While commonly used quantitative measures or financial ratios serve as a good benchmark for investing in businesses, one should also be aware of the underlying assumptions used to draft such numbers. These benchmarks may sometimes paint a completely different picture under different norms. This may not only affect the accrual based numbers but also cash flows and lead one to erroneously see a business as being way better in terms of profitability and/or creditworthiness than it is. Read More @ http://multi-act.com/mining-magic-of-full-cost-accounting/ Website - http://multi-act.com/ Contact Us - http://multi-act.com/contact

1. Published in July 2014

2. • While commonly used quantitative measures or financial ratios serve
as a good benchmark for investing in businesses, one should also be
aware of the underlying assumptions used to draft such numbers.
• These benchmarks may sometimes paint a completely different
picture under different norms.
• This may not only affect the accrual based numbers but also cash
flows and lead one to erroneously see a business as being way better
in terms of profitability and/or creditworthiness than it is.

3. In case of mining or resource
exploration companies, the full cost
accounting method may be followed
by a company.

4. All costs incurred in
property acquisition,
drilling, exploration
& completion are
capitalized.
This is aggressive
compared to the
successful effort
method which
capitalizes the cost
incurred on
successful property
exploration.
When some resource
company is engaged
in exploration of
more properties, this
method may show
profits, improve
interest cover and
net worth, while
lowering D/E

5. Follows full cost accounting
Company’s debt was c. USD
13bn as of 2012 & 2013,
which was USD cash-paying
with fixed coupons ranging 5%
to 7% on most bond issues.
Then how can only USD 227m
hit the income statement in
2013 (and USD 77m in 2012)
Adjusted interest cover is PBT adjusted for extraordinary costs
minus capitalized cost plus interest capitalized divided by
interest including capitalized interest.
Note: The mention of the above company serves as an example of ‘Mining Magic of Full Cost Accounting’. This does not indicate any
investment proposition in the company.

6. Source: Chesapeake 10K 2013

7. Source: Chesapeake 10K 2013

8. Operating cash flow appears high due to the classification of unsuccessful exploration cost in the
capex category.
Interest paid out goes mostly under the investing section as being capitalized than flowing
through operating cash flows fully.
Had the company not been able to swap acreages to generate cash, it would have to borrow
more to develop existing properties.

9. • The net worth could have been lower
and Debt/Equity higher had the
company been expensing
unsuccessful exploration costs
instead of routing it as an unproved
property asset item.
• Note that cost capitalized on account
of unproved reserves is not
amortized until properties are
evaluated.
Source: Chesapeake 10K 2013

10. • Reserves estimate
• Proven reserves get affected by price movements in the underlying
commodity.
• In case of a ceiling test, depending on the company cost structure, if
commodity prices decline materially, some portion of estimated
reserves may be found to have become uneconomical.
• Capex cycle
• When the price of a commodity is rising steeply with an
acceleration in profit margins, money may become easily available.
• Wherein, most players will expand not only with retained earnings
or equity dilution but also with debt.
• When the cycle turns, this bloated cost structure may bite back.

11. Note: The mention of the above company serves as an example of ‘Mining Magic of Full Cost Accounting’. This does not indicate any
investment proposition in the company.

12. Generated goodwill of $3.5
billion by acquiring Equinox
Faced impairments as
recoverable gold selling price
lowers
Sometimes write offs and
impairments are indicative of lax
accounting standards and poor
capital allocation practices.
Such impairments are followed
by equity dilution.

13. • Some mining companies have nearly all tangible book value
equal to unproved reserve cost capitalized. They are
swapping acreage to generate profit as optimism for the
shale boom continues.
• Hence, this is the result of accounting wizardry and should
not necessarily be used as an indicator of the health of a
company.

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Multi-Act Equity Consultancy Private Limited - SEBI Registered Portfolio Manager having Registration No. INP000002965
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