The value relevance of exploration and evaluation expenditures

Abstract

Purpose -This paper aims to investigate the value relevance of the various components of exploration and evaluation expenditures in the Australian extractives industry. Whether exploration and evaluation expenditures is more value relevant, following the adoption of AASB 6, and whether it differs for firms engaged only in exploration when compared to those also engaged in mining production is also examined. Design/methodology/approach -This paper uses a modified Ohlson model as a benchmark against which to compare an alternative valuation model featuring the disclosed components of exploration and evaluation expenditures. A sample comprising 430 firm-year observations between 2003 and 2009 is utilised. Findings -Written-off exploration and evaluation expenditures and the number of projects in which firms are involved is relevant to investors when assessing the value of extractive firms. Further, the implementation of AASB 6 has led to an improvement in the relevance of exploration and evaluation information in assessing firm value.Research limitations/implications -The sample is based on observations from the years 2003-2004 to the years 2006-2009. The authors do not incorporate 2005, as this is the first year the new standard was implemented, and there is the possibility of a settling in effect. The authors base our sample on the top 100 extractive firms in 2009. As such, these companies may not represent the accounting practices of smaller firms in the Australian extractive industry. Originality/value -The authors address a gap in the literature by examining the value relevance of the detailed line items of exploration and evaluation expenditure reported by extractives firms. The authors also explore the effect of regulatory changes by examining the value relevance of exploration and evaluation expenditures pre-and post-International Financial Reporting Standards (IFRS) 6/Australian Accounting Standards Board (AASB) 6 implementation. Finally, the authors contribute useful findings to the standard setters' ongoing deliberations aimed at producing a comprehensive standard on extractive activities by providing useful feedback on the relevance of accounting for pre-production costs under a regime using the "area of interest" method.

The Capitalisation of Intangibles Debate: Accounting for Exploration and Evaluation Expenditure in Extractive Activities

“…Interestingly, the findings by Zhou et al (2015) and Berry and Wright (2001) and in particular Power et al (2017) and Bryant (2003) reflect the comments by capital markets users in a 2018 EFRAG meeting. They indicated that users cope with the diversity of accounting policies followed by having some analysts who focus solely on oil and gas and not on other extractive industries.…”

Factors Affecting the Value-Relevance of Capitalized Exploration and Evaluation Expenditures Under IFRS 6

“…Harris and Ohlson (1987) report value-relevance coefficients of roughly 3.6 for SE and 1.25 for FC. 11 In a related small sample study, Zhou et al (2015) examine Australian mining firms applying the Area of Interest (AoI) method and report statistically insignificant coefficients of roughly 2.35 for mineral producers and 20.1 for explorers. Examining Australian loss-making mining firms, Wu et al (2010) report a statistically significant value-relevance coefficient of roughly 0.94, whereas Zhou et al (2015) report 1.67.…”

“…11 In a related small sample study, Zhou et al (2015) examine Australian mining firms applying the Area of Interest (AoI) method and report statistically insignificant coefficients of roughly 2.35 for mineral producers and 20.1 for explorers. Examining Australian loss-making mining firms, Wu et al (2010) report a statistically significant value-relevance coefficient of roughly 0.94, whereas Zhou et al (2015) report 1.67. The value-relevance coefficients for E&EE reflect the market value of the ongoing projects divided by the book value under the corresponding accounting method, as well as the addition of the time-value-adjusted marginal tax rate (because the capitalized expenditure will eventually be expensed and claimed as a tax credit, regardless of success; Magliolo, 1986).…”

“…In this case, investors will ignore the E&EE asset and only value development and productionstage asset values (which follow the usual standards on asset measurement and impairment). 13 Prior Australian research demonstrates that investors do value E&EE assets recorded under IFRS 6 (Wu et al, 2010;Zhou et al, 2015), but has not considered the role of supplementary information. Similar to prior literature on research-stage and marketing expenditures (e.g., Hand, 2003), our evidence suggests that investors value expenditures even when the likelihood of recovering future economic benefits is uncertain.…”

“….3. In prior research,Wu et al (2010) andZhou et al (2015) examine the value-relevance of Australian mining firms' financial disclosure (including capitalized E&EE), but they do not examine supplementary disclosure (such as resource estimates).…”