in financial statements that are more relevant to users' economic decision-making needs and no less reliable, or more reliable and no less relevant. In practice this makes changes rare, since the exemption removes the pressure to change and the criteria for changing are demanding.

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Measurement at Recognition and Afterwards

Exploration and evaluation assets are measured initially at cost.

The entity determines its own policy on which expenditures are included, which is where the successful efforts and full cost divergence operates. Expenditures that entities commonly consider include acquisition of exploration rights, topographical and geological studies, exploratory drilling, trenching and sampling, and activities in relation to evaluating the technical feasibility and commercial viability of extraction.

Expenditures relating to the development of mineral resources are specifically not recognised as exploration and evaluation assets, because development activity by definition occurs after commercial viability has been established.

After recognition, the entity applies either the cost model or the revaluation model, consistently with the classification of the asset as tangible or intangible. Where the revaluation model is applied, it follows IAS 16 for tangible assets or IAS 38 for intangible assets, though the IAS 38 revaluation model requires an active market, which rarely exists for exploration assets.

The obligations for removal and restoration incurred as a consequence of undertaking exploration are recognised under IAS 37, as covered in Post 42, with the corresponding amount forming part of the cost of the asset.

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Tangible or Intangible: A Classification That Sticks

An entity classifies exploration and evaluation assets as tangible or intangible according to the nature of the assets acquired, and applies that classification consistently.

Drilling rigs and vehicles used in exploration are tangible. Drilling rights and licences are intangible. Where a tangible asset is consumed in developing an intangible asset, the amount consumed forms part of the cost of the intangible asset, though using a tangible asset in this way does not convert it into an intangible asset.

The classification established during the exploration phase should be continued through to the development and production phases. An asset classified as intangible during exploration does not become tangible on reclassification simply because a mine has now been built around it.

Exploration and evaluation assets are presented as a separate class of asset, and are separately disclosed on the face of the statement of financial position and distinguished from production assets, where material.

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The Modified Impairment Model

Impairment is where IFRS 6 makes its second significant departure, and the departure is precise: IFRS 6 varies the recognition of impairment from IAS 36, while requiring the impairment, once identified, to be measured in accordance with IAS 36.

Two modifications operate.

Specific Impairment Indicators

Rather than applying IAS 36's general indicator framework, an entity assesses exploration and evaluation assets for impairment when facts and circumstances suggest the carrying amount may exceed the recoverable amount. IFRS 6 provides a specific list of such indicators:

The period for which the entity has the right to explore in the specific area has expired during the period, or will expire in the near future, and is not expected to be renewed.

Substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned.

Exploration for and evaluation of mineral resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources, and the entity has decided to discontinue such activities in the specific area.

Sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale.

The first three indicators share a common feature: they are about the entity ceasing or being unable to continue exploring. The fourth is about the economics of a discovery that will proceed but will not recover the cost incurred to find it.

The Aggregation Relief

This is the more commercially significant modification. IFRS 6 permits an entity to determine an accounting policy for allocating exploration and evaluation assets to cash-generating units or groups of cash-generating units for the purpose of assessing such assets for impairment.

The constraint: each such unit or group shall not be larger than an operating segment determined in accordance with IFRS 8.

The relief this provides is substantial. Under IAS 36's ordinary requirements, each individual unsuccessful exploration prospect might constitute its own cash-generating unit, generating no cash flows and therefore requiring full impairment. IFRS 6's aggregation permits the entity to test a group of prospects together, so that the value of successful discoveries within the group supports the carrying amount of unsuccessful ones.

This is precisely what makes the full cost method workable under IFRS. Without the aggregation relief, a full cost pool would be dismantled by IAS 36's cash-generating unit requirements.

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Reclassification and the Mandatory Impairment Test

An exploration and evaluation asset ceases to be classified as such when the technical feasibility and commercial viability of extracting a mineral resource are demonstrable.

Two requirements attach to that moment.

The asset is assessed for impairment before reclassification, and any impairment loss is recognised. This test is mandatory, not indicator-driven. The reasoning is that the modified impairment model, and particularly the aggregation relief, ceases to be available once the asset leaves IFRS 6's scope, so the entity must clear the asset through an impairment test while the exploration-stage framework still applies.

The asset is reclassified to the appropriate standard: IAS 16 for tangible assets, IAS 38 for intangible assets, applying the classification established during exploration.

When Does Technical Feasibility and Commercial Viability Become Demonstrable?

IFRS 6 gives no definition, which places the judgment entirely with the entity, and it is a judgment with real consequences: it determines when the modified impairment model stops applying and the far more demanding IAS 36 framework begins.

A recent example from filed financial statements illustrates how the judgment is actually exercised. A mining company disclosed that although a feasibility study for its principal project had been completed, it had not yet received the licences and permits required, and it therefore determined that the exploration and evaluation stage was not complete. The feasibility study alone, in that entity's assessment, did not demonstrate commercial viability where the regulatory permissions to proceed were still outstanding.

Common factors entities consider include: the existence of a completed feasibility study, the receipt of necessary permits and licences, the availability of financing, the existence of established mineral reserves rather than resources, and board approval to proceed to development.

The judgment must be applied consistently and disclosed, since two entities applying different thresholds will reclassify at materially different points in a project's life.

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Disclosure Requirements

An entity discloses information that identifies and explains the amounts recognised in its financial statements arising from the exploration for and evaluation of mineral resources, specifically:

Its accounting policies for exploration and evaluation expenditures, including the recognition of exploration and evaluation assets. This is the disclosure that carries the weight of the policy exemption: because entities may apply different policies, the policy itself must be visible.

The amounts of assets, liabilities, income and expense, and operating and investing cash flows arising from the exploration for and evaluation of mineral resources.

Details of the amounts capitalised, and amounts recognised as an expense, from exploration, development, and production activities.

Given the policy exemption, the accounting policy disclosure is not boilerplate. It is the only mechanism by which a user can determine whether the company applies successful efforts or full cost, what expenditures it capitalises, at what level it aggregates for impairment testing, and when it considers the exploration stage to end. A comparison between two extractive companies is not possible without reading it.

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Indian Extractive Context

India's extractive sector operates under Ind AS 106, the Indian equivalent of IFRS 6, alongside a licensing framework that has evolved through several policy regimes.

Oil and gas. Exploration blocks have been awarded under the New Exploration Licensing Policy, and subsequently under the Hydrocarbon Exploration and Licensing Policy with its Open Acreage Licensing Programme, which permits companies to bid for acreage of their choosing rather than waiting for government-defined rounds. ONGC and Oil India dominate domestic exploration alongside private and joint venture operators including Vedanta's oil and gas business and Reliance's offshore interests.

Indian oil and gas producers have historically applied the successful efforts method, consistent with the ICAI's Guidance Note on Accounting for Oil and Gas Producing Activities, which predates Ind AS convergence and which continues to inform practice. IFRS 6's policy exemption permits that continuation.

Coal and minerals. Coal India, NMDC, Hindustan Zinc, and Vedanta's mining operations conduct exploration under mining lease and prospecting licence frameworks governed by the Mines and Minerals (Development and Regulation) Act, as amended, with auction-based allocation now the norm for major minerals.

The licence boundary matters practically in India. Because IFRS 6 excludes expenditure incurred before legal rights are obtained, the substantial costs of bidding for a block under an auction or licensing round, including data purchase, technical evaluation, and bid preparation, fall outside the standard's scope and are generally expensed. Only once the block is awarded and the legal right to explore exists does capitalisation under the entity's IFRS 6 policy become available.

Site restoration obligations are significant. Indian mining leases and petroleum contracts carry restoration and abandonment obligations, and the associated IAS 37 provision, with its corresponding addition to asset cost, forms part of the exploration and evaluation asset where the obligation arises from exploration activity itself.

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Ind AS 106 vs IFRS 6

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What Big 4 Auditors Focus On

The technical feasibility and commercial viability judgment. This is the highest-risk judgment in the standard, because delaying reclassification keeps the asset within the more permissive IFRS 6 impairment framework. Auditors test the criteria the entity applies, whether those criteria have been applied consistently across projects and periods, and whether specific evidence, such as completed feasibility studies, permits obtained, reserves declared, and board approvals, supports the conclusion reached.

Impairment indicator assessment. Auditors test whether the four IFRS 6 indicators have been genuinely assessed for each area, with particular attention to exploration rights approaching expiry and areas where no further expenditure is budgeted, since both are objectively verifiable from licence registers and approved budgets.

The aggregation policy and its segment constraint. Auditors verify that the level of aggregation used for impairment testing does not exceed an operating segment, and that the policy has been applied consistently rather than adjusted to absorb a particular unsuccessful area.

Pre-licence expenditure. Auditors test whether costs incurred before legal rights were obtained have been expensed rather than capitalised, since the boundary is objective and capitalisation before that point is a clear error.

Accounting policy disclosure adequacy. Given the policy exemption, auditors assess whether the disclosed policy is sufficiently specific to allow a user to understand what has been capitalised, at what level impairment is tested, and when the exploration stage is considered to end. A generic policy note does not discharge the requirement.

Restoration provision measurement. Auditors test the IAS 37 provision for exploration-related restoration obligations, including the discount rate and the estimate of future restoration cost, and whether the corresponding amount has been correctly included in the asset's cost.

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Dip IFRS Exam Angle

IFRS 6 is examined less frequently than the major standards but appears regularly, usually testing scope boundaries and the modified impairment model rather than complex calculation.

Most tested areas:

Identifying which expenditures fall within IFRS 6's scope, applying both boundaries: after legal rights are obtained, and before technical feasibility and commercial viability are demonstrable.

Recognising that pre-licence and development expenditures fall outside the standard.

Applying the four specific impairment indicators rather than IAS 36's general framework.

Understanding the aggregation relief and its operating segment ceiling.

Recognising that an impairment test is mandatory before reclassification out of exploration and evaluation.

Common traps:

Capitalising pre-licence exploration costs. These fall outside IFRS 6 and are expensed.

Applying IAS 36's general impairment indicators instead of IFRS 6's specific list.

Aggregating for impairment testing at a level larger than an operating segment.

Treating the impairment test before reclassification as indicator-driven. It is mandatory.

Assuming IFRS 6 prescribes a single method. It permits both successful efforts and full cost, and requires disclosure of which is used.

Changing the tangible or intangible classification on reclassification. The classification established during exploration continues.

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FAQ

Why does IFRS 6 permit companies to keep using their old accounting policies?

Because it was issued as an interim standard ahead of the 2005 European IFRS adoption, at a point when the IASB had not completed a comprehensive project on extractive activities. Forcing convergence on either successful efforts or full cost would have imposed substantial cost without a settled conceptual basis for choosing between them.

Does IFRS 6 make extractive companies comparable?

Not on the treatment of exploration expenditure itself. Two companies applying different policies can report materially different assets from identical activity. The standard addresses this through disclosure rather than through prescription, which means comparison requires reading the accounting policy note rather than the face of the statements.

Are bid costs for an exploration block capitalised?

Generally no. Expenditure incurred before the entity obtains the legal right to explore falls outside IFRS 6's scope, and there is no asset to which it attaches. Costs of data purchase, technical evaluation, and bid preparation for a block that has not been awarded are expensed.

Why does IFRS 6 modify the impairment recognition rules?

Because applying IAS 36's cash-generating unit requirements strictly would require each unsuccessful exploration prospect to be impaired individually, since it generates no cash flows. That would make the full cost method unworkable and would produce impairment charges the standard's drafters considered inconsistent with the economics of exploration portfolios.

What happens to the aggregation relief after reclassification?

It ceases to be available. Once an asset leaves IFRS 6's scope, IAS 36 applies in full, including its cash-generating unit requirements. This is precisely why an impairment test is mandatory immediately before reclassification: it clears the asset while the more permissive framework still applies.

Is IFRS 6 likely to be replaced?

The IASB has had extractive activities on its research agenda for many years without producing a replacement standard. IFRS 6 continues to be described as interim, and entities should expect it to remain in force while planning on the basis that a comprehensive project could eventually change the position materially.

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This is Post 71 of the Global Fin X IFRS Series. Previous: IAS 41 Agriculture: Biological Assets, Fair Value and Indian Agri-Business Context. Next: Post 72: IAS 2 vs IAS 41: When Does Inventory End and a Biological Asset Begin.