Understanding Financial Statements of Mining

Companies
Part 1: Introduction - Statement of Financial
Position
Introduction - Companies, Reporting and
Regulators
You will cover the following points in Part 1: Introduction—Statement of Financial Position.

 an introduction to limited liability, financial reporting and regulators

 financial and accounting terminology

 the Statement of Financial Position

 cost and current value accounting

 assets, liabilities and equity

Introduction

Why do we want to read financial reports of any company? One of the answers may be to decide
whether a particular company is a good investment for oneself or for other entities one is associated
with such as lenders, suppliers and even customers. In that case, what sort of questions do we have?
Here is a set we can contemplate.

 What is the company worth?

 How much is it earning?

 Does it have a sufficient cash flow to carry out its aims?

 How is the ownership structured among various existing and potential shareholders?

 What events have taken place recently that will affect the company?
We look briefly at these questions, and then address each in more detail in the sessions that follow. For
the curious, there may be two preliminary questions worth addressing.

1. Why is business usually conducted by companies (rather than sole proprietorships or partnerships)?

2. Who decides how and when companies report?

Clearing up these two initial queries gives us some necessary background.

The Limited Company

In today's world, most economic activity is conducted by entities set up as companies. A company is
incorporated (brought into existence) under the laws of its home country. A company is said to have
limited liability (or just be "limited") because the legal and fiscal responsibility of any one owner of a
share is limited to the amount that the owner has invested. That feature has allowed thousands of
companies to attract investment of millions of dollars, pounds or Euros from a huge number of
investors. In contrast, a rich person could invest, say, $1,000 in a partnership that eventually went
bankrupt, whereupon a creditor of the partnership could sue the investor for whatever the investor was
worth—an unlimited amount and far more than the initial investment. It happens that companies can
(and must) use the terminology "limited" (or "ltd."), or "incorporated," or similar authorised wording to
legitimately warn potential creditors of the company that it has this feature of limited liability.

Generally, the laws governing companies make a distinction between companies that are privately
owned and those that are said to be "public," in which ownership is open to any member of the public at
large. In the mining world, there are both private and public companies involved in searching for and
developing mineral properties.

A public company tends to be regarded as more accountable (than a private company) to its
shareholders in a variety of ways. The actions of the public company need to be reported to the
shareholders (owners) who, by and large, are quite removed from day to day management. Financial
reporting is one of the main requirements imposed on a company by the laws of the country in which
the company is set up, and often the country in which it operates. Other legal impositions include labour
laws, environmental laws, etc. Here we are concerned just with financial reporting.

Example

Goldcorp Inc. is a major gold producer (2012 Revenues of $5.4 US billion) headquartered in Vancouver,
BC, Canada. It was formed under the laws of the province of Ontario, Canada. It has many subsidiaries
(companies that it owns), many of which will have been incorporated in other countries in which
Goldcorp operates. It has an obligation to produce financial statements for its shareholders (owners).
Financial Reporting

What is meant or included by the term "financial reporting?" It turns out that this term has a very clear
meaning to the investing community in literally dozens of countries. The reports tend to centre on two
specific concepts: the financial position or status of a company and the financial generation of profits or
net income. These reports could answer questions like: "What is our position now (our net wealth)?"
and "How well are we changing our wealth?" Before exploring the answers to these questions, let's look
briefly at those who regulate this flow of information.

Understandably, the statements of a company go into detail to ensure that the investing public is given
some minimum level of accounting information. As you may guess, this "minimum" is a moving target—
generally increasing over the years and certainly undergoing scrutiny and revision whenever we have a
breakdown in the integrity of the reporting. A major failure of a company (bankruptcy) coupled with a
whiff of fraud tends to excite the regulators.

Regulators

As mentioned above, companies are subject to many laws. In addition to laws governing incorporation
(which can have sections applying to financial reporting) there are also laws governing the transfer of
ownership—in short, laws controlling the markets in which shares are traded. In some countries, these
laws are highly prescriptive. In others, the laws delegate ruling authority to stock exchanges. For
example, there is a requirement by the Toronto Stock Exchange (TSX) that any listed company produce
financial reports in a timely and regulated fashion. Similarly, the London Stock Exchange (LSE) requires
at least three years of financial reports prior to listing a company for trading, and so forth.

Clearly it would be very expensive and also quite difficult to expect each stock exchange to develop its
own accounting rules. That's where we see national and International bodies producing the rules, with
the stock exchanges simply requiring the use of these rules.

Luckily, one of the advantages of globalization has been a move to standardize accounting. Today we are
faced with essentially two sets of accounting regulations—those of the United States, through
its Financial Accounting Standards Board (FASB), and those of the International Accounting Standards
Board (IASB). American standards are followed by not only US companies but also a substantial number
of Japanese and other Asian countries where American economic influence has been significant. In
contrast, over 120 countries accept the IASB as the institution that sets their accounting rules. Note that
in 2008 Canada formally decided to adopt International Accounting Standards, effective Jan. 1, 2011
(including the preparation of comparatives for year 2010).

Today, these two main accounting regulators are working together to reduce differences. In fact, for
many topics the accounting rules are essentially identical. For our purposes, we shall assume both sets
of regulations to be sufficiently close that we can treat accounting as one agreed-upon set of concepts,
principles and guidelines. We shall point out any important differences. Where there is agreement or
the differences are minimal, we shall use a common term "GAAP" which stands for Generally Accepted
Accounting Principles.

Use of Terminology
The Reports

Earlier we mentioned two main concepts in financial reporting. One is wealth at a point in time (a status
report) and the other is income or changes in wealth (a flow report). To clarify this, think of asking a
person two questions.

 What are you worth?

 What do you earn?

Clearly the first question calls for an answer that relates to some instant in time—likely "now". But an
answer to the second question requires an auxiliary question such as "Over what period of time?".

An answer to the first might be $1,700,000. An answer to the second has to involve a time element.
Thus it could be $80,000 per xxx. We get a very different impression of earning power if the $80,000 is
per year or per month or even per day.

The report that discloses the wealth status is called the Statement of Financial Position (or the Balance
Sheet, a name well established but decreasing in usage). The report that tells us about earning is called
the Statement of Income (or Statement of Earnings or even the Statement of Operations). Certainly
there are two other important statements, but the crux of the matter—the financial health of a single
individual running a small business in one city, or of a huge company employing thousands of people
spread over several continents—can be established with these two statements.

The remaining parts of what constitute the financial statements of a company consist of a Cash Flow
Statement, a Statement of Changes in Equity and a set of Notes that meet mandated disclosure
requirements for many financial items. Briefly speaking, the Cash Flow Statement presents the sources
and uses of the cash generated and spent in the same time period as covered by the Income Statement.

The fourth statement divulges changes to equity (ownership by the shareholders) due to such factors as
the sale of (more) shares and/or the redemption of shares, the profit earned or loss incurred, the
distributions of profit (dividends) and the issue, cancellation and exercise of share (stock) options.
Finally the Notes are a set of informative disclosures of details on items that either do appear on one or
more of the four financial statements or do not appear but are considered quite vital to have an
informed opinion of the company's position and potential. For large, major, global mining companies
such as Barrick Gold, BHP Billiton, Rio Tinto, and Vale, the Notes are extensive, often running to over 50
pages. You will see more on these two statements and the Notes in Part 2: Statement of
Income and Part 3: Statements of Cash Flow and Changes in Equity.
Accounting Jargon

Now it is time to discuss accounting jargon. We need to examine what certain words mean in the
financial reports that follow the IASB and FASB rules. They may be words that are quite familiar to you
but nevertheless have a special, possibly tight definition in an accounting context. Examples are
"goodwill," "minority interest," "amortization," "warranty allowance," "contingent liability," "prepaid
expenses" and so on. To get the most out of reading financial reports, it certainly helps to have an
understanding of accounting terms. After all, it is said that "accounting is the language of business."

The jargon will be introduced as we discuss various examples of the financial statements mentioned
above. Many of the special words will appear also in the Glossary in the Appendix.

The Special Meaning of the Term "Statement"

Right now, you might be thinking you know what a statement is—a sentence
or even a pronouncement such as "Damco is worth $4.5 million." Of course
this is an English statement—it has nouns, verbs, etc. But in a financial
reporting context, a statement is a list of various items together with dollar
(or other currency) figures. There are standardized titles, places where we expect subtotals, and
references to additional information. Let's examine a highly simplified fictional example of a Statement
of Financial Position and later a complex real one from a large International mining company. Note that
the components of fictional financial statements in this and other sessions have various interdependent
ratios that are patterned after actual mid- and large-size mining companies. For example, much of the
Remco example (Exhibits 1 and 3) is patterned after data of Kinross Gold Corporation. Viewing the
fictional one will prompt some questions we can address. See Exhibit 1 to examine the Remco Mining
Inc. Statement of Financial Position.
Here we might have several queries.

 Is the cash all in one country and one currency?

 What is in inventory and how is it valued?

 For the smelter, what does "net of depreciation" mean?

 When is the current bank loan due?

 What rate of interest is Remco paying on its bond debt?

 How much of the capital owned by the shareholders was initially invested and how much was
earned and retained in the business?

You can see how we might want some standardization and a requirement for a minimum level of details.

In contrast, we can look at a detailed, real example. See Exhibit 2, which comes from the report of
the Rio Tinto Group , one of the world's largest mining companies. The Rio Tinto example contains
many terms that need clarification, but this will come later. For our purposes, you have just seen two
financial statements at opposite extremes in terms of details.
The real life examples (Rio Tinto in this case) usually give the reader a handy cross reference to
additional information. Though Rio Tinto may quite voluntarily wish to assist its investors in reading its
reports, we should observe that a cross reference to the Notes is actually an IASB requirement. For
example, when we read "Inventories $6,136" we see a reference to Note 17 where we can expect to be
told several details regarding inventory, including valuation of the four underlying inventory categories
and information on the expected timing of the use of these inventories. You will see references to Notes
in the remaining sessions and expanded comments on Notes in Part 3: Statements of Cash Flow and
Changes in Equity.

The other statement we alluded to is the one reporting the results of struggling to earn a profit. A
simplified Income Statement appears in Exhibit 3.

Here we might have a few questions.

 Do the revenues include sales that have not yet been paid for by our customers?

 What is included in the term "cost of sales?"

 How long a life is contemplated when depreciation is $39,000?

 What is the average interest rate paid on the debt?

 What is included in "other operating costs and expenses?"

 Is this company paying any taxes and if so, then how much?

Not only do we want some standardization, but probably a lot more detail. The Income Statement will
be covered thoroughly in Part 2: Statement of Income, but it is worthwhile having a quick look here at
the Rio Tinto report—see Exhibit 4. Similar to the Statement of Financial Position (which Rio Tinto called
a Balance Sheet in previous years—not shown here), this statement also has considerable cross
referencing to the Notes. In short, many of the questions we have for Remco above are answered in the
detailed statements of mining companies adhering to International and/or American accounting
standards.
Articulation/Interdependency

Of course, the use of both statements together gives us insights into the operation of any company that
neither statement alone can provide. To use another example, imagine you are told that the net income
of company ABC is $2 million. Is this good performance or poor? One approach is to combine this
Income Statement figure with a Statement of Financial Position figure to see what resources were
needed to earn this $2 million. If the Shareholders' Equity amount is, say, $6 million, then ABC has
earned a very satisfactory 33% return (the $2 million net income divided by the $6 million equity). In
contrast, if the Shareholders' Equity is $28 million, then the return is around 7% and likely to be
considered poor.

We will build on this method of combining data from more than one statement as we proceed. We now
can turn to a detailed study of the first and possibly most important of the four financial statements. We
will continue to use both simplified fictional statements such as that of Remco above, and examples
from the diverse and sometimes quite surprising world of mining.

Statement of Financial Position

The Statement of Financial Position (SFP) is a summarized list of all the assets and the liabilities that a
company has. The difference between them is called the net assets. This is also called the (net) book
value or carrying value of the company. It represents the ownership of the company, or what is called
the shareholders' equity. This statement also summarizes the main equity categories.

In this session, we focus on the presentation of these asset, liability and shareholders' equity items. Here
we mean the classification and underlying accounting that is mandated by GAAP. Adherence by
companies to the classification system allows readers (users) of the statements to find specific items
quickly and to feel confident in knowing how related figures are established—rather like going to a large
food retailer and knowing the location of the bakery department, and the rules for minimum content
labelling.

The first grouping has already been hinted at: the assets, liabilities and the shareholders' equity items.
Within assets and liabilities, the next cut is time driven. Among assets, we have two major groups.
Current assets are items that are cash or are expected to either become cash or get used up within a
year. Long-term assets are all the other assets—more on that later. Similarly, the liabilities are placed in
two groups—the current liabilities (due in less than a year) and the long term liabilities (the remaining
debt).

Among the shareholders' equity items, the cut is not time-driven but rather source-oriented. Here we
see two main groupings.
  The money invested by shareholders to establish (or later to augment) the business.

 The earnings of the company that have accumulated but not been distributed (as dividends to
shareholders).

A third, relatively new, part of shareholders' equity exists called Accumulated Other Comprehensive
Income, but discussion of this is deferred to Part 2: Statement of Income. Now we can apply these
groupings in Remco Exhibit 5 (right) to the data presented earlier in Part 1: Remco Exhibit 1.

It is worth noting that US accounting GAAP calls for a set order of presentation within the current asset
and current liability sections. Internationally, the only requirement is that the categories of current
assets and current liabilities exist. Furthermore, internationally, we see some companies presenting
their long term assets before their current ones. Here again note the Rio Tinto Exhibit 2 (below).

A comment on International versus American GAAP

The above contrast between the presentation in the US format and the presentation in countries that
have adopted International standards prompts a comment or two. In general, it is not wise to assume
that one set of standards is more stringent than the other. The differences vary. For purposes of order of
presentation, it happens that American GAAP is the more prescriptive. But for other matters (discussed
later) we find International standards tighter (allowing less choice) than the American standards (Recall
that as of Jan 1, 2011, Canada joined over a hundred other countries using International GAAP).

Ratio Analysis

Two common ratios

Already, we are at a point where we can introduce a method of analyzing some aspects of the health of
a company. Ratio analysis helps us to compare several companies at one time or one company over
several time periods. It allows us to put large companies and much smaller ones on some comparable
basis, with some caution, of course.

A measure of liquidity—the current ratio

One measure that is used often to assess the liquidity of a company is the current ratio. This is a fraction
where the numerator is the amount of current assets and the denominator is the amount of current
liabilities. Normally, a healthy current ratio (of around 1.0 to 2.0) indicates that in the short run the
company has the current resources to meet its current obligations. In Exhibit 5 (above), the current ratio
is 1.71. It should be mentioned that this figure of 1.71 cannot be looked at in isolation. The breakdown
of the components of the current assets (and to a lesser extent the current liabilities) can have a strong
influence on what we think of the 1.71 figure. And, of course, the industry in which the company
operates has a bearing on our analysis. Take a look at the Rio Tinto Statement of Financial Position
shown earlier and repeated here (Exhibit 2, below right). The current ratio is 1.39, but without
considerably more information, this ratio is of limited use.

A measure of solvency—the debt to equity ratio

The term solvency usually implies a concern for the overall viability of a company. You can well imagine
a situation where a company has some short term liabilities—say a large volume of accounts payable
coming due—but has a strong long term asset base and little long term debt. Here we might feel that
the company could be experiencing a liquidity problem, but one that pales in view of the fact that the
company has an overall strong net worth position.
Related to the above, we introduce another measure that is a basic tool of analysis—namely the debt to
equity ratio. Unfortunately, it appears commonly in two forms—total debt/equity and long-term
debt/equity. Considering these two measures can be significantly different, you always need to verify
which definition is being used by a company in its reports or in an article appearing in the press.

For our simple example of Remco Exhibit 5 (above right), we can work out a (total) debt/equity ratio of
0.59 (280,000/475,000). That means there is $0.59 of debt for every one dollar of equity. This would be
considered a safe figure in most industries. Furthermore, it allows us to feel that the current ratio is not
an issue for this company. Why? Because Remco can likely secure an increase to its long term debt to
satisfy any short term concerns.

Let's examine Rio Tinto (see Exhibit 2, below right) from this perspective. Here the year 2012 total
debt/equity ratio is 1.03 (59,552/58,021) or 103%. This is a fairly high debt level. That prompts us to
review the previous year (2011) which turns out to be much the same at 1.02 (60,337/59,208). It turns
out that these last two years are a tremendous improvement from earlier years. Back in 2008, this
company had a debt/equity ratio of close to 300% and a current ratio of 0.66.

Just how this was achieved requires further information, including consulting at least three other
sources—namely the Income Statement (Part 2: Statement of Income), the Statement of Change of
Equity and the Notes (Part 3: Statements of Cash Flow and Changes in Equity); more on this later.

Did you notice that we got these Rio Tinto figures for 2012 and 2011 from the same sheet? That is
normal. GAAP (both American and International) require a company to put out the latest figures and
those of the previous year. We can then make comparisons, which is why the earlier figures are called
"the comparatives." Incidentally, this disclosure requirement applies to all four of the financial
statements and to figures presented in the Notes.

The Nature of the Assets

Just examining Rio Tinto's Statement of Financial Position (Exhibit 2) is likely to prompt some questions
about what some of the items are. Excluding the total and subtotals, there are three dozen separate line
items. Looking at the "what the company owns" aspect, it may help to introduce another way of
classifying assets. With some minor exceptions, what follows is applicable to many industries, including
mining.
The monetary items

We can think of assets as monetary or nonmonetary. The monetary ones are cash and items that are set
claims to receive cash, such as accounts receivable, notes receivable, loans receivable and certain other
financial instruments where the value of the asset tends to be a fixed, agreed-upon amount. Accounts
receivable are amounts owed to a company as a result of the company making a sale to a customer on a
credit basis—an arrangement usually calling for payment within 30 days or so.

The nonmonetary items

Here we have inventory, land, plant, equipment, patents and investment in other companies—a varied
range of assets that help the company to carry out its business of providing food items (retailers),
moving people (airlines), refining copper (mining companies), and so on. A useful way of classifying
(nonmonetary) assets used by the vast majority of companies is into two categories.

 assets held for sale

 assets held for use in the business

With a minor but important exception, these assets tend to be listed under different names. Normally,
assets held for routine ongoing sale are classified as "inventory." Assets that normally were used in the
business but are now up for sale usually appear under the title "Assets held for Sale." Let's be clear
here—the vast majority of items normally sold are under the title "Inventory," and of course are for sale.
For Ikea, the world's largest retailer of furniture, a chair is an asset intended to be sold. Assets used in
the business are ones that help to carry out business activities such as a cash register or a display shelf
at Ikea.

Note that among two industries we can see the same item classified in two ways. Boeing will be
classifying planes as "inventory." It is in the business of manufacturing and selling planes. In contrast,
WestJet and British Airways will classify planes as a part of the general collection of "assets used in the
business" but under the title "Property, plant and equipment" or maybe even just the word "Planes."
Suffice to say that inventory and the odd piece of equipment now up for sale (after some long use) are
intended to be turned into cash (through a sale) as soon as possible—and certainly in under a year.
Hence, they are classified as current assets. Very rarely is inventory ever classified as "long term." We
see in Exhibit 2 (above) that Rio Tinto has indeed some long term inventory, but this is under 6% of its
total inventories.

Precisely because we list inventory as a current asset, we need to value it conservatively—or at least not
above what we can sell it for. Hence there is a general GAAP rule that inventories are held on the books
at the lower of cost and market (the LCM rule). This means the lower of two values: what the company
paid to buy or produce the inventory and its current net realizable value (the normal selling price).
Long-term assets

The vast majority of long-term assets can be considered as constituting the company's "assets held for
use in the business." At what values do we see them on a Statement of Financial Position? The answer
to this is varied—and highly significant. It is an accounting area where historical values or current values
(also known as fair values or market values) might be used. The figures may involve a recognition of
wear and tear, obsolescence or serious impairment. These will involve a heavy reliance on future
estimates.

Here accounting decisions can have a major effect on the overall assessment of a company. Generally
the International rules and the American rules are very similar; however, there are two major
differences we need to address: one affecting most companies in any industry, and another specific
difference affecting companies in the mining sector.

More on Assets, Liabilities and Equity

One of the longest established principles in accounting is that long-term assets are recorded at the cost
paid for them—a historical cost number that is easily verifiable and thus quite reliable though not
necessarily relevant. Thus, land bought 15 years ago is on the books at, say, the $22 million paid for it at
that time. The fact that the land may well be worth $95 million now is not taken into account when the
so called historical cost model is used. This is the model predominantly in force in North America
presently.

The IASB takes the position that for some firms, there could be such a distortion in the overall valuations
of the company's assets that the use of current values should be allowed as an alternative. This is
precisely what the IASB allows. Any company choosing to report using International standards has the
option of electing to use the (historical) "cost model" or the (current) "revaluation model." This option
is outlined in IAS16—Property, Plant and Equipment and in IAS38—Intangible Assets. Clearly you will
want to determine which model a company is using. That information is mandated disclosure and will be
found in the Notes—usually in a note entitled "Summary of Significant Accounting Policies."

Either model happens to recognize that certain long-term assets have a finite life (not like land). These
assets get systematically pulled down in value from year to year in a process called depreciation. That
process is looked at in more detail in Part 2: Statement of Income; any recognition of depreciation is
certainly a change in wealth—a decrease to whatever net income is otherwise determined. Depreciable
assets are shown on any Statement of Financial Position at a lowered or net value which is (usually)
lower each year. Incidentally for mining companies, the systematic lowering of an asset such as a proven
copper reserve is called depletion(rather than depreciation).

Mineral Resources
Are mineral resources recorded as assets at market values or historical costs, or are they expenses?

One fundamental difference between companies involved in the extractive industries and those in other
industries is that some (often a substantial portion) of the long-term assets are hidden in the ground and
consequentially not easy to quantify. Does Teck Resources have x tons of mineable copper ore or is the
number closer to y? Should Vale's subsidiary in Peru value its ore at $z or at a lower figure? Should a
new junior exploration company value its findings after two successful drill holes or after fifty holes?

This is the second area where the IASB and the American FASB have differing opinions and rules for
accounting. The American rules have fewer alternatives, are more conservative and are thus the easier
to review first. The FASB rules specify that all exploratory expenditures (the use of cash to explore for
minerals) are to be treated as expenses and thus recorded on the Income Statement as a reduction of
company wealth. Does this make sense? It is certainly conservative and thus leads to no further
possibility of increased expenses in the future.

In contrast, in Canada, accounting for exploration expenditures can be compared to accounting for, say,
the construction of a specific asset. The funds spent on exploration can be recorded as a decrease to
cash and an increase to an ongoing asset called "mineral property" or "deferred exploration
expenditures." This can result in a quite significant difference in the Statement of Financial Position
between the asset values of a Canadian junior mining company and a more conservative American
junior. Consequently, a difference between their Income Statements will exist, with the American
company showing greater expenses in the exploratory years.

What is the IASB's position? The IASB has a similar stance to the one mentioned above in the Canadian
example. In essence, the company is allowed to choose between two options regarding accounting for
expenditures made on exploration for, and evaluation of, mineral resources. It can expense them or
capitalize them. For a company adopting International accounting standards, the IASB is allowing it to
"continue to use the accounting policies applied immediately before adopting the IFRS [International
Financial Reporting Standards]" (IFRS (2012)).

A final note on this point is to highlight the existence of choice. Any companies that were expensing
exploration and evaluation costs prior to adopting International standards must continue to do so.
Those that elected to capitalize these costs prior to switching to International standards are allowed to
continue doing so.

Long-Term Liabilities

In addition to identifying assets, the Statement of Financial Position reveals the sources of funding for
these assets. We see current liabilities (earlier discussed) and long term liabilities which can include long
term bank loans and notes payable, bonds and deferred income taxes. Again, the Notes are of
paramount importance. Here we will find the two key features of debt—namely the rate of interest and
the date of maturity. The Notes will also inform us if any of the debt instruments can be converted to
shares at the option of the lender. Furthermore, we will see some (limited) details on the collateral that
the company may have pledged to creditors in order to secure loans.

For mining companies in particular, we see long term obligations for "asset retirement obligations."
These liabilities can be voluntary or mandatory (government-imposed) obligations to spend considerable
sums in the future to decommission a mine and render the environment to some state agreed upon by
various affected parties. You need to read the Notes here as many companies list these under a catch-all
term such as "Other Liabilities."

These future expenses can also appear under different names. Click on Anglo American Exhibit 6 to see
the Statement of Financial Position; note that this company is still using the term "Balance Sheet".
Under the title "Provisions for liabilities and charges" we see approximately $2.4 billion. Details offered
in Note 26 (not shown here) disclose that over $1.6 billion of this figure are related to "Environmental
restoration" and "Decommissioning" charges—amounts that come to around 5% of the total liabilities of
this UK based world class mining company. For the reader, this hunting or sleuthing process is inevitable
when the volume of underlying data simply cannot be all presented on one Balance Sheet.
Shareholders' Equity

The Statement of Financial Position has a section devoted to the ownership of the company. Here we
see two main divisions.

 What was invested by shareholders for the shares when they were issued by the company.

 What profit has been both earned and still retained in the business.

Click again on Remco Exhibit 5 (right) and observe that shareholders invested $208,000 to secure
common shares of Remco Mining.
The retained earnings figure is $267,000 and informs us that at least that amount has been earned and
kept in the business as of the reporting date (July 31, 2013). However, note that this figure could have
been earned over, say, a five year period—in fact, it represents earnings since the start of the company.
Also, we need to appreciate that what was earned could have been a lot higher. Maybe it was $667,000
and some $400,000 of this figure has been distributed to the shareholders in the form of dividends—
earnings not retained in the company. We can look to the Statement of Changes in Equity and the Notes
in Part 3: Statements of Cash Flow and Changes in Equity to clarify what went on.

Click on Exhibit 7 to see the shareholders' equity section of another major mining company, BHP
Billiton . This company is also using the older but well-established title of "Balance Sheet." Notice that
the total equity of this company appears in two figures—the total for shareholders of BHP Billiton is
$70,664 US million and the total equity is $72,035 US million. The difference here is due to some $1,371
US million of equity in the net assets that belongs to minority shareholders in the companies that BHP
Billiton controls but does not have a full 100% ownership in. Understandably, this minority interest can
be called a "non-controlling interest"—the more modern term (adopted recently by BHP Billiton).
You may note five components that make up the $70,664 US million. The first two represent the amount
invested for the two kinds of shares this company has issued. The last term of the five—namely the
"Retained earnings"—is easily the dominant figure in this equity part. At almost $67 billion, this is the
amount earned in the past years and retained in the business (not paid out in dividends). Potentially this
equity could be paid out to shareholders if the assets were cash—but note that the vast bulk of the
retained earnings is tied up (along with funds borrowed) in assets held for use. Thus any move to
distribute a large portion of past earnings to shareholders would necessitate sale of assets—a position
shared by the vast majority of companies in any industry.

The other two equity figures are "Treasury shares" and "Reserves." The Treasury shares are a negative
number and represent the value of shares of BHP Billiton that the company happens to own. It makes
sense to list this as negative $540 US million so that we can derive the true equity outstanding (owned
by shareholders as opposed to the company owning itself). The Reserves are small matters regarding
premiums on the amount paid for shares, employee share awards, hedge reserves and other
miscellaneous items totalling less than 3% of the equity. The company details can be pursued at Note 20
for those few investors that are concerned.

We turn now to Part 2: Statement of Income concerned with the second of the two major financial
statements—the Income Statement—and comment on how it interacts with the Statement of Financial
Position.

You have covered the following points in Part 1: Introduction—Statement of Financial Position.

 an introduction to limited liability, financial reporting and regulators

 financial and accounting terminology

 the Statement of Financial Position

 cost and current value accounting

 assets, liabilities and equity

 details of what is included in the Income Statement

 sales

 cost of sales

 depreciation and depletion expense

 income taxes

 peripheral items that are common but not necessarily present in the Income Statement

 gains and losses on disposal

 impairment charges

 finance costs (interest expense) and leverage

 income from investments

 types of income

A Need for Some Details

The Income Statement (I/S) is usually a one-year or quarter-year performance report giving us the
results of operating the company, including its revenues from core activities, related expenses, and the
difference as a profit or loss. For some readers, the Income Statement is the key report. You will have
heard questions like "what is our bottom line this year?," "did our EPS go up the expected 10%?" and
"never mind the peripheral gains, what's our net operational income this quarter?" After reading this
session, you should be able to look at an Income Statement and sort out what you need to answer these
and other questions.

Recall that the Income Statement is considered as one of the two key financial reports available to
shareholders and other affected parties. This (unlike the Statement of Financial Position) reports for a
period or passage of time. Look at Pronto Exhibit 8 (right). Here we see the basic items in less detail than
GAAP currently allows, but this simplified form allows us to observe certain features.
Pronto Exhibit 8 could be the Income Statement for many businesses. It could apply to a simple grocery
retailer or a major mining company. The common elements here are the presence
of sales (revenues), expenses, and, by subtraction, the net income (overall profit). That profit
(sometimes referred to as "the bottom line") appears on the Statement of Financial Position as a part of
the item called Retained Earnings. It joins the earnings of previous years that have been retained in the
business (not paid as dividends to shareholders).

Furthermore, the net income figure is the one used in the determination of a very popular ratio, namely
the Earnings Per Share, or EPS.

In our simplified example, the sales reported at $60,000, could be $61,000 gross with sales returns of
$1,000, or this net figure may consist of sales of $70,000 with a relatively large $10,000 of returns. The
expenses could be mainly wages, or say only 30% wages and large figures for depreciation (say another
40%) and fuel (gas or electricity). Maybe the company is highly profitable but operates largely on
borrowed funds; here the "other expenses" could have $9,000 in interest charges to banks. Possibly
income taxes account for several thousand dollars. In short, more detail would be welcome.

In the early 20th century, the disclosure shown in Exhibit 8 (above) was perfectly acceptable. Since then,
many countries have experienced recessions, depressions, corporate frauds and other factors that have
caused regulators to insist on the presentation of far more information. After all, companies are far
larger than they used to be and involve a far greater separation of the roles of management and
ownership—the so called "insiders" versus "external" shareholders. If investors are to make informed
investment decisions then more information is needed.

At present both American and International accounting standards call for the inclusion of many "line
items" in the Income Statement. We could look at a dozen or so but restrict ourselves now to certain
main ones.

 sales

 cost of sales

 depreciation and depletion

These are chosen because they have certain features or complications that might not be expected by a
novice reader.

Sales

Some companies disclose sales in detail presenting total sales and, as a deduction, exchanges and
returns. Other companies show just a single net figure. The choice is at the company's discretion. In
retail and wholesale industries, you could expect a small but significant presence of sales returns and
your analysis of efficiency might benefit from a full three figure disclosure. In mining, where returns are
not an issue, we see the net approach used.

Have the sales been paid for? Here we have a uniform standard (meaning American GAAP and
International GAAP are the same). Sales are recognized when the "goods are handed over" or "work is
done"—in mining when the product is delivered. The recognition of both sales and expenses on a
"when goods or services are provided or received" basis and not necessarily when they have been paid
for is recognized universally as the accrual basis of accounting. Clearly, this means that when sales take
place on a credit basis, we immediately recognize sales and the presence of an asset called accounts
receivable. When cash appears later (in days or months), the receivables are simply reduced and the
cash is banked.

Cost of Sales

The cost of sales (in some countries referred to as cost of goods sold) is the cost of producing the item
that is actually sold. Prior to sale, the item is considered an asset and is recorded in inventory. A sale
thus triggers a reduction of inventory and a corresponding cost on the Income Statement.
Unfortunately, the term is open to a wide definition. In the case of some companies, the charges for
running related machinery (to produce the inventory) such as utilities, wages and even depreciation are
included in cost of sales. In other cases, the depreciation expense is listed as a separate item.
Furthermore, some companies group cost of sales together with other expenses on the Income
Statement. Consequently, you need to rely on the Notes and perform some analysis before achieving a
satisfactory comparison of results among competing mining companies.

Here we introduce two terms that are used not just in mining but indeed in all industries that provide
goods. The terms are period cost and product cost. The first is used for expenditures that are
"expensed" in the current period. The expenditures are deemed to have no future value—i.e. are not
thought of as constituting or adding to any asset. Two examples are the wage paid to a sales person and
the hydro (electricity) used to light and heat the accountant's office. These items appear on the Income
Statement of the time period in which they incur or are consumed.
In contrast, a product cost is an expenditure that creates or adds value to some item that will be sold
some time in the future. At Toyota or Ford, the labour cost paid to a worker assembling a car
is not treated as an expense (just yet) but rather an increase to the cost of the product being made—the
car. Here you can easily imagine that many costs could be deemed to be part of the car's inventoried
cost. Not only are wages and related benefits (health, pensions etc.) added to the value of the car but
also such less obvious items as depreciation on the assembly robot and a portion (or all) of the vice
president of manufacturing's salary and related office expenses.

The criteria here is "does the cost essentially exist only because a car is being manufactured or a ton of
copper ore mined and partially refined?" If the answer is "yes" then we have a product cost. Thus in the
case of an iron ore blast furnace, the manager's salary of say $90,000 is paid but no expense is
immediately recognized. Instead the $90,000 is added to the value of the metal that is accounted for as
inventory until it eventually is sold. Thus a product cost is an increase to the asset "inventory" and
augments a Balance Sheet item rather than appearing on the Income Statement. This is called
"capitalizing a cost." Only when the inventory is sold do we see product costs entering the Income
Statement as part of cost of sales.

Recall that a gross margin is the first level measure of profitability obtained when we deduct cost of
sales from the sales figure. Before comparing the gross margin results of two companies, it is vital to
determine what accounting policy a company is using regarding the capitalizing or expensing of certain
"big ticket" items such as depreciation. You will see some companies treating this as a period cost
whereas others are capitalizing depreciation (product cost). Let's see what some mining firms are doing.

Click on Exhibit 9 to the Arch Coal Inc. year-end 2012 Consolidated Statements of Operations, a publicly-
traded US based company. Observe that the first expense listed is "Cost of sales." We can see here that
Arch Coal has chosen to not have a gross margin line. Furthermore, it appears that depreciation,
depletion and amortization are NOT product costs (Arch lists them separately instead of being part of
"cost of sales").
In contrast, some other coal companies include an expansive set of costs including direct material,
consumption of overburden, coal mining, coal processing, labour related transportation costs to point of
sale and certain fixed and variable overhead costs directly related to mining activities AND depreciation.
They even include site rehabilitation costs that are future expenditures allocated to each production
year. You can see this in the Whitehaven Coal Limited (an Australian firm) Exhibit 10 showing the
Statement of Comprehensive Income for year ended June 30, 2012.
As mentioned earlier, other companies may not disclose cost of sales directly. Exhibit 4 is another
glimpse at the Rio Tinto Income Statement where we see a broader category called "Net operating
costs." That item has a reference to Note 4, where an investor would see the inclusion of over a dozen
identified costs to make up this cost of sales figure. Incidentally, both Whitehaven and Rio Tinto are
adhering to International accounting standards—a set of standards that clearly allow some freedom of
format as long as the reader can trace the details.
Depreciation and Depletion Expense

Many companies in a variety of industries acquire assets that will be used in the business (not sold like
inventory) and thus will be retained over several fiscal periods. Clearly it would be a reporting distortion
to consider the cost of, say, a large specialized mining truck as an expense in the year of acquisition. For
a truck such as the Caterpillar 797F (with a load capacity of around 400 tons) a company could easily be
paying around US $5 million. This particular model is deemed to have a life of up to 20 years.

How do we handle accounting for this kind of asset? We place it on the books as an asset at time of
purchase and then spread the $5 million of costs over the anticipated life. In this case we would record
an annual expense of $250,000. That expense is called depreciation. The annual depreciation charge
appears on the income statement even though it involves no cash flow. On the SFP (Statement of
Financial Position), we would see the net value of the truck lowered each year by $250,000.

This style of thinking takes place for any long term asset that gets used up in the process of providing
service. This applies even to assets such as ore bodies, though the term depreciation (which normally is
associated with wear and tear) is replaced with the word depletion. As you may imagine, depreciation
and indeed depletion can be computed on a per-unit-of-work-provided or a per-ton-of-ore-mined basis
rather than the time-oriented basis discussed above for the truck. When a per ton or other unit of
production method is used, we could see accounting treatment as either a period cost or a product
(capitalized to inventory) cost.

In capital-intensive industries such as mining, shipping and airlines, the charge for depreciation can be a
significant portion of the total expenses. Not surprisingly, isolating this one expense in the Income
Statement or in the Notes is an accounting requirement. Let's look now at Exhibit 4 (above right), the
Income Statement for Rio Tinto. This company has chosen to present a large catch-all item called "Net
operating costs" at $37,536 million (2012). A cross-reference to Note 4 informs the reader that $4,141
million (around 11% of the operating costs) are charges for depreciation. For intangible assets (such as
trademarks, patents and other contract based intangibles), the term amortisation is used instead of
depreciation. For Rio Tinto, this is an additional charge of $300 million.

Income Taxes

Most countries impose various taxes on businesses. Clearly higher taxes in any one country increase
government revenues but lower the incentives of a company to operate in that country. The most
predominant form of taxation of businesses is income tax or taxation of net income—the profit earned.
Though that may appear quite straight forward, you can get an idea of the potential problems when we
consider the following.

 If Granto Copper earned $5 million in 2012, can its taxes be lowered based on a loss of, say, $2
million in 2011, a year when it paid no taxes?
  If Granto Copper is operating in Mexico but is owned by Hallden Metals registered in Bermuda,
can a legitimate consulting charge of $400,000 from Hallden be treated as a (tax lowering)
expense by Granto?

 If Granto US buys a used Komatsu PC3000 Excavator Shovel for $900,000 US, what is the
maximum expense per year that can be used for tax purposes?

It gets worse. Many countries now allow companies to keep in essence two sets of books—one showing
figures that determine taxes and another showing figures that somehow represent a better—or at least
different—view of the economic value of the company. This has lead to basically two kinds of taxation
figures.

 taxes imposed and payable in the current year

 taxes that may be imposed under certain conditions in the future

The first is called "Current tax expense" and the second is called "Deferred tax expense."

What is critical here? Disclosure! International and American standards require firms to disclose taxes as
a separate line item. You cannot bury a tax figure in "other expenses" or "miscellaneous." Furthermore,
the current tax expense is going to cost real dollars fairly soon—within months. In contrast, deferred
taxes represent estimates of taxes to be possibly paid many years in the future. Clearly these two kinds
of taxes are disclosed separately both on the Income Statement and the Balance Sheet (the SFP).

We stated above that many countries allow a company to establish net income figures for shareholder
purposes that do not necessarily match those for tax purposes. An example can help to understand this
apparent "two sets of books" accounting. For tax purposes, a company may be able to claim a maximum
of 30% deduction for a certain asset—say, a large front loader costing $1 million. That is a tax expense of
$300,000 for the year. But for actual operating purposes, maybe the loader is expected to last, say, 12
years, and in its first year was used well below capacity. We may report to shareholders a drop in value
with depreciation at around $80,000 or around 8% of purchase price. In short we have a year-end net
asset on the books for shareholders at $920,000—a figure we feel is more realistic than what we would
derive using tax rules to our advantage.

This is quite legitimate. But eventually, the discrepancy between depreciation for tax and for
shareholders will be taken into account. In the interim, an item called Deferred Income Taxes is used to
essentially balance the books. This is a considerable simplification of the situation. Suffice to say that (a)
deferred income taxes do appear on both the Income Statement and the SFP and (b) they are not due or
payable in the immediate future, but are rather an estimate of what will eventually arise. To add to the
confusion, not all countries use the same terminology here. The recent move to adopt International
standards caused Canadian companies to drop the term "Future Taxes" in favour of the term "Deferred
Taxes" used both internationally and by American companies. At one time, the term "Future Taxes" was
deemed a more politically acceptable name than the often misunderstood term "Deferred".
Companies have a minor reporting choice here. We may see income tax as just one line on the Income
Statement, but in that case, a company must disclose the two figures—current and deferred—in the
notes. Alternatively, a company might choose to list both taxes right on its Income Statement. For
example, look at Goldcorp Exhibit 11. Goldcorp reveals "Income taxes" at $503 million US. Note 22 (not
reproduced here) indicates that $535 million is current (and thus due to various governments) and $32
million is actually a reversal of previously deferred taxes. The important point here is that despite the
single Income Statement figure of just over five hundred million dollars for tax expense, the actual
amount currently owed by the company to various governments (a cash requirement) is a bit higher.
Hence the importance of reading the Notes!
One other point to be mentioned in the tax area is the odd practice of showing some items "net of tax."
The vast majority of revenues and expenses are listed and totaled and the net amount is then taxed in a
separate line for tax. However, some items such as "Discontinued operations" are a summation of
revenues and expenses and associated income taxes for a segment of the company's operations that are
or will be shortly discontinued.

Finally in the tax area, note that many analysts determine the debt to equity ratio with long
term deferred tax liabilities removed from total liabilities. The reasoning here is that these quasi
liabilities are not costing any interest and in many cases may be deferred sufficiently far into the future
that they may as well be ignored. The figures are far from trivial. See the Consolidated Balance Sheets in
Exhibit 12 of HudBay Minerals Inc ). Here, removing some $241 million of deferred tax liabilities alters
the debt to equity ratio from 98.3% to 84.6 %—a significant and welcome change.
Peripheral Items
Introduction

In the last session, we have discussed the main Income Statement items that appear in essentially all
mining company financials. We omitted some self explanatory items such as Selling and Administrative
costs, and Exploration and Evaluation costs, and Energy costs. Now we turn to four items that are
common but not necessarily present in every Income statement.

 gains and losses

 impairment charges

 finance costs

 investment income

Gains and Losses on Disposal

The normal accounting for core income generation activities is to show both revenues and associated
expenses. By subtraction, also shown, we get the associated profit. Every now and then, there will be
income from a secondary source from updating long term assets or simply selling off assets no longer
deemed necessary to ongoing operations. An example will illustrate the point. Say in the year 2010, at
the end of February, Remco buys a Hitachi EX2500 Front Shovel for $3,000,000. For various reasons,
Remco decides to sell its shovel at the end of May 2013. During its life at Remco, the shovel was
depreciated at $30,000 per month. At an industrial auction, it sold the shovel for $2,000,000. On the
2013 Income Statement, this sale transaction will be presented in one line—namely Gain on Sale of
Assets $170,000.

What is notable here and how did we get the figures? Two aspects are worth pointing out. First, the sale
of a shovel is not Remco's main business. Mining coal or copper or some other ore is its core activity.
The shovel is "an asset held for use in the business." The second aspect is that since selling a shovel is
not core activity, we do not report the sale price (no revenue) nor the carrying value at time of sale (no
cost); instead we just disclose the net effect which is a gain in this case.

The figures are worth exploring. The sale was 39 months after Remco bought the Hitachi EX2500. During
that time, Remco depreciated the shovel by $1,170,000 (39 months × $30,000 per month). At sale date,
the asset would be shown on Remco's books by two figures—Asset Shovel $3,000,000 and a contra
(opposite sign) of $1,170,000 accumulated depreciation. The net of these two is $1,830,000 and is called
the book value or carrying value of the shovel at its disposal date. With a sale at $2,000,000 you can see
how a gain of $170,000 took place. We have one used asset disposed of at $1.83 M and asset cash of
$2.00 M received.
Before we leave this topic, observe that a gain took place in this case simply because the depreciation
recorded turned out to be a touch too much. The opposite can just as easily take place. If Remco's
management had felt that $24,000 per month was a reasonable estimate of depreciation then on sale
date, the shovel would be at a carrying value of $2,064,000. The shovel would still fetch $2 million at
auction and thus Remco would show a line "Loss on disposal of asset $64,000."

As you can see, lower depreciation may very well make the Income Statement more profitable (here by
$6,000 per month) but eventually a price is paid (here a loss instead of a gain on disposal). These figures
often reflect the fact that it is difficult to estimate both the life and the residual of any long term asset;
gains or losses on disposal are far more likely to take place than any chance of happening to depreciate
an asset over many years to what turns out to be its exact disposal value. This observation applies to any
industry employing considerable long term assets—i.e. capital intensive.

For example, two major American airlines depreciated their Boeing 747 aircraft over 10 and 15 year
periods. This particular model of plane continued to fly well in excess of 20 years. Accordingly,
companies selling their planes before the true life had expired usually experienced significant "gains on
disposal." This form of income (or loss in some cases) is not related to the current year's operations, but
rather to depreciating at rates that were either too conservative or too optimistic in past years.

Where depreciation is not involved, we still see disposals of long term assets. Land or shares in another
company are examples. Here losses could exist but we are more likely to see gains. Look at Exhibit 13
(below left) Newmont Mining Corporation. This is their 2012 Income Statement which has a line "other
income, net (Note 7) $278 million." Exhibit 14 (below right) is this Note 7 which incorporates 11 lines,
two of which involve the gains we discussed—one on sale of assets and the other on sale of some
investments. You can see the analytical advantage of having this form of peripheral income (usually not
intended but quite present) disclosed separately on the income statement.
Exhibit 15 is the Consolidated Statement of Earnings for Cameco Corporation , a major uranium mining
company. Notice here the presentation of a line "Loss (gain) on sale of assets" of around $1.7 million
loss in 2012 and $7.6 million gain in the prior year. Here the data appears directly on the statement with
no Note clarification. A reminder here: we do not see the selling price and the net book value of the
item being disposed—just the net gain or loss. Nevertheless, we are able to isolate these gains from all
other sources of income for Cameco, or indeed any company.
Impairment Charges

In boom times we see companies expanding rapidly and the presence of enough profit that worries over
incorrect asset values tend to be secondary. But with the onset of troubles, a downturn in commodity
prices or indeed in the whole economy, we are prompted to ask "Do we have any assets at significantly
overvalued figures?" This got asked a lot in the recent downturn of 2008 and onward. The outcome of a
"yes" is a requirement to book some unpleasant charge—an "impairment" expense on the Income
Statement and a reduction of asset value on the Balance Sheet. No cash flow is taking place but there is
certainly a wealth change for shareholders. The earnings per share (EPS) is dragged down and the book
value of a share is similarly affected. As you can imagine, with retained earnings and thus total equity
taking a downwards hit, we then see debt to equity ratios negatively impacted.

These charges can be quite immense. Furthermore, the company's auditors will be insisting on the
recording of impairment charges. An omission could give rise to a serious case of negligence against a
company and its auditors. Hence we spend a moment on this matter to get you familiar with concepts
that are not that well understood by many.

Generally on an annual basis, a company is required to compare the carrying value (the book value on
the company's own books) of any (group of) long term assets with what is called the "recoverable"
amount. That recoverable amount is the higher of the "net realizable value" today and the "value in
use." The current net realizable value is what amount the company would receive on an immediate (but
not distressed or hurried) sale to an unrelated and knowledgeable party. The value in use is a broader
term taking into account what cash flows the company is going to receive in the planned future using
the asset in question. A numeric example will help here.

Assume that our fictional mining company Remco, has a large bucket wheel excavator (BWE). Assume it
was bought at start of the year 2005 for $40,000,000 and is being depreciated straight line to zero over a
20 year period. That means that at year end of 2012, the BWE has been in service 8 years (not 7) and
would be on the books at a net figure of $24,000,000 (appearing as a cost of $40M with a contra
account of $(16M) called accumulated depreciation). At 2012 year-end we ask "is this asset over-valued
at $24M?" The two alternative measures we need are net realizable value and value in use. Though
these BWE's are not very portable, we assume here that at its geographic location, a net realizable value
for Remco's BWE is $21M. Without further investigation, we would conclude that Remco has an
overstated asset and would be booking an impairment charge of $3,000,000 (the amount needed to
reduce the carrying amount from $24M down to the recoverable amount of $21M).

But note that we have said recoverable amount is the higher of two concepts—the net realizable value
and the value in use. This second term represents the current value of the sum of all the anticipated net
inflows of cash that the bucket wheel excavator will bring in during the remaining 12 years of its life.
Estimating this involves many factors but the accounting process is most certainly allowed and usually
gives a figure that is higher than net realizable value. In our case here, we will assume that the value in
use amounts to $36,000,000 (this could be 12 sets of $3.0M per year, or uneven cash flows of increasing
amounts from, say, $2.6M per year to over $3.4M per year). Now we have data to conclude that the
recoverable amount at $36,000,000 exceeds the carrying cost (asset amount on the books)—i.e. we do
not have an overstated asset and thus no impairment to book.

Note one significant difference between American and International accounting standards. The
International standards insist that the value in use be the present or discounted value of the future cash
flows. This is always lower than the US undiscounted figures and thus more conservative—some might
argue simply more realistic. In our case above, let us assume that no discounting had taken place. Now
additionally we assume a need to discount the cash flows at say 5% per year. The stream of 12 annual
payments of $3.0M per year has a present value of $26.6M—a figure that is far closer to our carrying
value of $24M. Notice that if say a 7% interest rate was used, then the future cash flows would be
discounted to $23.8M and we would indeed have an impairment charge. You can imagine the
occasionally quite heated argument over how low a discount rate the auditors would allow a company
to use where the company is valiantly attempting to shore up the value in use.

How large can these charges be? Look at Exhibit 16 Lundin Mining Corporation's Consolidated
Statements of Earnings for 2012. Here earnings before income taxes and before the impairment charge
of over $67 million were around $213.9 million. The impairment that year reduced the earnings by over
31%. This impacts EPS and of course the book value and thus market stock values. Lundin was just one
of many mining companies that have recorded significant impairment charges in recent recessionary
times.
Finance Costs and Leverage

A major corporate decision affecting virtually all ongoing companies is how much of the company's
undertakings should be financed through borrowed funds. No doubt borrowing at, say, 6% and earning
returns on assets employed at, say, 15% tempts one to use "other people's money." In this example,
assume we have productive assets of $4,000 financed with $1,000 of shareholder money and $3,000 of
borrowed money. Here, we would initially earn $600 (15% of $4,000), pay the borrowers an interest cost
of $180 (6% of $3,000), and reward ourselves as shareholders with the remaining $420—a rather
attractive 42% return on our equity of $1,000. Needless to say, we might be considered lucky to have a
spread of 9% (the 15% return less 6% borrowing costs) and most fortunate to locate a lender who can
live with our 300% debt/equity ratio. The example is clearly a mild exaggeration but it should lead one
to see that knowing the finance or interest cost as a separate line item is an important part of any
overall analysis. Seeing this figure is easy—disclosure as a single line figure is compulsory.

Look at Exhibit 17 Peabody Energy's Consolidated Statement of Operations. Here we see the Operating
Profit (before interest charges) and immediately below a line named "Interest expense." Note how for
2010 and 2011 the cost of borrowing money was easily absorbed by the much larger operating profit.
However in 2012, the much lower operating profit (still positive at $172.5 million) was exceeded by the
interest charge of $405.6 million resulting in an overall loss for the year. Such are the perils of using
borrowed funds. The increase in interest charges for 2012 over previous years is highlighted by the
three-year comparative figure presentation (the 2012 figures reflect debt to finance the acquisition by
Peabody Energy of a competitor, namely the Australian firm Macarthur Coal Ltd. in late 2011).
Here the point is that the two GAAP requirements—namely separate disclosure of interest expenses and
the presentation of comparatives—can provide readers of financial statements with a critical viewpoint
that would otherwise be masked. We are prompted to examine quite separately why operating profit
dropped dramatically (2012 is an 89% drop from 2011) and why interest charges increased by 70%.
Recall that these are separate items with a cumulative effect.

Of course a high debt to equity ratio will involve significant interest expense, but exactly what impact
depends on not only the absolute dollar figures of debt but also the rates being charged by the banks or
other financiers. As you can imagine, at high rates (say in excess of 10% per annum) finance charges on
even a moderate borrowing could be quite crippling if net income pre interest is below average. A useful
ratio here (discussed in detail later in Part 3: Statements of Cash Flow and Changes in Equity) is "times
interest earned."

Income from Investments

Normally, companies earn their profit from selling food, or mining iron ore or flying people—either
items they sell or services they provide. Another source of income is simply buying and holding shares in
other companies that conduct the business. In mining (as in other industries) we see dozens of instances
of major companies taking a stake in their competitors, suppliers or even customers. When that stake
involves actually controlling another company, then the target company is called a subsidiary and its
operations are included (consolidated) with those of the main company. Often the decision to invest in
another company involves various successive purchases as the shares (of the target) become available.
One accounting rule here is that if company X does not control company Y then X's profits or losses in
owning some of Y get reported as a separate line item.

You can see the benefits here. We can judge whether the investment in another company is itself a
worthwhile venture, possibly earning proportionally more (or less) than the company is earning on its
core business assets. Furthermore, we may see some form of vertical integration taking place as a
company moves to invest in a supplier.

Exhibit 18 is the 2012 Consolidated Statement of Operations of Kinross Gold Corporation , a Canadian-
based mining company with gold interests in several countries. This company suffered substantial losses
on its own operations and on operations of a company it partially owns. We can see a line labelled
"Equity in losses of associate (6.5) million." Furthermore Note 7 of the Kinross 2012 financial statements
clarifies this loss as coming from owning a 25% interest in the shares of Cerro Casale, a gold operation in
northern Chile. When a company (called the investor) has an investment of 20% or more of the voting
shares of another company (called the investee) but not sufficient to provide control, then it is said to
have "significant influence." When this takes place, a method called "Equity Accounting" is used that
reflects, to some extent, the earnings or losses of the target company. The loss highlighted in Kinross
Exhibit 18 is an example of equity accounting.
The use of this method must be disclosed to readers in the Note entitled "Summary of Significant
Accounting Policies." It is not a requirement to disclose the names of the investee but several larger
mining companies do so. An excellent example of useful disclosure is offered by Goldcorp Inc. You will
see in Exhibit 19 an excerpt of Note 3 in which Goldcorp clearly outlines the accounting methods used to
reflect earnings or losses from some 17 entities over which it has either control or significant influence.
It is to be hoped that this kind of detailed presentation will eventually be mandatory.
A company does not have to have 20% or more of a target company to benefit from an equity
investment in the common shares of the investee. Holdings of under 20% can still produce a dividend
flow for the investor and appreciation of the share value of the investee. The fact is that the (smaller)
investment is regarded as requiring less stringent accounting rules. For these investments we simply
count dividends received as a form of investment income AND we count appreciation of the share value.
This is normally called the Cost method of recording an investment. Exhibit 20 displays the relevant
portion of Note 1 of the Peabody Energy Corp's year 2012 Financial Statements. Notice that Peabody is
using both methods since it has varying levels of ownership in its associates—cost and equity. From this
note you may have concluded that the equity method is a bit more involved than what you see here in
the two paragraphs above. There are requirements to take into consideration (such as the flow of goods
or services between the investor and investee) that render this subject quite complex. The accounting
rules for investments in other companies can easily form the subject matter for an entire course and are
thus not pursued further here.
Comprehensive Income and Net Income
Comprehensive Income

A relatively new concept (within the last decade) is the idea of reporting some wealth increases under a
title of "Other Comprehensive Income"—increases to equity that previously were either not counted or
counted in the "regular" Income Statement. Consider two examples from, say, one's own personal
finances.

1. Assume you own a home (a house or apartment). Assume you bought it Jan 1, year 1 for $300,000.
Over a long time period, we can assume that real estate increases in value. Now assume that from Jan 1,
year 4 to Dec. 31, year 4, your home went up in value from $410,000 to $485,000. Is this $75,000
increase in your wealth really part of your earnings or net income for year 4? Some argue "yes" since
you really can sell at year-end for a figure clearly higher than at the beginning of the year. Others argue
"no," offering the thought that all properties are now more expensive and that in "real" terms you are
no better off. And surely the tax department does not tax you on any increase in the value of your
(unsold) principal residence.

Accounting standards have evolved to the point now where this kind of increase in value is deemed to
be real and recordable but not quite of the same nature as earning a profit from revenues less
expenses. It gets put in a relatively new category called "Other Comprehensive Income (OCI)." You are
already asking "Does this end up in earnings retained by the company on the Statement of Financial
Position?" No, and it is not part of the amount available to pay dividends to shareholders. However,
since it arises from stating some properties at increased values, there has to be some balancing item in
the Equity section. The name is self-explanatory—Accumulated Other Comprehensive Income—and
should hint that this is the account that accumulates or totals the income of this nature reported over
several years.

2. Another example could be our company's ownership of some passive investment in a parcel of land
in another country. We assume that this investment of, say, $100,000 CAD was made in Europe at the
start of a year when the exchange rate was $1.00 CAD = 0.70€. Our land was bought in, say, France for
70,000€. A year later, the land could be worth still around 70,000€. In other words there has been no
increase to our land in France measured in the local currency—euros. But exchange rates may have
altered quite significantly. Assume a year-end rate of $1.00 CAD = 0.65€ (this is equivalent to $1.53 CAD
= 1.00€). This clearly means the euro has become more expensive or put another way, the Canadian
dollar has depreciated.

Our land at 70,000€ could be sold and the euros exchanged to yield $107,692 CAD. Question: does this
increase of $7,692 represent a change in our wealth? Answer: yes! So should it be on an income
statement? And if so, as part of regular income or part of some special category—again that new
classification "Other Comprehensive Income?" It gets tricky here. Though more rules may add
complexity, it may be wise to have more than one possible answer. It turns out that intention is a critical
component.
If we have no intention of selling the land for a while, then this "gain" is really quite tangential. Similar to
our house/apartment example, we show the asset as worth more in the domestic currency (the
Canadian dollar, in this example) and balance it with a recognition of a line called exchange gains as part
of Other Comprehensive Income. This treatment is all the more justified when we contemplate that our
gain might very well disappear in year 5. This subsequent year might very well see the Canadian dollar
recover thus negating a gain that we had booked as earlier arising from investing in euro-denominated
land. In our land example, it was the long term nature of the investment that led to a classification as
"comprehensive" income.

We should note that certain foreign exchange gains and losses are included in the regular determination
of net income. In contrast to our land example, assume our company is in the precious metals business
and sells 1,000 ounces of silver on Nov 15 year 4 at $20.00 per ounce to a United Kingdom buyer for
payment in pounds sterling Dec. 30. Here we book the sale and the receivable at exchange rate in effect
on date of sale—say $1.58 = £1.00 leading to a sale on our books at $20,000 CAD (but the contract calls
for us to accept £12,658—not Canadian dollars). Now assume that on payment date the UK pound has
deteriorated to $1.52 = £1.00. Our buyer now pays us the £12,658, and we go to our bank to change it
to $19,241 CAD. Impact here? We have an asset called accounts receivable on the books at $20,000 but
we only got $19,241 to extinguish it. The loss of $759 is real, is due to completed matters and is very
much part of our regular net income—not considered as an Other Comprehensive Income component

The above should trigger you to think that a company may very well have foreign exchange gains or
losses appearing in both its regular Net Income (or Profit and Loss) section and its Other Comprehensive
Income section. Does this discussion mean there are really five reports (not four) put out by companies?
No, but nearly yes! The requirement is to report a Statement of Comprehensive Income. The standards
are quite clear here. A company can choose to present this as one big statement (maybe all on one
page) or as two parts, called Statement of Earnings (or confusingly Statement of Income) and then a
Statement of Comprehensive Income. The final or "bottom line" of the first statement is repeated as
being the main source of income in the full broad view of the entire comprehensive income. You can see
this in Exhibits 21 and 22 (below) of Teck Resources Limited.
Note how the first statement (Exhibit 21, above left) has a so-called bottom line called "Profit for the
Year" at $870 million. This figure reappears as the first component of Exhibit 22. The next line is a title
for the four sources of other comprehensive income that Teck happens to have experienced in years
2012 and 2011. You can see the largest of these four is an adjustment to the Teck pension plan. Many
companies are experiencing pension losses as we restate upwards the present value of future pension
liabilities and restate downwards the expected returns on pension plan assets (the invested pension
funds)—both due to much lower interest rates than were the case in the opening years of the decade
2000–2010.

To reiterate two income concepts, we note that the Teck EPS is based on the $811 million that is "profit
attributable to shareholders of the company" (Exhibit 21, above left) whereas the increase to
shareholder's book values is the $687 million entitled "Total comprehensive income attributable to
shareholders of the company."

A complexity that nevertheless should be explained is the treatment for an investment using the so-
called cost method. Recall that this is used when an investor has less than 20% of the common (voting)
shares of the target or investee. Here both American and International accounting allows the investor
company to call the investment "Held for Trading" or "Available for Sale." The first classification is for
shares that will likely be sold fairly soon. Changes in value hit the Profit and Loss Statement—and thus
the net income figure and accompanying EPS. Despite its name, the second classification is for
investments that are essentially long term. Any changes in value here are considered as an item of Other
Comprehensive Income (OCI). But once they are actually sold, any gain (or loss) that was reported in OCI
becomes crystallized or real and gets transferred from OCI to the regular Profit and Loss.

You can see this item in Exhibit 23 of Boliden AB, a Swedish company involved in mining zinc, copper and
precious metals in mostly Sweden and Norway. The item related to the above is "Transfers to the
Income Statement −201 million SEK"—a negative transfer. Unfortunately on the regular Income
Statement, the positive 201 million SEK is buried along with other matters. But at least from the OCI
report we know that this figure changed from being a gain built up over several years and included in
OCI to a gain that required immediate full recognition in the regular income of 2012.
Ratios Related to Income

Though companies have been using the concept of comprehensive income for a decade now, it is
interesting to note that income-statement-based ratios still centre on the "normal" or narrower concept
of net income and exclude the OCI element. Two frequently encountered ratios are the gross margin
ratio and the net margin ratio.

Gross margin is defined as revenues less cost of sales. The gross margin ratio is the gross margin (in
dollars) divided by the sales. This used to be a commonly employed measure of performance at a first or
initial level. In some industries, the ratio is highly revealing. Retail and wholesale operations are
particularly suited to this ratio analysis. But manufacturing and mining distinctly less so. Recently we are
seeing two reasons for being cautious in the use of this ratio—namely:
  content concerns, and

 disclosure requirements.

The content issue is a matter of deciding what is included in the cost of sales (also called the cost of
goods sold). In mining and heavy manufacturing (such as the automobile or aircraft industries) we see
capital intensive operations—i.e. a high investment in machinery and information systems. You may
recall that the depreciation on these can be treated as a product cost (called inventoriable cost) or a
period cost expense directly. Similarly certain management costs related to production can be
capitalized to inventory or expensed. You can see where we are going here. Any company that
capitalizes many of its production expenditures and/or its depreciation will have significantly higher cost
of goods sold and lower gross margins than a company choosing to expense such items. Providing
inventory is sold in a timely manner, both companies will show a comparable net income but the
makeup of the income statement will be such that comparisons between one firm and the other are
either invalid or require considerable adjustments from information that may be available in the notes.
Exhibit 24 (above right) displays this problem. This exhibit also illustrates the second ratio oriented to
net income.

Net margin (ratio) is defined as net income divided by sales. This bottom line figure can be used to
compare companies of different sizes with much more confidence than gross margin ratio. Essentially all
the revenues and expenses are included in the net income figure. The minor and often trivial exception
will be the handling of gains or losses that might either appear in the net income statement
or not appear because the company is treating them as Other Comprehensive Income.

Turn to Exhibit 24 (above right) which displays the two ratios. Note that Company E is around twice the
size (in sales) of Company C. See how the gross margins of the two companies are quite different at 48%
and 65%. Yet the net margins of these two firms are the same at 15% each. This should prompt us to
analyze the composition of the Cost of Sales (COGS). You can probably spot the major differences.
Company C is capitalizing a lot of its depreciation and some of its administrative costs (such as
production related management salaries. In contrast, Company E is using a sparser policy of what gets
included in Cost of Sales. Here at Company E, we see Administration and Depreciation costs that are
much larger than double the figures at Company C. In short, the sales figures and the net income (pre
tax and after tax) are comparable reflecting that Company E is double the size of Company C. But any
conclusions as to efficiency at the gross margin level are simply void.

The second and more persuasive reason for the diminished importance of the gross margin ratio is
simply that International accounting rules allow companies to include cost of sales with other expenses.
In other words, the presentation of an income statement containing no gross margin stage is
permissible. Thus inter-company analysis is a time consuming task centering on extracting what
information is available in the Notes. Gross margins may just not be determinable.

In contrast, net margin analysis is more valid and quite revealing. One caution however: net margins can
mask certain complicating factors such as comparing companies that are highly leveraged with ones that
are operating with a high proportion of their own equity. Nevertheless, net margin is oriented to the
bottom line figure and can give information that can be used in comparisons both across time and
across a spectrum of mining firms. We discuss this further under Tools in Part 3: Statements of Cash
Flow and Changes in Equity.

Exhibit 25 displays data for six large companies with operations in many countries. You can see the
volatility of this ratio—one that will mirror buoyant and recessionary times in the mining sector.

In summary, you probably have noticed the presence (in the mining company exhibits) of many line
items that are just not explained in this session. Several of these could easily require an entire chapter
each. So, be warned. We have a few basic concepts in place, but for details you need to pursue other
more advanced sources.

You have covered the following points in Part 2: Statement of Income.

 details of what is included in the Income Statement

 sales

 cost of sales

 depreciation and depletion expense

 income taxes

 peripheral items that are common but not necessarily present in the Income Statement

 gains and losses on disposal

 impairment charges

 finance costs (interest expense) and leverage

 income from investments

 types of income
Part 3: Statements of Cash Flow and Changes in
Equity
The Cash Flow Statement
You will cover the following points in Part 3: Statements of Cash Flow and Changes in Equity.

 details of the Cash Flow Statement

 operations

 investing activities

 financing activities

 details of the Statement of Changes in Equity

 non controlling interests

 shares

 hybrid securities

 the notes to Financial Statements

 analytical tools

Overview

The Cash Flow Statement is a financial report informing us what overall cash was generated and what
was used up for a period of time—usually a year. The report has three sections, namely:

 operations—cash from core business activities;

 investing—cash related to acquiring and disposing of long term assets; and

 financing—cash related to acquisition and payment of long term debt, issue and redemption of
shares of our company and dividend payments.

In addition, there appears the opening and closing cash balances at start and end of the period.
Why have this third report? There are basically two reasons. One is that the Income Statement is not a
good indicator of what actual cash was generated from operations in the year. The other is that some
transactions use or provide a huge amount of cash but just do not appear on the Income Statement.
Let's address the first observation.

Accrual Based Income vs. Cash Flow from Operations

A company might report net income of $7,000 derived from revenues of $82,000 and expenses of
$75,000. But, among the expenses, there might be $5,000 of depreciation. This appears on the Income
Statement because some asset is being worn down and yet no cheque was written. If the depreciation
had not been recorded, the net income would be $12,000 and a lot closer to the actual cash being
generated in the year. Whenever we see a Cash Flow Statement that has the Operations section starting
with the net income, then we expect adjustments for depreciation. Indeed we expect adjustments for
any other similar expenses that require no cash outlay. Other examples are the amortization of a patent,
the impairment charge related to an overvalued smelter, and the payment of a portion of remuneration
done through issue of options on the company's shares or the shares themselves.

The non-cash expenses are not the only source of adjustments. On the Income Statement we record
both revenues and expenses on what is called an accrual basis. This is recognition at time of service
performed (a sale) or consumed (an expense) rather than on payment dates. Thus a credit sale of $1,000
made in, say, late November will appear on the Income Statement but the cash may not be received
until Jan. 3 of the next fiscal period.

Relating to the sales example above, the trick here is to see whether the accounts receivable balance
has changed from one year-end to another. If the receivable balance is $9,000 at Dec. 31, 2011 and is
$11,000 at Dec. 31, 2012 then we conclude that $2,000 of sales made in the year have not been
received in the bank. On the Cash Flow Statement we will see an item in the Operations section stating
"less increase in accounts receivable."

In reverse, the same sort of thinking can be applied to accounts payable. Here a firm may record a fuel
expense of $50,000 in early December and not have to pay for it until, say, January or even early
February of the next year. In this case the expense of $50,000 is a year 1 item but the cash flow is a year
2 cheque. The receivables and the payables are two prominent examples of any non-cash changes to
current working capital—the current assets less current liabilities seen on the company's Balance sheet.
Changes to both inventory levels and to prepaid expenses are two more examples of what companies
often lump together under the title "non-cash working capital items."

Exhibit 26 is the Cash Flow Statement for Teck Resources Limited , a Canadian-based firm involved in
mining chiefly coal, copper and zinc. Note how the Operations section starts with a net income of $870
million, but after various adjustments comes to a total of $2,795 million. You can see that the
depreciation alone is an adjustment of $951 million. On the Teck CFS, the changes to accounts
receivable and other current asset and liability balances appear in that final Operating line called "Net
change in non-cash working capital items" and amounts to negative $388 million. No doubt this list of
various adjustments (over a dozen in the Teck CFS) is a bit daunting. Suffice to say that they are all
present to convert a net income figure to what cash has actually been deposited to and withdrawn from
the bank.
Our second reason for producing a Cash Flow Statement is the presence in the year of many significant
transactions that are not classified as income related—at least not at the time of the transaction. They
appear on the CFS under either of two headings—Investing and Financing. Click on Exhibit 27 to see the
CFS of Newmont Mining Corporation , an American-based multinational gold producer with significant
assets or operations in the United States, Australia, Peru, Indonesia, Ghana, Canada, New Zealand and
Mexico.
The Investing Activities

Recall that we pointed out that a CFS reveals movement of cash that is quite separate from income
reporting. For example, the transaction of purchasing a $300,000 CEC portable Cone Crusher (mining
equipment) will use considerable cash but not affect the income statement at time of purchase. The
Investing section is reserved for all outflows and inflows of cash related to the purchase and sale of long
term assets. You can think of a sale as disinvesting. Thus any changes to long-term assets that involve
cash flows will be found here, including changes to property plant and equipment, intangible assets and
investments in the securities (shares and bonds) of other companies.

On the Newmont example, we see three years of disclosure. In their latest year, note the outflows of
over $3.2 billion mostly on property, plant and mine development. We also see that Newmont derived
$210 million from the sale of marketable securities and spent $220 million on other similar securities.
Generally this will be for shares in competitors that the purchaser may eventually use to acquire
significant influence or even control over the investee.

The Financing Activities

All changes involving cash flows that affect long term debt and the share capital of a company are
divulged in the financing section of the CFS. Examples include receiving a bank loan, issuing a bond,
issuing a mortgage and issuing common and preferred shares. These examples are clearly inflows. The
opposite transactions involving payment of debt and redemption (buy back) of shares are outflows and
are also to be found in the Financing section.

This is the section where dividends paid to our company owners (shareholders) is usually found. Careful:
here we have differences between American and International GAAP. The US standard offers no
alternatives—any dividends paid are always reported in Financing. In contrast, International rules allow
dividends paid to be reported in either Financing or in Operations. The IASB thinking here is that a
company can finance itself through debt or equity. The annual cost of debt is interest and is reported in
Operations (for both US and International GAAP). The annual quasi cost of equity is a dividend flow.
Thus the IASB is allowing the annual charges related to these two methods of financing a business to be
reported in the same section—Operations. Lesson? If the company is using International standards, then
look at both Operations and Financing to spot any dividend flow to the company's shareholders. In the
Newmont case (American company) we spot the dividend cash outflow in Financing and see substantial
increases for both 2011 over 2010 (101%) and 2012 over 2011 (another 41%).

In the Newmont (year 2012) example, we see examples of both new debt undertaken (bringing in cash
of $3.5 billion) and payment of old debt (outflow of almost $2.0 billion). There is also a small cash inflow
at $24 million for issue of common shares. Three years ago in 2009 (not shown in Exhibit 27, above),
Newmont had a share issue with an inflow of $1.3 billion. There tend to be intervals of a few years
between large share issues that reflect a substantial increase of invested equity. In contrast, the $24
million commented on above is typical of lesser amounts of cash inflow from ongoing exercise of stock
options granted to management.

CFS Related Comments

1. It is worth noting that a company that produces abundant cash from its core operations may very well
be able to fund its investment activities without increasing either long term debt or issued share capital.
Here we would see amounts of roughly the same size but of opposite directions in the Operating and
Investing sections, with little if any activity in the Financing sections.

2. Where a company is suffering severe operating losses, the Cash Flow Statement allows us to see where
the interim cash to survive is being raised. Maybe some long-term assets are being disposed of or the
company is increasing borrowings. In dire circumstances, the investing public may not be interested in
providing loans. Then issuing shares (usually at some lower than desired price) may be evidenced in the
Financing section of the CFS.

3. The CFS is naturally concerned with the movement of cash. But, some transactions simply do not
involve cash. For example, a large loan may get settled by issuing shares. Another example is the
conversion to shares of a convertible bond. This would give rise to cancellation of debt (the bond) and an
issue of the shares to which a bond holder is entitled.

In these above cases of material transactions involving no cash, GAAP requires disclosure in the Notes.
Here American and International standards are similar. Any transactions involving changes to debt or
equity that do not involve actual cash flows must not appear on the CFS and must be adequately disclosed
in the Notes. So if we see, on the Statement of Financial Position, a large shift in, say, long-term debt, but
do not see this in the Financing section of the CFS, then we should be prepared to read in the Notes of a
transaction that involved no cash. A dated but superb example of this kind of disclosure is seen in Exhibit
28 (above right) which is Note 19 of the 2007 Financial Statements of Lundin Mining Corporation . The
acquisition of Tenke Mining Corporation by Lundin involved spending $60,000 in cash and issuing Lundin
common shares valued at $1,330,820 or essentially around $22,000 of its stock for every single dollar of
cash. The same Exhibit 28 shows that in 2006, Lundin made a similar purchase. It was financed with the
issue of over $1.6 billion in shares. Elsewhere in Note 5 (not shown here) Lundin disclosed that this slightly
larger purchase was even more leveraged using only $50,000 cash. In short, here is an acquisition whose
disclosure is in the Notes, not the Cash Flow Statement. Observe the title—"non-cash financing and
investing activities."
4. Many companies preparing a CFS refer to "cash and cash equivalents" and call this their definition of
cash. What they mean here is that the CFS will treat certain very short term temporary investments in
sound debt instruments (maturing in 90 days or less) as being the equivalent to cash. It makes sense. A
company may not want to keep, say, $1 million in a bank chequing account when it can earn a small but
significant return placing the cash in so-called commercial paper. The shortness of the debt maturity is
supposed to ensure that the company has these resources as readily available as cash. The unfortunate
financial crisis in the fall of 2008 has made this assumption a shade less reliable than before. Nevertheless,
the definition of cash and cash equivalents remains as we have outlined.

5. Many companies are in situations where interest paid to banks or other creditors can be partially
capitalized (become part of an asset such as a newly-developed smelter). Here, the total interest paid by
the company during the year (cash outflow) might be much larger than the interest capitalized or the
remaining interest expensed (appearing on the Income Statement). As you might guess, GAAP requires
that any cash outflow for interest, whether expensed or capitalized, appears on the CFS. Comparing this
CFS figure with the interest expense is a quick way to decide whether the difference warrants reading
Notes on just what caused the interest capitalization. Now companies are required to disclose what cash
outflow for interest got capitalized in the year. This can be on a financial statement or in the notes. Exhibit
29 (right) is Note 6 of BHP Billiton's 2013 Financial Statements. Here we see that Financial expenses are
reduced to $1.5 billion by the line reading "Interest capitalised $(273) million."
In conclusion, the Cash Flow Statement provides investors and creditors with information that is
organized in a functional and cash-oriented manner. With some knowledge and patience, one can
usually construct a CFS from a comparative Statement of Financial Position and an Income Statement.
However, having the CFS available is clearly a useful tool to judge the nature and size of the cash flows
for the period. The relative sizes of the totals of the Operating, Investing and Financing sections is often
an indication of the financial health of the company. Hence, it is a mandated member of the four
compulsory statements.

The Statement of Changes in Equity

The Statement of Changes in Equity is a report that focuses on each major element of the shareholders'
ownership portion of the Statement of Financial Position. It gives opening balances, changes during the
year and closing balances for such items as common share capital, preferred share capital, additional
paid in capital (sometimes referred to as contributed surplus or share premium), share options and
warrants, retained earnings and accumulated other comprehensive income. The payment of dividends is
usually found here as well (though International standards allow this to be alternatively disclosed in the
Notes with corresponding adjustment to retained earnings).

In earlier times, the main change to a company's equity from year to year was the change to retained
earnings, through additions due to net income and reductions due to dividends (and losses). Indeed over
a decade ago the Statement of Retained Earnings was the main fourth report required by both American
and International GAAP. However we now see many companies issuing more shares to raise capital on
an ongoing basis rather than relying solely on the initial shares issued. Others have done the opposite,
buying back (redeeming) shares when this is considered appropriate. Furthermore, particularly in the
mining industry, we see increased use of stock options as a form of remuneration for both management
and other employees and as a form of payment for goods and services provided by those who are willing
to accept equity (instead of cash).

Coupling these above developments with the recognition of Other Comprehensive Income and the
associated balance sheet item Accumulated Other Comprehensive Income, we have a large array of
changes to the general ownership of a company. No longer is it sufficient to just report on one
component (the retained earnings).

Stratum Exhibit 30 displays a simple two year Statement of Changes in Equity. Here we can see various
changes that account for the overall shift in total Shareholders' equity from $952,500 to $1,412,350. It is
worth going through this example in some detail and tying certain items to concepts we have discussed
in earlier sessions. First, note that the format has time on the vertical scale starting from the beginning
of the prior year to the end of the reported year. We see, spread horizontally, the various components
of shareholder equity in this simplified example. Later, we see corporate examples with more currency
columns—say, one for preferred shares and another for options on common shares. This format is not
mandatory and indeed a few companies place the items (accounts) vertically and have time horizontally.
One can see examples of each.

1. Format: notice how the first number column (in italics) displays the number of common shares
issued and outstanding. Most companies display this figure to the nearest unit. All other figures (dollar
amounts in our example) are in units or thousands or millions.

2. Shares and issuance: from column (b) we can see what the average cost of shares is at various times.
For example, as of the beginning of 2011, the average price paid by an investor (in earlier years) for a
common share is $11.20 ($392,000/35,000 shares). Furthermore, the average issue price on 28
February, 2011 was $32 ($480,000/15,000 shares). This difference should not surprise us. As of the end
of 2010, the company had built up retained earnings and accumulated other comprehensive income of
$488,000 and $72,500. The total equity at the start of 2011 was thus $952,500, or $27.21 per common
share. Thus, a new issue of an additional 15,000 shares in February was likely to command at least the
book value of a few weeks ago—hence the success in selling an issue at $32 per share.

3. Shares and redemption: in year 2012, we can assume that the market price (stock market listed
price) fell a bit for whatever reason, and that management felt that this was a good opportunity to
redeem (buy back and cancel) some of its shares. This is allowed in many jurisdictions but only with prior
approval of various authorities regulating the capital markets. We should point out why various
regulators have a say in allowing a company to buy back its shares. That move shrinks the capital of a
company, affects the debt/equity ratio and is thus of legitimate concern to creditors (suppliers and
lenders). Various tests have to be met before a company is given a green light to purchase back and
cancel some authorized portion of its outstanding share capital. Notice here that the average price the
company had to pay investors is $29, but it is shown (usually) as a reduction of the share capital
account at the average on the books on that date which here is $17.44 ($872,000/50,000 shares) and a
reduction of retained earnings (in this case a further $11.56).

4. Dividends: some companies show dividends in a separate "dividend" column, but the Stratum
format of Exhibit 30 (above) is more usual. We see dividends of $62,500 and $52,000 paid out in years
2011 and 2012. The amount per share may be disclosed right in the table (done here) or you may have
to find it in the Notes. A common share dividend is normally set at some dollar figure and paid on all
common shares regardless of whether some of them have been outstanding for several years or just
several weeks.

5. Retained earnings: column (c) shows the changes to retained earnings that arise (i) from net income
(the ordinary income thus excluding "other comprehensive income"), (ii) from the payment of dividends
and (iii) from any retroactive changes due to accounting that calls for retroactive restatement (a change
in accounting policy) or a restatement due to prior errors. In Stratum Exhibit 30 (above) we have no
effects of restatement shown—a normal case.

6. In column (d), we see the accumulation of each year's Other Comprehensive Income. Recall that this
involves revaluations that affect items on our Statement of Financial Position (Balance Sheet) but not in
our regular Income Statement. In this example, we see a positive revaluation in 2011 and a negative one
(possibly due to a shift in exchange rates) in 2012.

7. Finally, column (e) gives us total equity of the company through time. With no preferred shares
existing for Stratum Mining, this column happens to be also the total book value of the common shares.
At year end 2012 we can determine the book value for one share to be $35.31 ($1,412,350/40,000
shares).

Go over Exhibit 30 (above) and the accompanying explanation at least once. You can now carry your
understanding of this relatively new financial statement to examples drawn from the world of mining. As
you may surmise, examples from established mining companies will involve more equity categories.
Click on Exhibit 31 to see the Statement of Changes in Equity of Barrick Gold Corp. , a Canadian firm
that is currently the world's largest gold mining company. This particular example is a clean, simple
statement that is only mildly more complicated than our explanatory Stratum Mining example (Exhibit
30) above. Note that on the right side instead of having one total for overall equity, there are three
columns: (i) equity for Barrick shareholders, (ii) equity for non controlling interests and (iii) total equity
for both groups of investors. We hope you realize what this means. It indicates that the main (parent)
company, Barrick Gold Corp., has investments in less than 100% of some of its subsidiaries. For example,
it owns 75% of the subsidiary Cerro Casale project—a huge gold mine in Chile.
Non Controlling Interests

Consolidated reporting (which always takes place when a company controls one or more subsidiaries)
involves showing 100% of the assets and liabilities of the parent company and all controlled subsidiaries.
Where the ownership is not 100% then a balancing item called "non controlling interest" is set up. Until
recently this tended to be called a "Minority interest"; some major companies are still using this older
term. Looking again at Exhibit 31 (above right), you can observe that on January 1, 2012, of the $25,554
million total equity, the Barrick shareholders owned $23,363 million and various other investors (owning
the shares that Barrick does not own of subsidiaries) have a stake worth $2,191 million. Just to
emphasize this concept, whenever the reporting company has investment in other companies at less
than 100% ownership, then we will see not one but three equity totals. Incidentally, the Barrick
Statement of Changes in Equity is a touch awkward to read since the vertical time line starts at Jan 1,
2012, proceeds to Dec 31, 2012 and then lists Jan 1, 2011 to cover activity of 2011. The standards allow
some flexibility here.

Preferred Shares

A few companies issue more than one kind of share. The most common example is the issuance of a
security called a preferred share. In features and risk, this share lies somewhere between bond-like debt
and the straight risky equity of a common share. The usual preferred share has a fixed dividend (stated
as a percent of its par value or as a dollar amount). An example is a "par $100 preferred with a dividend
of 6%." The fixed nature of this dividend resembles debt. But the dividend may not get paid. If the
company directors do not declare a dividend in, say, 2013, then no shares of any type are getting any
return that year. Consideration of payment in the future depends on certain features (cumulative versus
non-cumulative) that are beyond the scope of this course. You might be saying "where is the
preference?" Two places: (i) if any dividends are being paid, then preferreds are always paid before
common, and (ii) on wind up of the company (voluntarily or through bankruptcy), the preferred rank
after debt but before the common on distribution of what the company has left when disbanded.

Exhibit 32, the Freeport-McMoRan Copper & Gold Inc. Statement of Equity, reveals that this large
American company had issued 29 million preferred shares prior to Jan 1, 2010 for an issue proceeds of
$2,875 million. Incidentally, preferred shares normally have no voting rights. Exceptions sometimes
include votes in the year when a dividend is not paid. To this point, our discussion of preferred shares
should serve as an indication of the variety found in the securities business. Now we will discuss yet
another example of imaginative financial instruments.
Hybrid Securities

To make various securities more attractive to investors, companies have been quite creative in
combining in one security one or more features that are equity oriented and one or more that are
recognized as debt. We discuss just one such security here to give you a glimpse at this somewhat
complicated topic. A company can make a debt instrument such as a bond more attractive by including a
convertible feature allowing the bond holder to convert the bond to a set number of common shares.
This favours investors who want to ride the success if the company turns out to do well but can remain
as debt holders if the company appears to be struggling. It is a one way feature. Once the bond is
converted then the investor is a shareholder with the future benefits and perils this entails. The
accounting for this convertible bond consists of assigning two categories to the security—one is an
equity amount representing a sort of option on shares and the other is the value of the debt as if it had
no convertible feature.

Why are we mentioning this? The equity portion is not quite a true share yet and awaits the investor's
decision to convert. Hence when a company has issued so called hybrids, we have another column in the
Statement of Changes in Equity. Exhibit 33 Capstone Mining Corp. Statement of Changes in Equity
reflects the diverse equity structure of this mid-sized Canadian-based firm operating in the gold, copper
and silver sectors in Canada and Mexico. Note the fourth column entitled "Equity component of
convertible debentures." The January 1, 2012 balance (set up years before) is $1,146 thousand.
Capstone happened to pay off this debenture (bond) during 2012 without any investor converting. The
repayment terms included keeping the equity portion which we see reclassified with a reference to a
Note 13 (not shown here).
Observe that Capstone does not identify two of the equity columns as being related to other
Comprehensive Income. The GAAP labelling standards are a bit liberal here. Checking the
Comprehensive Income Statement (not shown), we would see that this company has changes to its
Investment revaluation reserves and Foreign currency translation reserves—i.e. Captstone is treating
these items as part of OCI and not part of the regular net income.

Treasury Shares

In some jurisdictions, companies are allowed to buy back some of their shares and keep them on the
shelf or "in Treasury." If the company wishes to issue more shares later, it can simply sell some of these
so called "treasury shares." These shares are stripped of their voting rights while held in Treasury and do
not count as "outstanding." For example, a company may issue 10,000 common shares in year 1. In year
3, it buys back 900 of these shares and does not cancel them. It ends the year with these 900 shares in
Treasury and available to issue back to the public or to employees. At year end we would say the
company has issued 10,000 shares and has 9,100 outstanding.

Click on Exhibit 34 to see the Statement of Changes in Equity of Imerys SA. Imerys is a French company
involved in mineral development and applications in ceramics, refractories, abrasives filtration and
building materials. It operates in over a dozen countries in several continents. The third currency column
is called Treasury Shares. Here we can see that Imerys spent 4.9€ million during 2012 buying back on the
open stock market some of its own shares. Later in another year, these shares may very well get resold
or issued to employees re bonus payments or simply get cancelled and destroyed.
You can well imagine that the concept of buying back some of a company's own shares and holding
them is a bit of an oxymoron. Incidentally, a company incorporated under the Canada Business
Corporations Act is expressly forbidden to have treasury shares. It can buy back its own shares but these
shares must be immediately cancelled. Later, the company can simply issue new ones when it wants. For
you, the point is to be aware that governing legislation in some countries allows a company to partially
own itself and in others not so. It is the author's view that jurisdictions not allowing the concept of
treasury shares (e.g. Canada) have made the concept of shrinking capital and its related presentation
considerably easier for the lay investor.

As we conclude this session, you can see that the new requirements for a statement outlining the
changes for all the major components of shareholder ownership goes much further than the former
requirement for just a Statement of Retained Earnings. It should not be a surprise to hear that both
American and International standards call for this enlarged picture—one that should be useful to not
only shareholders but also major creditors and analysts.

Notes, Tools and Conclusions

The Notes are the place where narrative explanatory information is provided. The information can
supplement that found in the four formal reports or can be separate "stand alone" facts. The notes are a
compulsory portion of the overall Financial Statements of a reporting entity. This is where we find the
significant accounting policies being followed by a company (particularly where the standards allow a
company to make a choice among alternatives).

It is also where we find information of aspects of the company's position and results of operations that
did not require representation in the four formal "number" statements. For example a company may
show its earnings per share either on the Income Statement or in the Notes. Another example relates to
equity. International standards require a company to inform the reader of the number of shares issued
and fully paid (and also those issued but not fully paid), but this information can be placed in Statement
of Financial Position or the Statement of Changes in Equity or in the Notes.

An International standard that can prove useful is the necessity to disclose the immediate parent and
ultimate parent of the company in cases where the reporting company is itself fully or partially owned
by another firm. As yet, this is not an American GAAP requirement.

What to look for in the Notes

The answer to this depends on what you want to know and what you have already gleaned from the
four number statements. In short, the Notes provide a ton of information; you may wish to safely
disregard many notes, but to pursue information relating to the latest debt borrowings aspects.

Which standards are being used? Usually the first note is a statement saying what GAAP is being used—
International or American, or that of a country not following either. One link on the homepage of
the International Financial Reporting Standards (IFRS) Foundation is named "Who Uses IFRS?". Here
we see the status of the various countries that have adopted IASB/IFRS reporting, and we see notes on
the intentions of certain countries, including the United States. Other links (e.g. grey tab "IFRS" which
leads to "Standards and Interpretations") will give you as much information as you want or need on any
of the 42 standards that essentially control all accounting for public (traded) companies in any industry
in any of over 120 countries.

Then we see notes on matters related to assets (such as a depreciation policy), then liabilities (new
interest rates, covenants) and share capital (options, issues). Some notes can help you to determine
whether the company is highly optimistic (e.g. expecting a long asset life) or quite conservative.

In mining, this is where we find whether all exploration and evaluation costs are being expensed or
treated as an asset (to be depreciated or depleted in the future with a charge to each ton mined or
processed). As mentioned earlier (in Part 1: More on Assets, Liabilities and Equity) American rules here
are quite conservative. Exploration costs are to be expensed. In contrast, International rules allow some
latitude. Those wishing to pursue this further should read International Standard IFRS 6: Exploration For
and Evaluation of Mineral Resources (IFRS (2012)).

Incidentally, the Notes are often called Notes to the Financial Statements by many companies and yet
the Notes are regarded as part of the Financial Statements. This small but unfortunate naming problem
exists. The fact is that GAAP (American and International) makes it very clear that the Notes are an
integral part of the overall package called Financial Statements. The International standards state at
IAS1 para 10: "a complete set of financial statements comprises: [...] e) notes comprising a summary of
significant accounting policies, and other explanatory information." Furthermore, auditors are required
to audit the content of each note as part of the material on which they give an opinion.

Earlier, we referred to the fact that both the Statement of Financial Position and the Income Statement
contain cross references to the Notes. This is mandatory for companies preparing under International
standards and more or less followed by companies using other standards. But the Notes go further than
just adding info regarding these dollar statements. They are where we can find answers to important
queries regarding matters that are never detailed in the dollar columned Statements or are time lagged
(will appear in the next or subsequent years). Depending on the particular mining company, some or all
of the following selected Note topics may be highly relevant to your interests.

 acquisition cost analysis

 impairment details

 pension cost status

 asset retirement obligations and related environmental costs

 taxes (kinds and geographic location differences)

 share (stock) options granted, exercised or lapsed

 discontinued operations and complete mine closures

For an example of a critical note regarding the equity structure, look at Exhibit 35 (left): Vale SA Note 18
Stockholders' Equity (2012). This global-sized mining firm, based in Brazil, has made sure it cannot be
taken over by any other company or other entity. Read that restrictive paragraph referring to "special
golden shares." Maybe if some other countries had seen fit to allow or implement this publicly
announced and properly disclosed protection, they would be home to more mining companies. It is Vale
SA who took over Canadian based Inco Ltd. in 2006, thus becoming at the time the world's largest
producer of nickel.
Two subject matters that normally raise the interest of analysts and investors are Contingencies and
Subsequent Events. They are not always present and even knowing of their absence can be reassuring.
Contingencies

Consider these questions. Has the company undertaken to provide aid (financial or of some other form)
to other parties? Is the company cosigning loans or exploration and development agreements that
earlier were considered prudent but are now regarded as potentially more expensive than planned and
possibly creating material future liabilities? Is the company facing a tax enquiry or an environmental
review? Is the company involved in law suits? Here we turn to notes normally titled "Contingencies."

A contingency is an uncertain gain or loss of the current accounting period that will be confirmed or
negated by some action taking place or not taking place in the future. For example, a mine may have
recently contaminated a river to the extent that a costly cleanup maybe necessary. The spill occurs in
the current period, but the outcome of a loss, if any, is not decided until a court case is heard in the
succeeding year. Most companies operating in circumstances where people can be injured or property
can be damaged or disputed over will face law suits; the note on Contingencies is where we find out the
nature and the possible size of the litigation.

For example, Exhibit 36: Whitehaven Coal Ltd. Note 30 Contingencies displays information on a
contingent loss that could be potentially over $157 million AUD. To place this in context, the figure is
around 5% of the total equity of Whitehaven and a much higher percentage of a year's normal income.
Normal guarantees by the reporting company could turn sour. The potential loss here could be small or
significantly large. Again, the Notes can help you. For example, in the Notes to the Financial Statements
of Lundin Mining Corporation (for 2012) we find Note 22 Commitments and Contingencies. The relevant
paragraph, found in Note 22 c) states the following.

"A Swedish bank has issued a bank guarantee to the Swedish authorities in the amount of $12.3 million
(SEK 80.0 million) relating to the future reclamation costs at the Zinkgruvan mine. Additional bonds of
$2.5 million (SEK 16.2 million) and $1.5 million (SEK 10.0 million) are to be provided in 2016 and 2024,
respectively. The Company has agreed to indemnify the Swedish bank for this guarantee."

This is where we find that Lundin is on the hook for future reclamation costs. This liability may or may
not be on the Statement of Financial Position depending on the probability of having to pay in future.

Events after the reporting period

When reading the reports of a company, we should note the length of time it took from closing off the
accounting to actually receiving an approval from the auditors to release the report. You can get this
information from the Auditor's Report which includes the date it was signed. This period is usually four
to eight weeks but can extend to a few months. In some jurisdictions, a report has to be released within
6 months, or else the company is considered delinquent in its filings.

The point you may be wondering about is what is happening between the fiscal year-end and the date of
the audit report? If this is, say, 8 or 9 or 15 weeks, much may be happening. One requirement (of both
International and American) standards is the necessity to inform readers of any material information
that has taken place subsequent to year end. Internationally this is called "Events After the Reporting
Period." American terminology is "Subsequent Events." Under either title, we can find in the Notes
information regarding, say, a potential or actually realized merger or takeover. We can be informed of a
new substantial contract or the loss of business due to nationalization of a subsidiary. In short, it is
worth casting a quick eyeball at this particular note.

Exhibit 37: Capstone Mining Corp. Note 26 Subsequent Events reveals an interesting cash flow taking
place after year end 2012. The company has spent nearly $6 million buying back its own shares. You
would not see any of this in the Statement of Changes of Equity or the Cash Flow Statement in the
presented years: either 2012 or 2011. Why? There was no buy-back then. The Subsequent Events note is
what informs us here.
We could expand considerably on note disclosure here. Suffice to say that an analysis of a mining
company (or any company for that matter) would be grossly deficient if we overlooked the Notes. Some
companies (unfortunately not the majority) prepare a page listing the contents of the Notes. An
excellent example of this desired information is provided by Rio Tinto. Look at Exhibit 38 (right) from this
company's 2012 report to get a comprehensive idea of all the subjects covered. We can save much time
when companies offer this feature.
Analytical Tools: Ratios

You may recall earlier discussion of the use of ratios to put analysis of various companies on some
comparable basis. Here we list the ratios we have already examined and look at others that supplement
the information we get from the four basic statements. We have discussed current and debt to equity
ratios in Part 1: Introduction - Statement of Financial Position. This first pair are Statement of Financial
Position (Balance Sheet) oriented. They are status reports of liquidity and solvency. In Part 2: Statement
of Income, we presented two Income Statement related ratios—namely gross margin and net margin—
again ratios using data from just one financial statement.

As you can imagine, we need to develop tools that take into account both wealth change and wealth
size. A net income of $4 million is a poor performance if we needed an asset base of $60 million to earn
it. In contrast, a return of say $3 million is very healthy if the asset base is $10 million. In short you can
see how using one or more figures from the Income Statement combined with one or more from the
Statement of Financial Position can augment our analysis. Described below are two common and often-
quoted ratios.

Return on assets (ROA)

Unfortunately this gets calculated in more than one way. Some people use net income divided by total
assets. Others purify the ratio by removing interest charges on debt. We will pause for a moment here
to discuss this issue. Precisely because companies use leverage (incur long-term debt as a way of
financing the assets) to different degrees, we need a measure that removes the leverage component.
Imagine a company that financed all its assets with equity, i.e. had no debt at all. In this case, return on
assets and return on equity would be the same. In order to compare the operating performance of
companies that happen to choose differing levels of debt (including no debt), we strip out the cost of
servicing debt. And often these comparisons are made between companies operating in different tax
jurisdictions, charging different tax rates. It turns out then that a common measure of ROA is net
income before interest charges and income taxes. True, the charges for interest and for taxes are very
real, but removing them allows us to make useful comparisons between companies.

What denominator should we use? We normally use either the opening year balance of equity or an
average of opening and closing. When you see ratios in business articles, there is usually a page of
definitions. Look there to see what definition (what alternative formula) is being used. Note the
difference here. Assume a company has a January 1 total asset figure of $1 million. Assume it earns $300
thousand (pre interest and taxes) and pays out none of this. The no-dividend stipulation means that Dec.
31 total assets could be viewed as opening assets plus earnings or $1.3 million. This is a great
simplification since it ignores any change to assets through major purchases or disposals. A weighted
quarterly average will lead to a more accurate return than a return using only assets at start of year.
Now we do the math. Using opening assets, we get a 30% return on assets. But using the average of
opening and closing we get a return of 26% (300,000/((1,000,000+1,300,000)×0.5)). Which to use? Both
are employed. Just make sure you are consistent and that your comparisons are comparable to those
published in various media.

Click on Exhibit 39 to see ROA determinations for selected mining companies for two recent years. This
set makes no adjustments for interest or tax expenses. Note the extremes from a loss of 2.5% to a profit
of 25.0%
Return on equity (ROE)

This is the "bottom line" divided by shareholders' equity. It is determined with all expenses in place
including interest and income taxes. Again the denominator can be opening year balance or an average
of opening and closing. We normally find more volatility among ROE figures than ROA since a small
change in either ROA or in the interest rate can result in a larger change in ROE.

Times interest earned

We earlier discussed the debt:equity ratio—a key indicator of financial leverage. We can refine our
thoughts on the ability of a company to handle debt by using a second ratio that uses an Income
Statement item. We may have a very high debt:equity ratio of say over 100% and yet be satisfied that
the company is sound. If the net income level is sufficiently large, and interest rates are low to modest,
then our company is earning adequately to handle the rent on the debt—the interest expense. The ratio
that depends on this thinking is "times interest earned." This ratio consists of the operating profit pre
tax and pre interest expense divided by interest expense alone.

See Exhibit 40: Vedanta Resources PLC Income Statement to follow how this ratio is determined.
Vedanta is a London-based company with around 90% of its operations (long term assets) based in India
(copper, zinc, aluminum, iron ore and others). The "Profit before taxation" is $1,705.9 million. This, of
course, is derived from all revenues less all expenses including interest. We now remove the expense
item ("finance costs") of $1,194.0 million which gives us a pre tax pre interest figure of $2,899.9 million.
Dividing this last figure by the interest itself (2,899.9/1,194.0) gives us a Times Interest Earned ratio of
2.4 which is reasonable but not exciting. In short if you were a lender, you would be watching carefully
which way any trend is going.
Vedanta joins many other companies in this current period in having a ratio at around two to four times
interest earned (in contrast, BHP Billiton has a 17 times interest earned ratio for 2012). A ratio of say, 10
times the interest amount shows a healthy ability to handle debt compared to ratios in the 2–4 range—
an attribute when we see commodity prices and hence net income as quite volatile.

Earnings per share

The earnings per share, or EPS, for common shares consists of net income less dividends for preferred
shares divided by a weighted average number of common shares. This concept can be used to compare
one year's basic EPS with that of a previous year. When a company has convertible securities (bonds,
preferred shares and options) then a diluted EPS is presented, displaying the lowest possible EPS that
could take place if such securities did experience conversion to common shares.

Price to earnings and price to book

Two ratios that involve market (external) share prices are as follows.

 price to earnings

 price to book

Price to earnings, normally called the PE ratio (P/E) is a ratio involving the share price (quoted in the
stock market) divided by the EPS. This ratio is thus independent of the number of shares issued or the
overall size of the year's earnings. A multiple of, say, 20 implies paying $20 for $1 of earnings. Thus, a
P/E of 20 is equivalent to a 5% return (1/20). This ratio is often shown with current quarter earnings;
when this is done the earnings are multiplied by 4 to give a ratio comparable to the annual ones.

The price/book value (P/B) is a ratio that measures how much more (or rarely less) the market price of
share is compared to the net book value as revealed in a company's equity portion of a Statement of
Financial Position. A ratio of, say, 2.3 or 230% means the (stock market quoted) share price is 2.3 times
the value on the books. This can and often is a reflection of the difference between fair (market) values
and the historical cost amounts recorded in the books. It can also be an indication of how much implied
goodwill is embedded in the market price of the share.

Conclusion

In conclusion we hope we have spurred you to want to pursue the wealth of information found in
company Notes to financial statements. Furthermore you should feel armed to use or determine on
your own certain key ratios that make comparisons between mining companies both interesting and
useful. Maybe this introductory course has whetted your appetite to pursue further study of accounting.
It is, after all, "the language of business" and as such is subject to continual change to mirror the
evolving business environment.

You have covered the following points in Part 3: Statements of Cash Flow and Changes in Equity.
 details of the Cash Flow Statement

 operations

 investing activities

 financing activities

 details of the Statement of Changes in Equity

 non controlling interests

 shares

 hybrid securities

 the notes to Financial Statements

 analytical tools
Appendices
Glossary
A

account - A record of additions, deductions and balances of individual assets, liabilities, equity, revenues
and expenses.

accumulated OCI - Amassed other comprehensive income.

acid ratio - A short-term test of solvency involving cash and other current monetary assets divided by
current liabilities.

asset - An economic resource owned or controlled by an entity that will provide future benefits.

associate - An entity over which the investor has significant influence.

audit - An examination of a company’s financial statements by independent qualified public

bond - A long-term debt instrument that usually pays interest periodically and a principal amount at
maturity.

capitalize - To include the cost as a stand alone asset or part of another asset.

CICA - Canadian Institute of Chartered Accountants (the accounting standard setting body in Canada).

common share - A basic ownership class of corporate equity, usually carrying a right to vote, and a share
in earnings, and a share in any liquidation proceeds after prior claims.

comprehensive income - Total income reported by an entity including net profit and all other changes
to shareholder equity other than those arising from capital (share) transactions.

consolidated statements - Statements of parent and all its subsidiaries taken together.

contingency - a possible gain or loss, the confirmation or negation of which takes place in a future
accounting period.
current ratio - A measure of liquidity involving current assets divided by current liabilities.

debenture - A bond that has no specific pledged security for repayment.

debt/equity ratio - A measure of solvency involving a firm's total liabilities divided by its total owners'
equity.

deferred income tax - An expense representing estimated future income taxes resulting from temporary
differences between an asset’s book value and its value on a tax basis.

discontinued operations - Net income or loss from a business segment that is for sale or has been sold
in the current period.

EBIT - Earnings before interest and taxes.

EPS - Earnings per share.

equity - Ownership by shareholders represented by total assets less total liabilities.

equity method - A method of accounting for investments involving the investor recording a pro-rata
share of investees’ income and recording a deduction of dividends from investment.

expenditure - A payment (that could be for an asset or an expense or reducing a liability or equity)

expense - A decrease in owners' equity incurred in the process of earning revenues.

FASB - Financial Accounting Standards Board. The American institution charged with setting American
accounting standards.

future income tax - See deferred income tax.

GAAP - Generally accepted accounting principles.

IAS - International Accounting Standards.

IASB - International Accounting Standards Board.

IFRS - International Financial Reporting Standards.

intangible asset - An asset with legal form, economic value but no physical presence such as a patent.

inventory - Items available for sale.

investee - An entity owned (fully or partially) by another entity (investor)

investor - An entity having an equity position (ownership) of another entity (investee)

liability - An obligation or debt.

net income - Sales less expenses including income taxes ("the bottom line").

net margin - A ratio of net income divided by sales.

other comprehensive income - Income components that affect overall wealth but are not included in
net income (profit).

preferred share - An ownership class of corporate equity, ranking ahead of common shares as to claim
on earnings and liquidation proceeds, usually with a set dividend, and without a vote.

prepaid expense - A temporary asset that will become an expense in the current period, e.g. an
insurance premium.
price/book ratio - The stock market quoted price divided by the net book value of a common share.

price/earnings ratio - The stock market quoted price divided by the earnings per share (EPS).

quick ratio - See acid ratio.

ratio - a relationship of two measures using division (as opposed to subtraction)

retained earnings - The accumulated undistributed earnings amassed by an entity since its inception.

revenue - Inflows of earned resources from providing goods and services to customers, reflected as
increases in equity.

ROA - Return on assets, (net income divided by total assets, with or without adjustments for interest
expense and taxes).

ROE - Return on equity (net income divided by shareholder equity).

shareholder - An entity (person or corporation) owning a share representing ownership of equity in a

stock - Equivalent to share.

tangible asset - An asset with physical form (compared to intangible asset).

times interest earned - A ratio involving income before interest expense and income tax divided by
interest expense.

List of Exhibits
Exhibit 1: Remco Mining Statement of Financial Position (internal)
Exhibit 2: Rio Tinto Statement of Financial Position (Rio Tinto 2012 p. 142)

Exhibit 3: Remco Mining Income Statement (internal)

Exhibit 4: Rio Tinto Income Statement (Rio Tinto 2012 p. 139)

Exhibit 5: Remco Mining Statement of Financial Position (internal)

Exhibit 6: Anglo American Consolidated Balance Sheet (AngloAmerica 2012 p. 139)

Exhibit 7: BHP Billiton Statement of Financial Position (BHP Billiton 2013 p. 198)

Exhibit 8: Pronto Corp. Income Statement (internal)

Exhibit 9: Arch Coal Consolidated Statement of Operations (Arch Coal AR p. F-5)

Exhibit 10: Whitehaven Coal Ltd. Statement of Comprehensive Income (Whitehaven 2012 p. 69)

Exhibit 11: Goldcorp Consolidated Statement of Earnings (Goldcorp 2012 p. 5)

Exhibit 12: HudBay Minerals Inc. Consolidated Balance Sheets (2012 p. 1)

Exhibit 13: Newmont Mining Corporation Statements of Consolidated Income (p. 93)

Exhibit 14: Newmont Note 7 to Consolidated Financial Statements (p. 114)

Exhibit 15: Cameco Consolidated Statement of Earnings (Cameco 2012 p. 3)

Exhibit 16: Lundin Consolidated Statements of Earnings (p. 4)

Exhibit 17: Peabody Energy Corp. Consolidated Statement of Operations (Peabody 2012 p. F-2)

Exhibit 18: Kinross Consolidated Statement of Operations (Kinross 2012 p. 4)

Exhibit 19: Goldcorp Annual Financial Statements 2012: excerpt of Note 3 (p. 11)

Exhibit 20: Peabody Energy Corp. Annual Financial Statements 2012: Notes to Consolidated Financial
Statements, Excerpt of Note 1 (Peabody 2012 p. F-11)

Exhibit 21: Teck Resources Consolidated Statement of Income (2012 p. 76)

Exhibit 22: Teck Resources Consolidated Statement of Comprehensive Income (2012 p. 77)
Exhibit 23: Boliden Consolidated Statement of Comprehensive Income (Boliden 2012 p. 77)

Exhibit 24: Gross and Net Margins Compared (internal)

Exhibit 25: Net margins of Selected Major Mining Companies (internal)

Exhibit 26: Teck Resources Cash Flow Statement (Teck 2012 p. 78)

Exhibit 27: Newmont Cash Flow Statement (Newmont 2012 p. 95)

Exhibit 28: Lundin Supplemental Cash Flow Information (Lundin 2007 p. 70)

Exhibit 29: BHP Billiton Note 6 of 2013 Financial Statements (p. 218)

Exhibit 30: Stratum Mining Statement of Change in Equity (internal)

Exhibit 31: Barrick Gold Corp. Statement of Changes in Equity (2012 p. 78)

Exhibit 32: Freeport-McMoRan Copper & Gold Corp. Statement of Equity (2012 p. 72)

Exhibit 33: Capstone Mining Statement of Changes in Equity (Capstone 2012 p. 8)

Exhibit 34: Imerys Consolidated Statement of Changes in Equity (Imerys 2012 p. 147)

Exhibit 35: Vale SA: Note 18 Stockholders' Equity (Vale SA 2012 pp. F-36-37)

Exhibit 36: Whitehaven Coal Ltd. Note 30 Contingencies (2012, p. 121)

Exhibit 37: Capstone Mining Corp. Note 26 Subsequent Events (Capstone, 2012, p. 55)

Exhibit 38: Rio Tinto 2012 Contents—Financial Statements

Exhibit 39: Return on Assets for Selected Mining Companies (internal)

Exhibit 40: Vedanta Resources PLC Income Statement (p. 113)