The International Accounting Standards Board (IASB) has issued two sweeping accounting pronouncements on revenue and leases that will need to be adopted over the next two fiscal years.
Unless you have been living under a rock, you have probably heard about these pronouncements and better still, begun planning for their adoption. These new standards impact every industry, and the mining and natural resources sector is no different. We are going to drill down into these standards to give you some insight into the key changes, and how this may impact your mining interests.
IFRS 15 – revenue from contracts with customers
Revenue underpins and impacts many crucial businesses. It also impacts control processes including budgeting, compensation systems, IT systems, KPIs and investor metrics. Revenue is often the largest figure in a financial statement and a figure that stakeholders, the public and financial reporting regulators are continually scrutinising. This new standard could have a major impact on how companies recognise and ultimately report their revenue, leading to a knock on impact on investment and capital allocation decisions.
The new revenue recognition standard will replace IAS 11 – construction contracts and IAS 18 – as a single standard to cover all types of revenue. The new standard implements a five-step process which requires management to determine if:
- a contract exists
- the underlying performance obligations
- the transaction price
- the allocation of the price to the different obligations
- and the recognition of revenue as the obligations are satisfied.
This new standard will require companies to go through this five-step approach for each of their contracts with customers. For mining companies selling concentrate, or other products that require assaying before a final price is determined, there could be material considerations around volume, discounts, recovery of metal and ultimately, the amount of revenue recognised in the accounting period. There can also be significant differences regarding royalties.
How could this impact mining companies?
Some mining companies may see little or no impact on adoption. For instance, diamond miners who sells their raw diamonds at auction are likely to continue to recognise revenue at the point the sale occurs. This may even be true for most mining companies that sell a finished product, eg copper cathode or gold bars. While there are some complexities around determining the transaction price, the timing and quantum of revenue recognition could be identical.
There could also be a significant impact on mining service companies. For instance, there are some full service companies that perform drilling and blasting services, smelting and transportation services. Often these are all covered under one contract and it will be important for management to identify all of the obligations within the contract to properly determine the revenue recognition under the new standard..
The standard will also require that the comparative periods are accounted for under this new standard. For periods starting 1 January 2018, IFRS 15 will be mandatory. This means that for companies with a December year end, the change to the comparative period begins 1 January 2017. For some companies the adoption could have a material impact that requires changes to processes and controls. This could also affect any mining company that seeks a public market flotation, where historical financial information may need to be prepared in accordance with this new standard. Similarly, valuations achieved in an IPO or M&A transaction may also be impacted by these revenue recognition issues.
IFRS 16 – Leases
For periods beginning on or after 1 January 2019, the current IFRS leasing standard will be replaced by IFRS 16 ‘leases’. This represents the first major overhaul of lease accounting for over 30 years and will bring major changes from the current accounting practice. Understanding the impact of IFRS 16 on your business along with careful planning and change management will be key to ensuring smooth transition.
Most businesses lease assets, from photocopiers and phone systems to offices and cars to giant extraction equipment and drills. Under the old leasing standard, companies were required to analyse leases to determine whether they were finance or operating leases. Operating leases only require rent expense to be recorded while finance leases require recognition of an asset and related liability.
Under the new accounting standard, all leases will now require the lessee to recognise a ‘right-to-use’ asset and a related liability for the lease payments on their balance sheet for each leased asset with a life of more than 12 months. It should be noted that there are some exceptions for low value items, and that the accounting for leases as a lessor will not change.
The result is that almost every leased piece of equipment will now be put on the face of the financial statements together with the related lease payable. This will allow the user of financial statements to understand the quantum of assets utilised by the company that are leased. Those companies with significant assets under operating leases will be impacted the most and will effectively gross up the assets and liabilities. It may also impact a company’s EBITDA as there will no longer be depreciation from assets under finance leases hitting the P&L, only the charge from the accretion of the right-to-use assets. The impact of this on mining and mining services companies can be very material, in the context of valuations for stock market listings and M&A transactions. This can also have an impact on debt covenants.
Transitioning to this new standard at the date of adoption will take a coordinated effort and require management to capture all of the information on their current leases. Companies that have begun this process have reported that the biggest challenge has been collecting all of the data from their leases to help identify the adjustments that will need to be made on transition.
If companies have not done so already, it is imperative that an impact assessment is carried out and a transition plan potentially put into place. To find out how we can assist you, from providing a high level impact assessment, to advising on and implementing a full transition, please contact Chris Raab.