(a) (i) The Framework acknowledges a variety of measurement bases including historical cost, current cost, net realisable value (NRV) and present value. It refers to NRV as a settlement value which will be determined by a future transaction. Thus in order to determine NRV, the directors would need to refer to IAS 2 Inventories for the definition and IAS 10 Events after the Reporting Date. The directors should consider any adjusting events which provide evidence of conditions which existed at the end of the reporting period in order to determine NRV.
IAS 2 defines NRV as the estimated selling price in the ordinary course of business less the costs of completion and costs of sale. In this case, the NRV will be determined on the basis of conditions which existed at the date of the statement of financial position. IFRS 13 Fair Value Measurement does not apply to IAS 2 as regards NRV even though the measurement method is very similar. Any future price movements will be considered if they provide information about the conditions at the date of the statement of financial position but normally these movements would reflect changes in the market conditions after that date and therefore would not affect the calculation of NRV. The NRV will be based upon the most reliable estimate of the amounts which will be realised for the coal. The year-end spot price will provide good evidence of the realisable value of the inventories and where the company has an executory contract to sell coal at a future date, then the use of the forward contract price may be appropriate. However, if the contract is not executory but is a financial instrument under IFRS 9 Financial Instruments or an onerous contract recognised as a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, it is unlikely to be used to calculate NRV.
(ii) Fill should calculate the NRV of the low carbon coal using the forecast market price based upon when the inventory is expected to be processed and realised. Future changes in the forecast market price or the processing and sale of the low carbon coal may result in adjustments to the NRV. As these adjustments are changes in estimates, IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors will apply with the result that such gains and losses will be recognised in the statement of profit or loss in the period in which they arise.
(b) IAS 16 Property, Plant and Equipment (PPE) requires an entity to recognise in the carrying amount of PPE, the cost of replacing part of such an item. When each major inspection is performed, its cost is recognised in the carrying amount of the item of PPE as a replacement if the recognition criteria are satisfied. Any remaining carrying amount of the cost of a previous inspection is derecognised. The costs of performing a major reconditioning are capitalised if it gives access to future economic benefits. Such costs will include the labour and materials costs ($3 million) of performing the reconditioning. However, costs which do not relate to the replacement of components or the installation of new assets, such as routine maintenance costs, should be expensed as incurred.
It is not acceptable to accrue the costs of reconditioning equipment as there is no legal or apparent constructive obligation to undertake the reconditioning. As set out above, the cost of the reconditioning should be identified as a separate component of the mine asset at initial recognition and depreciated over a period of two years. This will result in the same amount of expense being recognised as the proposal to create a provision.
IAS 36 Impairment of Assets says that at the end of each reporting period, an entity is required to assess whether there is any indication that an asset may be impaired. IAS 36 has a list of external and internal indicators of impairment. If there is an indication that an asset may be impaired, then the asset’s recoverable amount must be calculated.
Past and future reductions in selling prices may indicate that the future economic benefits which relate to the asset have been reduced. Mining assets should be tested for impairment whenever indicators of impairment exist. Impairments are recognised if a mine’s carrying amount exceeds its recoverable amount. However, the nature of mining assets is that they often have a long useful life. Commodity prices can be volatile but downward price movements are more significant if they are likely to persist for longer periods. In this case, there is evidence of a decline in forward prices. If the decline in prices is for a significant proportion of the remaining expected life of the mine, this is more likely to be an impairment indicator. It appears that forward contract prices for two years out of the three years of the mine’s remaining life indicate a reduction in selling prices. Based on market information, Fill has also calculated that the three-year forecast price of coal will be 20% lower than the current spot price (part (a) of question).
Short-term market fluctuations may not be impairment indicators if prices are expected to return to higher levels. However, despite the difficulty in making such assessments, it would appear that the mining assets should be tested for impairment.
(c) The ED Conceptual Framework for Financial Reporting states that an entity controls an economic resource if it has the present ability to direct the use of the economic resource and obtain the economic benefits which flow from it. An entity has the ability to direct the use of an economic resource if it has the right to deploy that economic resource in its activities. Although control of an economic resource usually arises from legal rights, it can also arise if an entity has the present ability to prevent all other parties from directing the use of it and obtaining the benefits from the economic resource. For an entity to control a resource, the economic benefits from the resource must flow to the entity instead of another party.
Although the ED gives some guidance on the definition of control, existing IFRS Standards also provide help in determining whether Fill controls the mine and therefore should account for it as a business combination. IFRS 10 Consolidated Financial Statements states that an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Further, IFRS 15 Revenue from Contracts with Customers lists indicators of the transfer of control of an asset to a customer. One of the indicators is that the customer has the significant risks and rewards of ownership of the asset which is basically exposure to significant variations in the amount of economic benefits
A business combination is defined in IFRS 3 Business Combinations as a transaction or other event in which an acquirer obtains control of one or more businesses. A business is further defined as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return…..’ Thus, the producing mine represents a business and Fill now owns a majority of the interest in the business.
However, this is not a business combination as Fill does not have the ability to affect decisions unless another participant agrees to vote with Fill. Although Fill will control 52% of the mine, it cannot direct the use of the economic resource unless one of the other participants agrees with an operating decision proposed by Fill and approval is given by 72% of participants. However, Fill can prevent the other parties from directing the use of the mine if the purchase goes ahead, because the other two parties cannot make an operating decision without Fill’s consent.
Prior to the purchase of the additional investment, the approval of decisions required agreement by 72% of the participating interests. A joint control situation existed between the entities. Following the additional purchase, if there is still a joint control situation, the acquisition of an additional interest in a joint operation should apply all of the principles on business combinations accounting in IFRS 3 and other IFRS Standards with the exception of those principles which conflict with the guidance in IFRS 11 Joint Arrangements. These requirements can apply also to the initial acquisition of an interest in a joint operation. For there to be a joint control situation, there must be an agreement signed by the venturers which stipulates which of the parties are required to give unanimous consent.