IFRS 6 exploration and evaluation

What does IFRS 6 cover?

Spending in the exploration and evaluation phase: acquiring rights to explore, topographical, geological, geochemical and geophysical studies such as seismic surveys, exploratory drilling, trenching and sampling, and evaluating the technical feasibility and commercial viability of extraction. It does not cover what comes before, activities before the company has the legal right to explore, or what comes after, development of a field once its viability is demonstrated, which falls under IAS 16 and IAS 38.

Which exploration and evaluation costs can be capitalised?

IFRS 6 lets a company set an accounting policy specifying which expenditures it recognises as exploration and evaluation assets, and apply it consistently. It exempts companies from the usual IAS 8 hierarchy when they set the policy, so most kept what they used before adopting IFRS. A policy can be changed only if the change makes the accounts more relevant and no less reliable, or more reliable and no less relevant. In practice, two broad approaches are common: capitalising all exploration and evaluation costs for an area until its outcome is known, or expensing geological and geophysical costs and capitalising only licence and drilling costs, a successful efforts style policy. See successful efforts vs full cost.

IFRS 6 exploration: one licence, two policies

An oil company pays CU 5 million for an exploration licence and spends 8 million on seismic surveys. Its first well, costing 20 million, is dry. Its second, costing 15 million, finds oil, but at the year end the discovery is still being appraised. Before the licence was awarded it spent 2 million on regional studies.

Both are acceptable under IFRS 6. Under the first, the dry well stays on the balance sheet while the area as a whole is still being evaluated, and is written off if the area is abandoned. Under the second, the loss is recognised when the well is found to be dry. Investors comparing explorers need to read the policy note before comparing profit or assets.

How are exploration and evaluation assets measured and classified?

At cost initially, then under either the cost model or the revaluation model, consistent with IAS 16 or IAS 38. Each asset is classified as tangible, such as drilling rigs and equipment used in exploration, or intangible, such as licences and drilling rights. Depreciation of tangible equipment used in exploration is itself an exploration cost and is capitalised under the company's policy.

When are exploration and evaluation assets tested for impairment?

Only when facts and circumstances suggest the carrying amount may exceed the recoverable amount. IFRS 6 lists examples: the exploration right has expired or will soon and is not expected to be renewed; no substantive further spending on the area is budgeted or planned; exploration has not found commercially viable quantities and the company has decided to stop; or data show that the carrying amount is unlikely to be recovered in full from development or sale. Assets are tested in cash-generating units, or groups of them, no larger than an operating segment. See impairment of oil and gas assets.

What happens when a discovery is commercial?

Once technical feasibility and commercial viability are demonstrable, typically when the company and its partners sanction development, the assets are no longer exploration and evaluation assets. They are tested for impairment first, then reclassified to development assets within property, plant and equipment or intangible assets, and from then on depleted under IAS 16 and IAS 38. See depletion and units of production.

What about farm-ins and licence swaps?

Many companies reduce their risk by farming out part of a licence: a partner pays some of the exploration costs in exchange for a share. IFRS has no specific rule for farm-outs in the exploration phase. A common practice is that the farmor recognises no gain, reduces its exploration asset by any cash received and records nothing for the partner's future spending on its behalf, while the farmee records its spending as its own exploration asset. See joint operating agreements.

How does US GAAP compare?

US GAAP has no equivalent of IFRS 6. ASC 932 prescribes successful efforts, and SEC rules permit the full cost method as an alternative; each has detailed rules for exploration costs. See oil and gas accounting, and for minerals, exploration and evaluation in mining.

This guide is general information. It is not tax or legal advice for your situation.