Has the time come for juniors to take exploration costs off the balance sheet?
21 November 2022 | Minutes to read: 3

Has the time come for juniors to take exploration costs off the balance sheet?

By Nicholas Benbow

You know the playbook – get hold of that promising target, be it gold, lithium, or a number of other minerals and secure the tenement. Then get to work establishing an exploration program, including desktop reviews of the topography, geological surveys and exploratory drilling. Once this work yields some promising results, package it up for listing on the ASX, firstly proving its commercial bona fides with a pre-listing seed raise before the full IPO.

But how to account for those exploration costs? This is often overlooked during the pre-IPO phase, when a company’s accounting policies are established, as the attention of directors is fixated on the geological results.

The fact is that explorers are given a lot of levity in how they may account for such costs – from capitalisation, partial capitalisation to the full expenditure method. Historically, most of Australia’s ASX-listed explorers, have chosen to capitalise those costs. Traditionally, it was felt that this approach enhanced their overall balance sheet and therefore offered a more compelling offering to market to investors. Recently however, many new entrants have chosen to expense these costs. Here are some of the very smart commercial reasons why:

  • Keeping track of those capitalised costs
    These costs need to be tracked by their area of interest for each period and then justified to their auditor as to why they represent a future economic benefit. Specifically, that the business expects to recoup these costs through successful development and exploration, and that the costs will not be impaired in the balance sheet. This may be extra admin that the company could instead devote to what is immediately required – a focus on the exploration program and raising capital.
  • The future impairment risk
    Each area of interest is tracked for its net accumulated exploration costs. In the event that a regulatory authority elects to not renew the right of tenement to that area of interest, these costs will need to be written off. That impairment charge may compound the negative sentiment the company has already copped in announcing the loss of the tenement right. Worse still, a regulatory authority may delay extending an exploration tenement, and with bureaucracies as they are around the world, this occurs frequently. The directors are then left in a form of purgatory in determining whether a current right of tenure (AASB 6 Aus7.2) exists that would allow a capitalisation. Finally, additional impairment pressures may occur if the accumulated capitalised costs of exploration taken to the balance sheet exceed the market capitalisation of the company. The back-and-forth with auditors in satisfying that impairment may or may not exist in such circumstances and can be avoided if all of such costs are expensed from the outset.
  • Do investors really care?
    Finally, and most importantly, directors need to assess whether this capitalised number actually means something. From an accounting perspective, it should represent accumulated costs capitalised to the balance sheet for areas of interest, nothing more. If some of those costs represent a significant breakthrough discovery, there is no benefit of an uplift to the value of the asset that can be taken to the profit or loss.Most directors appreciate that their shareholders are savvy to where the real value lies; in the results of the exploration program and the likelihood that the program will progress to an ultimate vend-out to a major producer, or a transition within the company to a production program. And if a production program is achieved, these costs need to amortize as the resource is extracted, pro-rata over its total reserves – and commonly mining producers, regardless, refer to cash costs of production and exclude from their performance metrics the amortization charge. If a production program is achieved, no such reconciliation between cash cost and amortized cost of production is necessary, and therefore the results to investors are much clearer and more obvious.

Exploration companies are given much more freedom of accounting choice, relative to their peers in biotechnology (who are prohibited from capitalising any research expenses) and in technology (who need to succeed very stringent criteria under AASB 138 to justify capitalisation). But this freedom presents further difficulties down the line for explorers in tracking those costs, justifying their non-impairment and what exactly is the use and utility of that asset to investors. If directors and shareholders both have confidence in the underlying assets’ bona fides, an expenditure policy accounting for exploration costs would greatly simplify matters and allow a company to focus squarely on what matters – the ultimate success of the exploration program.

Has the time come for juniors to take exploration costs off the balance sheet?

Nicholas Benbow

Nicholas is a Director in our Audit and Assurance division. He specialises in accounting for complex business transactions, including acquisitions, divestments and restructures, particularly in situations where a business is primed to realise its growth potential. Nicholas works closely with companies through the IPO process, assisting with Audit and strategic advice.

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