Auditing Mining Industry

Overview:

The mining industry sector is a major backbone of the Philippine economy. The long
history of the industry has been much affected by the vicissitudes of the international market, as
well as other domestic factors. With the adoption of the 1986 Constitution, the concept of
awarding mineral rights has been drastically changed from leasehold to a system of contracts
for various modes of production. Such changes have, as expected, temporarily unsettled the
industry. The preponderance of small-scale mining, the growing public awareness on the
environment, increasing labor and energy costs are concerns which should be addressed.
Amidst all these, and in the framework of very stiff competition in the region for investments,
new thrusts and directions, without compromising general stability, are urgently required for the
overall development not only of the industry but for the whole country.

The Philippines is the fifth most mineral-rich country in the world for gold, nickel, copper,
and chromite. It is home to the largest copper-gold deposit in the world. The Mines and
Geosciences Bureau (MGB) has estimated that the country has an estimated $840 billion worth
of untapped mineral wealth, as of 2012.About 30 million hectares of land areas in the
Philippines is deemed as possible areas for metallic minerals. According to the Mines and
Geosciences Bureau (MGB), about nine million hectares of land areas is identified as having
high mineral potential. The Philippines metal deposit is estimated at 21.5 billion metric tons and
non-metallic minerals are at 19.3 billion metric tons, as of 2012.

Module Objectives:
• Know the nature and background of the particular specialized industry;
• Learn the overview, statistics, and updates of the specialized industry in the Philippine
setting;
• Identify the different audit considerations and trends for the industry.
Nature and Background of Specialized Industry

A country’s socio-economic development largely depends on theextentand composition

ofitsnaturalresources.Examplesof natural resources include forestry, minerals, andcommercial
sources of energy (like coal, oil, natural gas, and hydro power).
Miningandmineralprocessingareactivitiesforextractionandprocessing minerals for commercial
use. The mining sector is likely to contribute to the development of the economyof
anycountrythroughtaxesfromlarge-scaleminingcompanies and contribute to social–
economic infrastructuraldevelopment within the area where the mine is located. The mining
sector can:
• create employment opportunities both directly in the mines and indirectly
on services to the mines,
• provideeducationandhealth services,
• increaseforeignexchangereserves,
(reducingacountry’s foreign exchangedeficit),
• improveinfrastructure likeroadsand watersupply, and
• create other economicactivitiesto supportthemines instead of importing all
supplies from abroad.

A working definition of mining according to the United Nations Environmental Program

(UNEP) could simply be“the extractionofminerals fromtheearth”.Theword“minerals” in this
case would cover a wide variety of naturally
occurringsubstancesextractedforhumanuse.Althoughthisdefinition is adequate for our purposes,
mining can also be seen asaprocessthatbeginswiththeexplorationanddiscoveryofmineral
depositsandcontinuesthroughore extractionandprocessing to the closure and remediation of
worked-out sites.

Minerals are a non-renewable resource, so mining represents a temporary use of the

land. The mining life cycle during this temporary use of thelandcan bedivided into the
followingstages:exploration,development,extraction,processing,andmineclosure.Inthissection,we
explain thevariousphasesof mining,theassociatedimpactineachphase,and
thesuggestedmitigationoramelioration measures. The figure below sets out the five
physical stages of the life cycle of a mine.
 Figure
Life cycle of

Project
Exploration Mining and milling
development

Abandoned mine / Smelting and refi-

Mine closure
rehabilitation ning (benefication)

The exploration phase of mining

Explorationactivitiesencompassall actions in the fieldthat
precedefeasibilitystudies.Explorationactivitiesinclude initialreconnaissance flights and
geophysical surveys, stream sediment studies and other geochemical surveys, construction of
access roads, clearing of test drilling sites, installation of drill pads and drilling rigs, benching,
trenching/pitting, erection of temporary accommodation,andpowergeneration forexploratory
drilling. Explorationactivitiesalsoincludedeterminingthelocation,size,shape, position, and
value of a body of ore using prospecting methods.

The development phase of mining

The development of a mine consists of several principal activities: conducting afeasibility
study, including a financial analysis to decide whether to abandon or develop theproperty;
designing the mine; acquiring mining rights; filing an Environmental ImpactAssessment (EIA);
and preparing the site for production. The development phase may include such activities as
• overburdenstripping andplacing,
• road/trail,buildingand/orhelicoptertransport,
• drilling andtrenching,
• erectingtreatmentplants,preparing disposalareas,andconstructing
services,infrastructure such as power line or generating plants, railways, water, supplies and
sewerage, laboratories and amenities.
Overview, Updates, Statistics of the Specialized Industry in the Philippines

The extractive sector in the Philippines makes a relatively small contribution to the
national economy. The latest disclosure (2018 EITI Report) shows the mining sector contributes
the most in the sector with 0.89% to GDP and 5.99% to total exports. However, there is
considerable anti-mining
mining sentiment in the country especially at subnational levels where
environmental impact and displacement of indigenous peoples caused by mining operations
have been the focus of much debate. Small
Small-scale
scale mining is also contentious, due to poor
regulations and overlapping policies between central and local government.

The Philippines is a leading producer of mineral commodities such as nickel, gold and
copper. While mineral production volume increased slightly in 2018, production has gradually
decreased since 2015 -2017.
2017. Nevertheless, the country is only behind Indonesia
esia as the world's
leading producer of nickel. Other commodities being produced in the Philippines include
chromite, zinc, iron, silver, crude oil and natural gas. While the mineral sector slightly picked up
in 2018, coal saw a slight dip in production co
compared to its 2017 value. Domestic oil production
follows a similar trend as coal - declined from 3 million barrels of oil in 2014 to only 1.1 million
barrels in 2018. Exploration activities in mining are spread nationwide, while coal production is
focused
d in the province of Antique. Oil and gas exploration is focused offshore.

The Philippines is one of the most highly mineralized countries in the world with vast
reserves of gold, silver, copper, nickel, and chromite. In 2018, the Philippines accounted for
6.4% of the world’s total estimated reserves of nickel.
 The main taxes levied on the mining sector are corporate income tax, excise tax on
minerals and royalties on mineral reservations, while the major oil and gas levies are the
government’s share in oil and gas revenues, corporate income tax and withholding tax on profit
remittance to principal.

The Bureau of Internal Revenue (BIR) is the main body responsible for collecting taxes
paid to central government, while the Mines and Geosciences Bureau of the Department of
Environment and Natural Resources and the Department of Energy collect sector levies for
mining and coal, oil, and gas respectively. Local government units (LGUs) are responsible for
collecting subnational payments.

Oil and gas service contracts (PSCs) are awarded through competitive public bidding,
while mining permits are awarded through direct negotiation. Several moratoriums on the
issuance of mining licenses implemented in previous years from 2012 to 2017 have affected the
number of mining projects in the country.

As of February 2021, there were 309 Mineral Production Sharing Agreements, 5

Financial or Technical Assistance Agreements and 13 existing Exploration Permits for the
mining sector.

Beneficial Ownership (BO) disclosure and Politically Exposed Persons (PEP) reporting
in the Philippines has been a significant aspect of transparency in the Philippines. The multi-
stakeholder group identifies tax evasion, money laundering, and compliance with the
Constitutional provisions on the nationality of mining companies as the national issues that their
work on beneficial ownership aims to address. It faces constraints, however, in terms of data
privacy restrictions.

The Philippines EITI previously published a Beneficial Ownership (BO) roadmap on 15

December 2016. Several milestones of the Roadmap have been accomplished by the beginning
of 2021, including the integration of BO in the mainstreaming efforts of PH-EITI, the increased
coordination with the SEC and the pilot disclosure of BO information. According to the 2018 EITI
Report published in December 2020, 41 out of 65 covered companies/projects fully or partially
disclosed beneficial ownership information. A total of 128 name entries were declared as
beneficial owners.
 Securities Exchange Commission (SEC) Memorandum Circular (MC) No. 15 (issued in
July 2019) enhanced the BO Declaration form. The revised General Information Sheet (GIS)
under MC No. 15 mandates corporations to fill out a beneficial information declaration form that
asks for nine categories of beneficial owners and their information, including complete name,
residential address, nationality, tax identification number, and percentage of ownership or voting
rights.While there is currently no public register of beneficial owners, work has begun to ensure
that BO information, contracts and extractives information is integrated into one publicly-
available portal.

Audit Considerations

Key Financial Concepts in the Mining Industry(see PFRS 6 Exploration and Evaluation of
Mineral Resources for more information)
• Revenue: Ore (tons) x Grade (g/t) x Recovery x Payability x Metal Price
• Royalties: Properties often have royalties on them (e.g., 2% Net Smelter Return)
• Operating costs: Per ton basis (e.g., $2.50/ton for mining)
• Capital costs: Includes initial capital (construction of mine) and sustaining capital
(ongoing equipment, etc.)
• Reclamation costs: Takes place at the end of a mine’s life; accrued for accounting
purposes but not accrued in a cash flow model.
• Depreciation: A percentage of production bases over the entire life of the mine
• Taxes: Can often be complicated with mining companies operating in several countries;
mining specific taxes and royalty agreements need to be considered
• Changes in working capital: Changes in accounts receivable, inventory, and accounts
payable should be factored into a cash flow model.

Challenges in Mining Industry in the Philippines

• Responsible Mining under Philippine Mining Act
• Circumvention of Permits
• Interfacing with LGUs
• Delays in the declaration of Indigenous Peoples (institutional issues with National Center
for IPs)
 • Impact of COVID-19 pandemic

High-Level Questions About Revenues from the Extraction of Minerals

• Are the revenues from the extraction of minerals significant? (Each source of revenue
should be assessed individually, and their importance should also be assessed in the
aggregate. While large revenues can be significant on their own, some smaller sources
of revenues may also be significant because of their function. For example, leases,
 licenses, and permits may be important because they enable departments to know who
should be paying royalties and fees.)
• Is there a significant difference between predicted and actual revenues? If so, what is
the explanation for this difference?
• Are there any new revenue sources? (For example, is there a new resource with its own
royalty system, such as a recently developed diamond mining industry?)
• Has new relevant legislation or regulation been introduced or have significant changes
been made to existing legislation and regulation recently?
• When was the last review of the revenue framework conducted? When is the next one
planned?
• Where significant changes in revenues are observed, are they in line with current market
conditions and production levels?
• Has the revenue framework (and supporting regulations) been criticized for being overly
complex or unclear? Is there significant public interest in the topic?
• Have there been any public complaints or reporting of any inappropriate practices in the
sector (transfer mispricing, for example)?
• Have annual financial audits identified significant or chronic issues with regard to the
collection of revenues from the extraction of minerals?
• Is there a regulated royalty audit regime in place? If so, is there 100-percent audit
coverage or risk-based coverage? Are audits completed on a timely basis? In addition,
have internal audits of revenue collection processes been conducted?
• Is there significant reliance on self-reporting of production level?
• Does the government have sufficient expertise to verify information reported by the
private sector?
• Have previous performance audits of mining revenues been conducted by the audit
office? Has progress been made by the government to address prior recommendations?
• Is there segregation of duties between the collection of revenues and the assessment of
the completeness of revenues received?
• Has the government clearly established the objective it is pursuing through its revenue
framework for the mining sector?
• Is there legislation or regulation in place to ensure the public has access to reliable
information on the payments the government receives from mining companies?
High-Level Questions About Financial Assurances for Site Remediation

• Is there a regulated system of financial assurances for site remediation in place? Is the
system recent or well-established? Has a remediation fund been established?
• What is the current cost estimate (potential liability) for rehabilitating all mining sites in
the jurisdiction?
• What is the state or risk of unfunded liability in the jurisdiction? Is the risk increasing over
time?
• If there is a remediation fund, what is the current balance of this fund?
• Have there been any recent or looming changes in environmental standards or
legislation that are expected to affect required securities?
• Does the duration of the securities match the expected duration of the expected liability?
• Is there documented guidance on how to estimate remediation costs?
• Are remediation cost estimates periodically reviewed by the government or an
independent expert?
• If regulations allow for self-insurance, what is the relative frequency of self-insurance by
mining companies in the jurisdiction?
• Are there mechanisms for regular monitoring of sites and monitoring of associated
securities? Are these mechanisms implemented? What is the frequency of site visits?
• Are the licensing and inspection functions segregated?
• Is there a process to ensure that financial assurances are released only when
compliance with site remediation requirements is achieved and documented?
• Are site inspections providing sufficiently complete assessments? (For example, can
inspections identify underground contamination?)
• Are there sufficient penalties in place to encourage compliance with financial assurance
requirements?

Assessments:
1. State the nature and background of the specialized industry.
2. What are the relevant statistics, and updates of the specialized industry in the Philippine
setting?
3. Identify the different audit and accounting considerations and trends for the industry.
4. Look for at least 2-3 audited financial statements of companies under the specialized
industry in the Philippines and list down your observations from audit report to the financial
statements.