Course:EOSC311/2020/Geology Knowledge for Accounting in Mining

Summary

Companies are responsible for keeping track of their own financial position through calculating and presenting their own financial statements. These statements will include information such as revenue, expenses, inventory, and debt. Although financial statements typically only present viewers with numbers corresponding to a particular account, there is a lot of work that goes into calculating each of these account values. Account values are investigated and re-calculated to determine accuracy through a third party known as an auditor. When doing work for a mining company, auditors are reliant the expertise of geologists in order to properly assess the value of certain accounts. Some examples of accounts that rely on geologist expertise include the following:

• Mineral Reserves and Resources
• Mining Assets
• Stripping Costs
• Inventory

In order to follow the proper accounting standards, auditors require help from geologists. Without the assistance of geologists, mining companies would be left with inaccurate financial statements. Intentionally misleading geologists and auditors is fraudulent and can result in heavy fines.

How Accounting and Geology Relate

Accuracy in financial reporting is pivotal for understanding the current financial situation of a company. Sadly, accurate accounting cannot simply be done by looking at a variety of receipts, there are many aspects of the business that require educated estimations and expert input in order to determine an accurate value of how the company is currently performing financially, and their estimated future performance. The usage of geology for accounting is important when working for a mining company as it impacts multiple account values, and ultimately the value of the company itself.

It is important for me to understand how geology is used in accounting for mining companies since beginning in September, part of my job will be to ensure mining companies are providing accurate financial statements. If I cannot identify the account values that are partially or completely reliant on geologist evaluations, then I will not be able to properly assess whether the mining company is presenting their financial information correctly.

Understanding the Work of an Auditor

In the most basic sense, an audit is the examination of a company's financial reports by a third party to ensure fairness and accuracy. Auditors need to gain an understanding of their clients before auditing begins to develop an appropriate strategy. The audit strategy will consist of directions, time required to gather evidence, and amount of evidence needed to correctly verify the various values assigned to different parts of the company. Part of an auditor's responsibility is looking through each account listed on their financial statements to ensure the value assigned to a particular account meets proper auditor criteria such as:

• Accuracy: transactions are recorded at the appropriate amount
• Completeness: all transactions that need to be recognized have been recognized
• Classification: transactions are allocated to the correct accounts
• Existence: assets and liabilities on the financial statements are real

Auditors will need to examine appropriate documentation relating to the account being assessed as well as the related accounting rules to ensure the account is evaluated accurately. They are also required to look at the accounting department of the mining company itself to determine if their work is being done correctly and if safety nets are in place to catch any accounting errors. An auditor's job is to assess the financial statements created by the mining company itself and provide an educated opinion based on the information they have been provided. Auditors are not calculating the perfect value for each account due to the unrealistic length of time it would take. Auditors are responsible for ensuring the financial statements are not materially misstated (accurate enough to not impact the decisions of those relying on the financial statements). The end of the audit will result in an audit report which will include an auditor's opinion, listing account values that could not be correctly verified or did not have the correct value. The mining company chooses whether to follow the advice of the auditor but failing to do so reflects poorly on the mining company.

Accounts Requiring Help from a Geologist

Mineral Resources and Reserves

Powder River Basin is one of the largest coal producing areas in the world.

Auditors are dependent on geologists and their professional assessment of mining outputs in order to determine various account values. One of the most important calculations is figuring out the value of the minerals yet to be extracted. These are classified as mineral resources and reserves. A mineral resource is a mineral deposit that has the potential to be mined. It is divided into 3 categories: Inferred, Indicated, and Measured. The categories are organized by degree of geological confidence. Inferred has the lowest degree of geological confidence and therefore cannot legally be given any financial value. A mineral reserve is the indicated or measured part of a mineral resource that can be economically mined. An auditor cannot individually determine whether a mineral reserve can be mined economically. Geologists are needed to assess the percentage of the desired minerals contained underground and their overall quality. Geologists are also needed to determine how much of the mineral can actually be extracted in order to ensure the value of the mineral reserve is not overstated. For example, take into consideration the Powder River Basin in Wyoming, United States. This region produces more coal than any other region in the US. However, 70% of the coal deposits in Powder River Basin are not included in the value of their mineral reserve due to being located at a depth that is not financially feasible. Geologists were able to determine the shape of the coal deposits, and in doing so were able reasonably predict the amount of coal that would be worth extracting from Powder River Basin. Auditors lack the geological knowledge to figure out the underground deposit shape and how much is accessible yet it is crucial for determining company value. It is clear that auditors rely on geologists when assigning value to mineral reserves.

Mining Assets

Geologists are also needed to help auditors properly assess the overall depreciation of some mining assets. Depreciation is when the recorded value of a long lasting asset decreases over time. When an area is being investigated for mineral extraction, there are costs incurred to explore and evaluate the amount, type and quality of the deposit underground. Costs associated with the exploration and evaluation of a mining area are considered to be a long-term mining asset. Because of this classification, costs associated with exploration and evaluation can be spread out throughout the production life of the mine, regardless of when they actually occurred. If costs for exploration and evaluation occurred in the first year of operation and are all included in the first year's financial statements (instead of being spread out for the entire life of the mine), the company will appear to have a first year that is significantly worse than reality. For that reason, geologists are needed to assess the total production a particular mining site will be able to extract throughout the life of the mine and how long it will take. The longer a mining site can be in production, the less exploration and evaluation depreciation costs that will be on their annual financial statements since they are more spread out. With a proper understanding of a mining site's capacity, an auditor can assess the appropriate distribution of exploration and evaluation expenditures. This total production value is always changing. Geologists are constantly on the look out for technological advancements or other areas around the mine that have the potential to increase the total production of a site. Technological innovations such as automation and the usage of artificial intelligence has allowed mining sites to increase the projected production, meaning their exploration and evaluation expenditures need to constantly be changed based on the assessment of the geologists.

Stripping Costs

When extracting minerals from a mining site, there is always overlaying rock and other unwanted materials in the way of extracting the desired minerals. The expenses associated with removing unwanted materials in order to access the desired mineral deposit is known as stripping costs. Stripping costs, similar to mining assets, have their total cost divided up and spread out over the life of the mine regardless of when the actual expenses for stripping occurred. Geologist input is required to verify that the costs to remove unwanted waste did in fact increase the accessibility of the mineral deposit so that the expenses can be spread out over the life of the mine. If a geologist can prove that the stripping costs will most likely provide economic benefit to the mining company, it will also increase the value of their mineral reserve due to higher mineral accessibility. Once again, an auditor lacks the knowledge to assess how much of a particular mineral a mine can extract, so they are dependent on geologists to perform chemical and physical tests on soil and rock to determine the size and concentration of the mineral deposits, as well as how much can now be mined economically when unwanted materials are removed. Copper Mountain Mining Corporation has become more reliant on stripping costs in order to accommodate an increase in production. They were able see an increase in copper production in part due to spending a large sum of money on stripping costs in 2019. The value of the mine increased significantly because geologists were able to verify that the stripping costs did in fact allow for more minerals to be extracted from their sites annually. The stripping costs were able to be spread out over a longer period of time, classifying them as 'Deferred Stripping' and reflecting a more positive financial position.

Inventory

Chalcopyrite is a mineral containing copper. The copper inside needs to be at a significantly higher concentration before it can be used for electronics.

When mineral extraction is taking place, a mine will temporarily hold onto the extracted minerals in anticipation of a customer purchase. While the goods are waiting to be sold, they are classified as inventory. What exactly is included as inventory for a mine is complicated since minerals typically go through a long process before they are ready to be sold. After copper ore is taken from the ground, it requires ore mineral concentration and chemical treatment before the copper is ready to be sold. Mining companies must include all run-of-mine ore, work-in-progress and finished goods. Run-of-mine ore is included in inventory as soon as it has been extracted and a reasonable assessment of value can be made. Work-in-progress inventory value includes all minerals that are undergoing smelting, refining, or any other process to reach the desired ore concentration. The finished goods value is all minerals that are ready to be sold. Geologists are required since costs directly associated with extracting the desired mineral will be included in the value of inventory. A geologist must recognize when the desired mineral is being extracted since costs before this moment are considered stripping costs, while costs associated with extracting the desired mineral will be the value of their inventory itself. Proper calculation of inventory value determines whether the process of turning an extracted ore into the desired end product is cheap enough to be profitable.

Consequences of Improper Procedure

Unfortunately, not all mining companies follow the expertise of geologists when assessing mine value and making their financial statements. There have been numerous incidences of mining companies intentionally misleading geologists and lying to shareholders. The consequences of doing so being extremely damaging to the company itself.

Bre-X Gold Mine

This Canadian mine claimed to have gold reserves of 200 million ounces in 1997. Their market value was around $4.4 billion. Unfortunately, the project manager Michael de Guzman tricked geologists by putting shavings of his wedding ring into the mined ore from the ground. He also paid gold panners to from 1994-1997 to add gold flakes to the mined ore in order to continue to mislead shareholders into believing the site was rich with gold. Indonesian and American mining companies realized the fraud when they were unable to find any of the promised gold at the supposed 200 million ounce location. Bre-X faced a high number of lawsuits and ultimately went bankrupt. Because geologists were mislead, the value of Bre-X determined by auditors was extremely inaccurate. Auditors rely heavily on the expertise of geologists to determine company value. When the geologists are mislead, it is impossible to accurately assess the financial position of the company. This is why Michael de Guzman was able to get away with lying about mine value for years.

Rio Tinto

As one of the largest mining companies in the world, Rio Tinto has faced controversy with failure to disclose the proper value of a coal mine in Mozambique. Purchased for $3.7 billion in 2011, the mine was later sold for just $50 million in 2014. After the initial purchase in 2011, over the next year while mining operations began, the company was able to raise billions of dollars from shareholders as they constantly praised the mining site as one of the greatest undeveloped coal mining areas in the world. Unfortunately, Rio Tinto was restricted in how they were allowed to transport the extracted coal and the quality of the coal extracted was lower than expected. Rio Tinto bosses mislead investors and their own board for almost 2 years in hopes of covering up the major losses from the Mozambique purchase. Rio Tinto ended up paying a fine of $36 million for intentionally reporting inaccurate financial information. There is limited information on how Rio Tinto was able to misstate the value of their mining assets but if qualified geologists were allowed to properly assess the coal deposit, in cooperation with auditors, the value of the Mozambique mine would have been correctly stated much earlier and the fine could have easily been avoided.

Conclusion

Auditors cannot solely rely on receipts and cash on hand to accurately assess the financial position of a mining company. Because auditors lack the knowledge to correctly determine when the desired mineral is being extracted and the sort of quality that is being excavated from the ground, they require the expertise of geologists. Geologists provide information to help auditors assess the value of mineral resources and reserves, mining assets, stripping costs, inventory, and other aspects of financial statements. When geologists are mislead or lied to, auditors cannot properly determine the value of a particular mining site. This causes the financial statements to be materially misstated, leading to hefty fines or even bankruptcy. Having geologists and auditors work together with complete, accurate information ensures the financial statements of a mining company reflects their true value.

References

This Earth Science resource was created by Course:EOSC311.