Search Financial-Accounting.us

Natural Resources - Noncurrent Assets in Financial Accounting

Natural resources are assets such as mines containing gold, silver, copper, or other minerals; wells containing oil or gas; and timberlands. Natural resources (also called wasting assets) are important assets of firms in the extractive industries.

Initial Valuation

Natural resources acquired from others are valued at their historical cost, but many firms self-explore and develop natural resource sites. The accounting for this type of situation is somewhat controversial. The issue involves the treatment of exploration costs associated with unsuccessful sites.

One approach, the full cost method, capitalizes the exploration costs of both successful and unsuccessful sites as an asset. This approach recognizes that a firm cannot expect success every time it attempts to locate valuable resources. Accordingly, the expenditures associated with both successful and unsuccessful sites are viewed as costs incurred to obtain successful sites.

The successful efforts method immediately expenses the cost of unsuccessful sites. Only the costs directly associated with locating and developing successful sites are capitalized. Because assets are recorded at lower amounts and expenses are recognized more quickly, successful efforts is the more conservative method. Case study 6.2 describes how the Newmont Mining Corporation accounts for its exploration costs.

Case Study 6.2

Newmont Mining Corporation
Excerpt from Financial Statement Notes

Mineral exploration costs are expensed as incurred. When it has been determined that a mineral property can be economically developed, the costs incurred to develop such property are capitalized, including costs to further delineate the ore body and remove overburden to initially expose the ore body. Such costs, and estimated future development costs, are amortized using a units-of-production method over the estimated life of the ore body. Ongoing development expenditures to maintain production are generally charged to operations as incurred.

Significant payments related to the acquisition of exploration interests are also capitalized. If a mineable ore body is discovered, such costs are amortized using a units-of-production method. If no mineable ore body is discovered, such costs are expensed in the period in which it is determined the property has no future economic value.

Required

Does Newmont use the full cost or the successful efforts method? Why?

Solution

Newmont uses the successful efforts method, indicated by two aspects:

Exploration costs are expensed as incurred. No costs are capitalized until it is probable that a property has valuable reserves.

Costs incurred to acquire exploration interests are capitalized. If no reserves are found, however, the costs are expensed immediately.

GAAP permits the use of either method. Large firms such as Exxon tend to use successful efforts, while small firms tend to use full cost because higher net income and larger asset values make them appear more profitable in the short term. The higher net income and larger asset values under the full cost method also reduce the likelihood of violating loan covenants based on accounting ratios. Large, established firms are in much less danger of violating loan covenants. They select the conservative successful efforts method because the lower reported net income helps reduce the political costs of the very visible oil industry. That is, lower net income numbers help the oil industry to argue that it is not unduly profiting at the public’s expense.

Natural Resources Topics

Related Noncurrent Assets Topics