These companies own unproved mining claims – land that may or may not contain valuable natural resources. Most of these companies have three things in common – they have no revenue, a large source of share capital and an amount for deferred development charges. They don’t have any revenue because they aren’t selling anything and share capital is huge because they need money to finance all the testing. Deferred development costs are all the expenses that have been incurred to test for the existence of natural resources.
You’re able to capitalize them – thanks to accounting guideline 11 – as it’s assumed the mines will provide a benefit in the future in the form of “ice” for Lil’ John’s pimp cup or “bling” for rappers like 50 Cent and T-pain. However, all these capitalized deferred charges are subject to an impairment test every year to make sure companies aren’t keeping worthless assets on their balance sheet. Essentially companies estimate the undiscounted future cash flows that will be generated by the mines, if this amount is less than what’s been recorded as a deferred development cost the company will have to write the balance down.
Alright, so here’s my problem. I need assurance over the balance for “deferred development costs.” The primary assertions to be tested are existence, rights/obligations and valuation. This is important. Whenever you are auditing an account balance you’ll be looking at some combination of completeness, rights/obligation, existence and valuation. This is a good “go-to” if you’re ever wondering why you’re auditing something. If you’re looking at the transactions that make up a balance you’ll be testing some combination of occurrence, classification, accuracy, cut-off and completeness. Yes I realize some overlap, but that’s ok, they aren’t mutually exclusive.
There are two types of ownerships when it comes to mining claims – patented and unpatented. The former is land that’s owned outright by someone. You see, back in the day you could just up and by land. Now, most of the land is owned by the government. And that gives rise to unpatented claims, which is a form of ownership that allows company’s to lease the land from the government for 10-21 year periods.
If you have a patented claim you’re know as a freeholder. It’s just business jargon for someone who holds the land “free of encumbrances.” Meaning, you don’t have to deal with payments to other random people. As long as you pay your property taxes every year you’re good to go. If you skip these payments for two years the government can actually repossess your land (thank-you section 197.1 of the Mining Act, you were so easy to find).
Since you own the land, that implies the existence of some legal document that can prove this, which would help me prove existence as well as rights. From there I’d be able to prepare a continuity schedule starting with the initial acquisition price of the land. I could then vouch all the significant future payments above my diminimus value (sometimes you set a range for materiality like 5,000 – 25,000) to their corresponding invoices and then apply the criteria in accounting guideline 11 to test if they should be capitalized. That would be alright. Unfortunately, it’s extremely rare to find patented claims since the government started acquiring mining properties over 100 years ago. Lame.
This is what I’m dealing with. Most companies will have to acquire land that’s already owned by the government. But a company can’t go straight to the government and ask for a lease. A company can only lease a mining claim after they’ve spent a certain sum of money by a specific date. That sums is based on the units contained in a claim – a company has to spend $400/unit. Therefore, if Company A buys a mining claim with 10 units who’s development costs must be paid within 3 years, then Company A will have 3 years to incur $4,000 in development costs. After that they can apply for a 21 or 10 year lease.
Fortunately, the Ministry of Northern Development and Mines (yes, I’m not making that up this ministry does exist) has a listing of all the companies that lease various claims. On the surface it sounds awesome. I even went to the site to check out these schedules and they’re really good. There are two huge problems though. First, there’s no deadline for filling mining expenditures. So the ministry’s website may not be up to date. It’s very possible that there’s a time lag between what our client has reported as deferred costs and what’s reflected on the ministry’s website.
The second problem is much bigger – the ministry allows companies to sublease claims. For instance, if Company A has entered into a 21 year lease with the government, they can turn around and lease their mine to Company B. This screws everything up because the website won’t list Company B as the leaseholder – the Ministry of Northern Development and Mines does not track subleases. In this situation I’m going to need legal agreements with companies “A” and “B.” And I’ll also have to check for the Ministry’s authorization, which is required when companies create sublease agreements.
I’m meeting with the CFO tomorrow and I’m hoping he’s made some awesome continuity schedule that ties into both the balance sheet and the ministry’s website. That would be awesome.