Mining Development Risks: Going Concern and IFRS Challenges

The most dangerous phase in mining isn’t exploration, it’s development. This is where projects become capital intensive, assumptions get tested, and going concern risks start to emerge.

In this episode, we unpack the financial reporting challenges that arise as mining entities transition out of IFRS 6 into IAS 36, and why this shift often exposes deeper issues. We explore how going concern becomes a critical judgment area, especially when funding, timelines, and engineering realities don’t align.

From revenue uncertainty under IFRS 15 to embedded leases, inventory valuation, and complex funding structures, this episode highlights where things start to go wrong and when entities should have known.

🎧 In this episode, you’ll learn:

•  Why the development phase is the highest-risk stage for financial reporting 
•  How going concern risks build before projects fail 
•  When to exit IFRS 6 and trigger IAS 36 impairment
•  Why revenue and funding structures introduce volatility and judgment

Financial Reporting Conversations is brought to you by Basford Consulting helping professionals go beyond compliance and get financial reporting right.

For technical insights, training, and resources that make the unknowns in financial reporting known, visit basfordconsulting.com

🔗 Connect with us:
LinkedIn: Wayne Basford & Judith Leung
YouTube: @BasfordConsulting
Website: basfordconsulting.com

Transcript

SPEAKER_01 0:00

Welcome to Financial Reporting Conversations brought to you by Basic Consulting.

SPEAKER_00 0:04

We're here to make unknowns and numbers of accounting, like auditing and commitment standards numbering, so we can avoid the blindfredding mistakes and do financial reporting better.

SPEAKER_01 0:13

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SPEAKER_00 0:18

Whether you're a preparer, auditor, director, or litigator, our aim is to help you get it right. Hello and welcome to Financial Reporting Conversations. I'm Judith Lum, and as usual, I'm joined by Wayne Bassford. Wayne, I know you're currently working on an ice cream course and a webinar on small cap miners and mine developers. Why is it worth presenting a separate course, especially for developers and mining companies?

SPEAKER_01 0:45

Remembering we live in I I personally live in Perth and Western Australia. And interestingly, a lot of projects are going into production now. And a lot of projects are going into production because the gold price is high, the silver price is high, the zinc price is high. And it's a risky process. And a lot of either the accountants working on the the accounts working on moving the phase into from exploration to development to production, they're not automatically experienced on that transition. And the same with the auditors, that there are not historically that many mines that go into production each year, and they're risky and they're interesting from an accounting perspective. You go from being a very, very simple entity, a junior explorer, where you only really get equity, some convertible notes, you're protected by the great world of IFS6, and then suddenly you are borrowing, you're gearing, you're raising finances, you are in the world of IS-36 on impairment, you have got extremely complex financial instruments, and the massive risk is as you move into development, it can all go wrong, and you don't actually get into production, and you're a real going concern, and suddenly you're the headlines as to another development company has collapsed. So this is meant to help the auditors and the financial controllers think about all the pain they're going to go through as they move exploration, development, production.

SPEAKER_00 2:39

Thanks, Wayne. So sounds like mining has a set of its own unique issues, and you've touched on some of the accounting challenges like 36 and going concern. What are other some accounting other accounting challenges that preparers and auditors should think about for this particular sector?

SPEAKER_01 2:59

Again, it depends on where you are on the phase. And you know, this is for the developers, the mid-cap miners. From an accounting perspective, as I said, it's complicated. There are more leases around than you can imagine, even though you don't necessarily enter into a formal lease arrangement. You are capital intensive, you need roads, you need power stations, you need pipelines, you need railroads, you need big mining equipment, all of which could be on balance sheet, could be using mining services contractors, haulage contractors, but you may get a lease. And as possibly you should be talking about more than me. The financial instruments are complicated. So you've got off-take agreements, streaming agreements, royalty agreements, interest in convertible notes, you've got bank debt that can actually insist that the miners take out a certain amount of derivatives that actually go into hedging arrangements. You've got the complexities of inventory valuation, you've got the complexities of revenue recognition, and all of this as you're moving from exploration, where you've had a staff of perhaps 20 geologists to suddenly needing to employ directly or indirectly hundreds, thousands of people, and from having no real property plan and equipment, you've got an enormous amount of infrastructure. And from having no borrowings to having some of the most complicated borrowings in any sector. So it's complicated.

SPEAKER_00 4:48

Thanks. Yeah, so in the life of a mining project, the move from exploration to development represents a very critical inflection point from an accounting perspective. How does an entity go about determining whether they're still can still have the protection under IFRS 6 or should be moving out of IFS 6?

SPEAKER_01 5:09

So evaluation ceases when you believe you have a commercially viable project. The great protection of IFRS 6 ceases when it's you can demonstrate the project is commercially viable, that you're going to go into production. And this is entities desperately try to stay in IFRS 6 as long as they should, and which is correct, because you have these phases, you have feasibility study, you have a pre-bankable feasibility study, you have a definitive feasibility study, you may then have a bankable feasibility study. But a bankable feasibility study does not necessarily trigger going into development. You have a feasibility study, you have a very detailed feasibility study, and therefore you're using that study to raise funds. Now, depending on the market, depending on the confidence of the funders, even though you've got a bankable feasibility study, you might not get any funds. So normally people entities wait until they've actually got the financing to build the mine. And that is the trigger to move from IFS 6 to move into IS-36 and IS-16. Remembering when you move from expiration, you must test the asset for impairment. And another one to watch for it is not necessary that you move all of the E into development. It may be a case you've got large tenements, a collection of tenements, and you've proven only a proportion of that is going to be mined in the short term. So you've got to be aware that when you move into development, which bit of my exploration asset am I going to develop? So subjective and complex.

SPEAKER_00 7:18

Yeah, so there sounds a lot of judgment involved, and usually people would wait until when they've got funding from the bank of visibility to move. And once you move, you need to reclassify your assets from six to um IS 16, but you have to do maybe not all of them, and essentially we need to do the impairment test. Let's talk about another area. Um, that's you know here you always talk about going concern. Why are going concern assessment particularly sensitive in this development stage mining entities?

SPEAKER_01 7:54

If we look at the history, we look at collapses, it went wrong. And we're into almost a perfect storm. A developer, a single asset developer, it's got no operating cash flows. So we've got no operating cash flows, but we are committed to spending millions of dollars, hundreds of millions of dollars of building a mine. We go and raise funds, and we can either, and it's usually a mixture of raising funds through debt and equity, and we are desperate to get into production. And horribly, the funds run out before we get into production, or in some cases, we end up having to pay interest on the funds we've borrowed before we've managed to get into production. Why do the cash flows not marry up? Well, something's gone wrong in the project. And there's all sorts of things that can go wrong in the project. Wonderful discussion with a mine engineer once who explained to me, you don't know what's there until you've dug it. So you may have done great geology, you may have done great test drilling, you may have a very well done jaw statement, but it's all done on a sample basis. So only when you're really digging the ore do you realize it's there, the ore is actually there. And a lot, all bodies are always unique. So they build plants with the concept, a theory of this is how we're going to extract the mineral, this is how we're going to extract the gold, extract the silver. And the chemistry is unique. So even though on this project we estimated we would be able to get a 90% yield because of this ore body, and because of this imperfection, and because of this, we're only going to get a 70% yield. From my horrible cynicism, the accountants, the numbers, are at the exposure to engineers and to mine engineers. And this word, if you look at the Dilbert things, this is a scary world where the bean counters, the accountants, the financiers deal with the real world of engineering. So we're building a mine. Did the person who said this is what we need get that specification right? Did they actually say it was the correct time to build it? And then something goes wrong. The engineering doesn't work, there's delay in procurement. The person actually supplying the equipment has never, or the entity supplying the equipment has never built that type of equipment before. So there's so much risk involved, and we've borrowed hundreds of millions of dollars, and if the two don't marry up, we run out of cash.

SPEAKER_00 11:08

And we've got a going concern issue, and that explains why.

SPEAKER_01 11:22

And it's right, but everybody, everybody involved in development companies need to understand the risks, you know, and that is the directors, the audit committee chairs, the auditors. When we see a development project go wrong, and this is the real world, this is the world of uh natural resources, development projects go wrong, mainly because of engineers. Everybody then looks at it and says, When should we have known that it was going wrong? When should we have known that the project was not going to be delivered on time? When should we have known it was going to cost a lot more than we were expecting? When should we have known we weren't going to get a 90% yield? We were only going to get a 70% yield. Because when it comes to accounting, and this is both impairment under 36 and all the going concern uncertainties that should be disclosed. What went wrong? When should the users of financial statements been told something was going wrong? You know, when do you see there's a going concern uncertainty? At the moment, we are six months behind schedule and we have interest payments that are due two months before we are now currently scheduling to go into production. At the moment we can't get the thing to work, or we are only managing to get 50% recovery when the entire mine plan and BFS said we were going to get a 90% recovery. When should have that and how much of that bad news should have been disclosed within the going concern uncertainties? And going back to the real world of bias, I might need my financiers to advance me more money in order to finish this project. I might need to go to the market and ask for more shares because I need more cash to finish the project. Do I want to tell them bad news? Or am I driven, incentivized not to mention the bad news and the reality of it's not this development project isn't going as well as I expected?

SPEAKER_00 13:56

Definitely a um going concern and major issue during that phase where we move to production and when we're building um production. So moving forward to onto the life cycle of a project when we actually production has commences, for many developers, this is the first time they would recognize revenue.

SPEAKER_01 14:24

The easy one, even when you go on to step two of IFRS 15, what are we actually selling? In some instances, we will be selling ore, and we'll be providing shipping services, and we'll be providing insurance services, so they're distinct performance obligations. But the major one is the reversal constraint. We mining typically sell ore transfer the ownership of ore with a load of unknowns, so we don't know the exact quantity of the gold, of the silver, of the zinc contained in the material we've sold. We don't know the quality of it, we don't know whether it's got impurities in it that will cause problems with extracting the mineral ultimately, and uh we don't know uh the the commodity price. So when you sell a mineral, it is subject to provisional pricing, it is normally subject to provisional pricing, and that clashes then with the reversal constraint within IFS-15. So you can only recognise revenue if it's highly probable it won't reverse. So you need to be conservative on this is the amount of silver in the concentrate, this is the likely impurities. Now that is the reversal constraint, and you recognize revenue based on your conservative view of how much mineral is contained in the ore or the concentrate you've sold. And then a lot of pricing, because they get smelted, they get extracted, you actually only get the the the consideration you get is based on the commodity price when the ore is ultimately processed. So you're subject to derivative risk, the future uh price of gold, the future price of silver. Now, when you recognize your receivable, you've actually got a derivative asset. Or you've got that you your asset moves up and down dependent on the gold price, the silver price, and then you're in your world of IFRS9. So revenue can be a lot more complicated than selling a gold bar to the Perth Mint.

SPEAKER_00 17:02

If you're finding this discussion useful, please take a moment to click like, subscribe, and share. It helps others in the financial reporting community discover financial reporting conversations and keeps you up to date with every new episode. Entities, something a lot of people are not aware of frequently miss, are embedded leases. They're actually sort of embedded into some complex like operational contracts that are usually not labeled as leases, but like contractor agreements and but often contain lease components, and we frequently do come across those. Can you share some of the typical examples that we see?

SPEAKER_01 17:42

Almost textbook, let's do an IFRS 16 course, and the textbook are the mines. The mines, by their nature, are capital intensive, and when you look at their operation, so if you go into operation, you have wet hire, dry hire. A lot of mining companies do not employ miners, they actually employ mine contractors that do everything for them. And these mine people supply all of the mining equipment, all the diggers, the generators, etc. And if they supply them without people, that is dry hire. If they supply them with operators, which is the most typical case, that is wet hire. And then there's a lot within the definition of IFS 16, is there a specified asset? Do we get sole use of it? Do we direct the use of that asset? And it are the substantive substitution rights. All of those need very complex analysis on facts and circumstances, even the location of the mind can tip whether you're in a lease or not in a lease. You've then got the big infrastructure, you've got railways, you've got pipelines, you've got transport equipment, the trucks, the trains, the haul trucks, ships, power stations, you've got a whole gamut of whether it falls within the IFS 16. You've just got you've just got a power contract, you've just got a haulage contract, but are you within the scope of IFS 16? You even can get easements that mines have typically got easements that you cannot, you've got the fields around it, fields with sheep or whatever, but there are strict easements that nobody can do anything to a particular strip of land without asking the mine's permission, that can fall within a lace. So expect when you're signing up, when you're moving into development, into getting all the pieces together to go into production, who's going to do the mine, who's going to power the mine, who's going to ship the ore to port, who's then going to ship the ore to the end customer. You are in a world of IFRS 16.

SPEAKER_00 20:21

Look out for those embedded leases in um in those contracts. Now, moving on to the application of IS2 inventory. Inventory, now that we have some ore body or gold or what um other minerals, inventory valuation is another complex and highly judgmental area. Can you talk us through that?

SPEAKER_01 20:45

It is complex in terms of now. Remember, most inventory models within a mining operation is driven off a unit of production. So you're actually making a key estimate what is the total number of mineable tons I'm going to produce over the life of the mine, and that is how I absorb the depreciate the cost of the mine into each ton of ore. You've then got great subjectivity about what is the standardized cost of production. Have I got stripping costs where I'm produce I'm working but I'm not producing any mineable ore? Am I going through low grade ore that's not normal production? Am I switching over a long wall if you're into coal mining? And then the wonderful world of low grade stockpiles, high grade stockpiles, co product, byproduct. It is a very judgmental, very subjective area of accounting. And obviously, if you put a lot of value into inventory. You put a lot of value into low-grade stockpiles, you put value into byproduct, you're going to improve profits. The more that you can capitalize into inventory, the more profitable you're going to be. And remember, you'll get situations with low-grade stockpiles. You may deliberately say, I'm not going to process the low-grade stockpiles at the moment. So my plan is to process the high grade ore quickly. My plan is to get as much cash as I can for processing the good ore. I may have a mining campaign that says I'm going to just extract as much ore as I can in the first few years. But I know, you know, maybe the first 20% that I actually mine, I'm not going to process immediately because it's low grade. So I'm going to dig through the top part, I'm going to stockpile it, and I'm then going to sell and process the better grade ore quickly. There's massive subjectivity. The more I capitalise into that low grade stockpiles, the more profitable I am in the early years. Or I may have materially misstated the accounts.

SPEAKER_00 23:20

But doesn't that impact the NRV of the low grade?

SPEAKER_01 23:24

The NRV is the low grade, but you've got to then it's all into mining estimates. So I've got the low grade, and now a lot of the complexities, I've got low grade, but my plan is to blend it. So my plan is at the moment I couldn't sell that low grade, I couldn't process it, but I can come up with key judgments that providing I've got enough high grade, and in some cases I might actually get the high grade from doing a deal with somebody else that might have a mine close to the mill. So you can actually either commercially or aggressively justify why the low-grade NRV works, but there's a great deal of subjectivity to low-grade ore.

SPEAKER_00 24:12

So definitely another complex area when you've got different types of inventory as well as byproducts.

SPEAKER_01 24:26

You know, we live in a world of inherent risk factors. Complex, subjective change, and subject to bias. Now, what your mining changes constantly, depending on where God put the ore body and what God put in the ore body, it is complex, these complex, it is subjective. Life of mine, blending it, it's subject to change, it's subject to commodity price. And there is the opportunity to be biased, over optimistic throughout these judgments.

SPEAKER_00 25:06

Developers, and as you've touched on when we talked about going concern, um, they require a lot of funding. And many funding arrangements are rarely as simple as straight debt or equity. Sometimes we we we do see straight equity, but we do see a lot of whole range of interesting funding arrangements. Can you share some that we commonly see?

SPEAKER_01 25:29

You've got classic. The the ideal TechSpot model is we raise so much on equity and then we just borrow vanilla bank debt to pay off over the life of the mine. In reality, I'm desperate for funding, I'm desperate for quick funding. So there's a lot of prepaid off takes. So the funding comes in and it's going to be settled by the developer selling gold, selling ore to the entity that's pre-funded it. And this has got a question of whether it's actually got embedded derivatives, whether it is deferred revenue, whether you're going to be able to satisfy the own use exemption. Are you going to be able to repay that the amount that you've been advanced by delivering or is there an obligation if you don't deliver it in time or the the your the commodity price falls, you're actually going to have to repay more cash? You've got situations where stream streaming arrangements are interesting, so you know technically there is no there are har hardly any silver mines in the world. Silver is typically a byproduct or a co-product of either a gold mine or a copper mine. So the major silver producers in the world, they have bought streams. They go to an ent to a gold mine and say, I will buy the rights to all of the silver in that mine. Or I'll buy the rights to 50% of the silver in that mine. It's complicated again, whether it's revenue, when you recognise revenue, whether it's a financial instrument, and as you know too often, a lot of these arrangements will involve convertible notes. Part of the higher risk uh financing its convertible notes, convertible into all sorts of interesting features of warrants, attaching warrants, most of which are not compound financial instruments. They do contain embedded derivatives, they do fail the fix-for-fixed. And you've got some very interesting accounting. You may have loans, there are big, big, particularly you know, the first angel loans, whereby they're loans, they're clearly loans, they've clearly got an interest payment on them, they've clearly got a repayment schedule, but the interest is linked to the profitability of the mine, a profitability of an area of interest, which in old-fashioned terms of IS39 have to get readjusted as an AG8 adjustment. So the better the mine does, the more revenue that you're predicting from the mine, the larger your liability that you need to measure remeasure at every reporting date. So the better the mine's doing, the larger your financial liability, and potentially you could you could create a loss because of the AG8 adjustment.

SPEAKER_00 28:49

Yeah, typically now sort of see with convertible nodes that people are better at identifying liabilities and not just automatically assume it's equity when um we have they have to issue equity. But like the things that I'm currently seeing is that people not accounting for that liability correctly, whether it's fair value through PL or treating that liability as a residual. So um, I mean, yeah, a lot of these, like as you said, like um a lot of these remeasurements of the liability would cause profit loss uh volatility. And although sometimes people consider them as non-cash, they do impact ratio. So it does has have a business impact in an indirect way.

SPEAKER_01 29:35

There are major miners I've seen where where it was just horrible. If they were having a good year, and in this case the the iron ore price was increasing, they actually made a loss because their liability increased. When the iron ore price was looking poor and the forecast future iron ore price had gone down, the liability would go down and they'd recognize a profit. And the accounting is the accounting, but even for this this miner, explaining this to investors, even the accounting's correct, explaining this yes, we've made a profit, but that's really because it's bad news because the iron ore price has fallen, is a difficult thing to explain in the director's report or in analysts' briefings.

SPEAKER_00 30:25

Now, Wayne, last question. Um, I know this is gonna be I'm I'm aware of the time, but from an auditor's perspective, what are some of the things that they should look out for? Now, um I know you'll have like a lot to share, and let's keep, but I'm just trying to keep it short, and you know, you we have um a course and a one and a half hour course that we we can go into detail.

SPEAKER_01 30:49

So some highlights again back to basics. When you move from exploration to developer, you are in inherent risk overload. You've gone from a very simple arrangement in an explorer, but you've now got complexity, you've got subjectivity, you've got change, and you've got the potential for bias. It is a scary world for auditors, and the overriding aspect that everybody should be aware of. Audits get into question when something has gone bust. So when we're looking at a developer, the key issue is what is the risk of us running out of cash? What is the risk that we will not produce as much cash as we need to finish the project to service debt? And for everybody, for the directors, for the auditors, understand things go wrong. You do not all the it's a great bankable feasibility study. It was done with absolute diligence, it was done by very competent people, but what's gonna happen when you start digging and processing the ore? So the auditors need to be on top of how's it going? Is the project on time? Are we getting the expected yields? Are there any engineering problems? And you know, this goes into going concern and it goes on to subsequent events. So is anything gone wrong? So I'm signing the accounts off on the 30th of September. What's how's it all gone on the project between 30th of June and the 30th of September? Any problems? Are we going to be on time? Those that's the key focus of an auditor as it's going into development. And yeah, there's a lot more detail in the course.

SPEAKER_00 32:50

Yeah. So today we've talked about, um, covered a bit uh relevant issues on miners and mind developers. So we've talked about going concern. Uh before that, we also talked about going from IFRS 6 to out of IFS 6 to IS36 and the impairment uh triggers that we need to assess. And then we talked about going concern, we talked about revenue, we talked about funding, we talked about embedded leases and inventory. So if you'd like to explore these issues further, Wayne will be presenting a webinar and icepring course on miners and mine developers. And if you're interested, please contact us for more details. Thanks again, and we'll see you in our next episode.

SPEAKER_01 33:39

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SPEAKER_00 33:50

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