Variable Mining Costs – How Should They Be Treated?
12 May, 2023
Jessica Feola, HJ Ustler
Canada
Variable expenses: one would consider this to be one of the easier aspects in the analysis of a mining claim; however, that is far from the truth. When it comes to mining losses, the determination of which costs are considered variable and which are fixed may not always be as straightforward as it would appear, leading to differences of opinions and discussions with the insured’s representatives.
In order to determine which costs are variable, one needs to understand normal operations and the processes in place. A fundamental step in any loss situation is to examine the detailed operating statements (monthly or annual) along with any detailed monthly management reports and inquire as to how costs have been impacted as a result of an incident.
Typical mining expenses include drilling, blasting, stoping, loading/mucking, hoisting, hauling, backfilling, consumables, and support equipment.
Should operations cease at the mine itself, it is typically easy to determine which costs ceased as a result of an incident and therefore, are to be considered as variable.
However, what happens if an incident is downstream at the mill and mining continues? In this situation, mining continues and all mining costs continue to be incurred – therefore, how or why should they be considered variable? This is a typical issue that arises which needs to be explored in detail with all parties.
Mining costs, specifically those costs which are considered variable, are often times inventoriable costs, which means that they are not expensed in the period in which they are incurred when the ore is mined, rather they are recorded as an asset and expensed at a later date when the ore is processed and sold as a finished product. This often leads to many discussions until a resolution is reached and the insured comes to terms that the costs are to be considered variable.
In a claim scenario, if mining costs were not considered as variable, then the insured would either be indemnified for a cost that was not incurred (assuming no ore was processed) or indemnified for a cost that would later be recovered (at the time of sale, assuming that the ore was processed).
In addition to the costs mentioned above, most of the time there is an issue as to how mining labour is to be treated – did labour cease post-incident or did labour continue? If labour ceased following an incident, labour would be treated as a variable cost. Should mining labour continue to be incurred, we need to understand why it continued and what work was being performed. If mining operations continued, then this direct labour would likely be inventoried and therefore, should be considered variable as it is fully utilized and will be recoverable at a later date when the ore is processed and sold. If upon analysis of the labour costs incurred it is determined that labour costs were related to repair or remediation work, then labour may still be considered variable in the business interruption loss however, this labour can potentially be considered in other areas of coverage (i.e., property damage / extra expense) if applicable.
In addition to mining costs, there are variable processing costs and general administrative and overhead costs, including royalties. The determination of variable costs in these categories is typically less contentious after assessing and discussing with the insured. However, there is an item which can sometimes become contentious: depreciation, depletion, and amortization (or DDA).
In very general terms, depreciation typically relates to the expensing of tangible assets (such as different types of equipment, crushers, mills, etc.), depletion typically relates to capitalized mine preparation costs and amortization typically relates to intangible assets such as goodwill, licenses, mineral rights etc. DDA can generally have both fixed and variable components, based on the capitalized costs being expensed and their nature.
Thus, while mining DDA costs almost always include a variable cost component that should be considered in any loss measurement, the analysis of DDA costs requires consideration of the nature of both the activity and the costs involved. This analysis will be very site- and situation-specific and will require discussion with site personnel to resolve this somewhat subjective allocation.
Like many business interruption issues, there is no one answer that “fits all”. In order for the parties to come to an understanding, an initial conversation regarding costs and their nature should take place at the onset of a loss. As the claim progresses, detailed discussions and analysis of appropriate documentation are required. Obtaining an understanding of the insured’s operation and costing structure at the onset of a loss will greatly assist in the loss calculation and hopefully avoid any issues later.
The statements or comments contained within this article are based on the author’s own knowledge and experience and do not necessarily represent those of the firm, other partners, our clients, or other business partners.
Jessica Feola
CPA, CFE, CGMA, Senior Manager
- +1 954.772.5198
- jfeola@mdd.com
- Miami - Ft Lauderdale (Latin America Operations), LATAM
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