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BDO NATURAL RESOURCES TECHNICAL UPDATEAPPLICATION OF IFRS 15 TO MINERS

2BDO Natural Resources Technical Update - Application of IFRS 15 to MinersAPPLICATION OF IFRS 15 TO MINERSBDO NATURAL RESOURCES - TECHNICAL UPDATEIt is reasonable to say that the miningsector is far less impacted by IFRS 15Revenue from Contracts with Customersthan sectors such as telecoms, software,construction and indeed mining servicecompanies.However, it is wrong to assume that miners are not impactedby this new standard and mining companies need to considerpotential impact areas.To analyse IFRS 15, it is necessary to consider whether thecontract is within the scope of the standard and consider thefive key steps in application of the standard.SCOPE - IS THE CONTRACT WITH A CUSTOMER?The standard applies to income earned from contracts withcustomers. Some sales of commodities may be outside thescope of the standard if the counterparty does not meet thedefinition of a customer as defined in the standard.IFRS 15 defines a customer as:“a party that has contracted with an entity to obtain goods orservices that are an output of the entity’s ordinary activities inexchange for consideration.”Arrangements where the parties are participating in an activitytogether and share the risks and benefits of that activityare not considered contracts with customers; these areparticipation arrangements.All of the relationships in a partnership or collaborationagreement must be understood to identify whether all or aportion of the agreement is a contract with a customer or isoutside the scope of IFRS 15.Determining whether the contract is even within the scope ofthe standard may be a challenge in relation to the following: Accounting for off-take arrangementsAccounting for streamingProduction sharing arrangementsRoyalty payments and other payments to mineral ownersForward-selling contracts to finance developmentProduct exchanges.STEP 1: IDENTIFY THE CONTRACTMost of the issues in application of IFRS 15 to miners are whereminers enter into long-term supply and off-take arrangementswith customers rather than where the commodity is sold on thespot market.Linking of ContractsIFRS 15 requires miners to link contracts if they were enteredinto at the same time and were linked economically. In someinstances, a miner may enter into a number of agreementsor a series of agreements with the same customer. In thesesituations, they will have to determine whether the agreementsshould be linked, in which case the pricing of the combinedcontracts will have to be allocated across the distinctperformance obligations (being the promise to deliver aquantity of a commodity). Processes and systems will have tobe put in place to identify and account for linked contracts.

BDO Natural Resources Technical Update - Application of IFRS 15 to MinersContract ModificationsSTEP 3: DETERMINE THE TRANSACTION PRICEBy their nature, long-term supply and offtake agreementsare spread over a period of time. This significantly increasesthe likelihood that these contracts are altered over thecontract term. For example, change in contracted quantity,pricing, grade or term will give rise to a contract modification.Contract modifications are accounted for as either a separatecontract or as part of the existing contract, depending uponthe nature of the modification. Systems and process willneed to be in place to be able to correctly identifysuch modifications.Step 3 of IFRS 15 introduces as number of complex issues forminers including:STEP 2: IDENTIFY PERFORMANCE OBLIGATIONSIn its simplest form, miners have a single performanceobligation, being the promise to supply a customer with aparticular mineral.In long-term supply contracts this may be a series of distinctperformance obligations, being a series of deliveries. However,there are certain situations where the miner providesadditional services such as: Prepaid off-take contracts Streaming Variable pricing.Prepaid Offtake ContractsIn a number of situations, the miner may enter into a supply/financing arrangement whereby it receives cash from thecustomer well in advance of supplying the commodity.Such contracts are usually drafted to satisfy the own useexemption of IFRS 9 Financial Instruments, whereby thecontract will be satisfied by delivery of the miner’s output.The ‘customer’ may be a financier that receives repayment viathe delivery of physical product. InsuranceUnder existing practice, a prepaid off-take contract wouldtypically not record any financing costs. For example, MinerX enters into a gold loan to supply 1,000oz of gold over thenext four years at 1,000 per oz., with the 1,000 per oz.being at a discount to the current forward / spot prices. Such atransaction would initially be recorded as: Storage.Dr Cash 1,000,000Careful analysis will be required as to what services areprovided and as to whether these services are performed atthe same time as ownership of the commodity is transferredto the customer. If they are not provided at the same timethe recognition of revenue relating to those services mayneed to be deferred or accelerated.Cr Deferred revenue 1,000,000 ShippingIt is also important to determine whether the miningcompany is acting as a principal or as an agent in providingadditional services. Miners acting as agents do not recogniserevenue for any amounts received from a customer to be paidto the principal.Revenue is recognised at 1,000 per oz. as the gold isdelivered. Applying IFRS 15 requires the miner to accountfor the financing arrangement built into the contract and,therefore, the miner will effectively gross up revenue andrecognise a financing cost.3

4BDO Natural Resources Technical Update - Application of IFRS 15 to MinersThis will result in increased revenue, being much closer to themarket price of gold, and a financing charge. If the miner wereconstructing a qualifying asset, the financing charge would becapitalised in the cost of that asset.This type of contingent pricing arrangement typically has fourcomponents giving rise to uncertainty as to the amount theminer will ultimately receive:Streaming Quantity and quality of commodity provided (for example,moisture content)Streaming arrangements are a form of alternative finance inthe natural resources sector, where a miner will stream someor all secondary minerals to a customer. For example, a goldminer sells 50% of the silver it produces in return for an upfrontfee and a set price per ounce for silver actually delivered tothe streamer, that is, the customer. The arrangement typicallyinvolves the streamer having the right to a minimum quantity ofsilver, which if not delivered will result in the repayment of partof the initial upfront payment. However the amount of silverdelivered to the customer is not limited, with the investor takingsome or all of the exploration upside for silver. Future commodity price Quantity of valuable bi-products Quantity of contaminants.Whilst it can be argued that movements in the commodityprice are not connected with whether the miner has fulfilledits performance obligation and are therefore not subject to thereversal constraint, the variability as to the quality and quantityof the ore / concentrate provided are directly related to theminer’s performance and will therefore be subject to the reversalconstraint.Streaming arrangements cause two practical issues whenapplying Step 3 of IFRS 15:STEP 4: ALLOCATE CONSIDERATION TO PERFORMANCEOBLIGATIONS Firstly, there is an embedded finance charge that will have tobe grossed up in the same way as the prepaid offtakes; andIFRS 15 requires a miner to account for each distinct goodor service as a separate performance obligations. There aresituations where a commodity is sold together with services (forexample: storage, shipping and insurance) and accordingly therevenue arising under the contract is required to be allocatedto the separate performance obligations in accordance with thestand alone selling prices of those services. Secondly there are practical issues applying the reversalconstraint to such a transaction. Revenue can only berecognised to the extent it is highly probable that it willnot reverse. Miners will have to be very conservative inestimating the quantity of commodity that will be suppliedunder the streaming contract, which is likely to initially seeless revenue being recognised per ounce sold than undercurrent practice.Variable PricingA much debated area of practical application is where theultimate pricing of the commodity sold is determined at a pointin time after the product is supplied to the customer, typicallybeing the commodity price when the ore or concentrate isactually smelted.STEP 5: RECOGNISE REVENUERevenue is recognised when performance obligations aresatisfied; normally this is when legal title to the product passesto the customer as this is what indicates that control has passed.It is important to understand the terms of trade in orderto determine when control of the goods has passed to thecustomer. Common terms of trade and the timing of incomerecognition for miners are:

BDO Natural Resources Technical Update - Application of IFRS 15 to Miners5 CIF – the miner has to pay the costs of freight and insuranceassociated with the shipping. If risk and title only pass to thecustomer on unloading at the destination port, then revenueis recognised at the date of unloadinglimited storage space or delays in production. IFRS 15 requires ananalysis to determine if the miner has satisfied its obligation totransfer the product by determining whether the customer hascontrol of the product. Factors to consider are: FOB – control of the goods transfers to the customer at themoment that the product passes the ship’s rail, as a result,revenue is recognised by the miner upon delivery tothe carrier The reason for the bill-and-hold arrangement must besubstantive (for example, the customer has requested thearrangement) Mine gate – control of the goods transfers to the customerat the moment that the product passes the mine gate, as aresult, revenue is recognised by the miner upon the productpassing the mine gate.A miner may enter into a bill and hold arrangement with acustomer if a customer requests delayed shipment because of The product must be identified separately as belonging tothe customer The product currently must be ready for physical transfer tothe customer, and The entity cannot have the ability to use the product ordirect it to another customer.

FOR MORE INFORMATION ON THEAPPLICATION OF IFRS TO MINERS,CONTACT OUR IFRS ADVISORY EXPERTS:JOHANNESBURGBert LopesT: 27 (0) 11 481 3186E: blopes@bdo.co.zaServaas KranholdT: 27 (0) 11 481 3072E: skranhold@bdo.co.zaJacques BarradasT: 27 (0) 10 590 7346E: jbarradas@bdo.co.za/BDOSouthAfrica/bdoafrica/bdo sa/company/bdo-south-africawww.bdo.co.za10/19BDO Advisory Services (Pty) Ltd, a South African company, is an affiliated company of BDO South AfricaInc, a South African company, which in turn is a member of BDO International Limited, a UK companylimited by guarantee, and forms part of the international BDO network of independent member firms.BDO is the brand name for the BDO network and for each of the Member Firms.

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