Critical Accounting Estimates

Critical Accounting Estimates

The preparation of the Company’s consolidated financial statements requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as well as the reported expenses during the reporting period. Such estimates and assumptions affect the determination of the potential impairment of long-lived assets, estimated costs associated with reclamation of exploration properties, and the determination of stock-based compensation and future income taxes. Estimates and assumptions may be revised as new information is obtained, and are subject to change. Management believes that the Company’s accounting policies and the estimates used in the preparation of the consolidated financial statements are appropriate in the circumstances, but are subject to judgments and uncertainties that are inherent in the financial reporting process. Actual results could differ from estimates and the differences could be material. The most critical accounting policies upon which the Company depends are those requiring estimates of impairment, assumption about fair value and future income taxes. Please refer to Note 3 of the audited, consolidated financial statements of the Company for the years ended April 30, 2009 and 2008 for a description of all significant accounting policies.

Impairment of long-lived assets

The Company capitalizes all costs related to investments in resource property interests on a property by-property basis. Such costs include resource property acquisition costs, and exploration and development expenditures, net of any recoveries. Costs are deferred until such time as the extent of mineralization has been determined and resource property interests are either developed or the Company’s mineral rights are allowed to lapse.

The Company’s management reviews the carrying value of the Company’s mineral properties when there are events or circumstances that may indicate impairment. In making an assessment of the potential impairment of the Company’s mineral property interests, management has used estimates of future mineral prices, mineral resource quantities, and operating, capital and reclamation costs, as well as making judgements on the potential of certain projects based on the available information at the balance sheet date. These estimates are subject to certain risks and uncertainties that may affect the determination of the recoverability of deferred mineral property interests. Although management has made its best estimates of potential impairment, the interpretation these factors is subjective and do not necessarily result in precise determinations. Should an underlying assumption change, the resulting estimates could change by a material amount.

All deferred resource property expenditures are reviewed, on a property-by-property basis, to consider whether there are any conditions that may indicate impairment. When the carrying value of a property exceeds its net recoverable amount that may be estimated by quantifiable evidence of an economic geological resource or reserve, expenditure commitments or the Company’s assessment of its ability to sell the property for an amount exceeding the deferred costs, a provision is made for the impairment in value.

The Company’s most significant long-lived asset consists of capitalized acquisition and exploration costs for its resource properties. The Company’s resource properties are at three different stages:

• development (Renard);
• advanced exploration (Aviat, Churchill and Qilalugaq); and
• grass-roots exploration.

To test for impairment on its resource properties, management uses an undiscounted future cash flow method for the development stage project; an estimate of “in-situ” value for the advanced projects and the criteria set out in Paragraphs 16 and 18 of Accounting Guideline 11 – Enterprises in the Development Stage for the grass-roots exploration projects.

The National Instrument 43-101 report (“NI 43-101”) filed by the Company in December 2008 contains a detailed cash flow model, with a “base-case” and an “upside” scenario. Management has evaluated the cash flow model under both scenarios against the carrying value of the Renard Diamond Project and is of the opinion that the estimated future cash flows (undiscounted) from the project exceed its carrying value of $131.2 million as at April 30, 2009 and that no write-down for impairment is warranted on this basis. Management strongly believes in the potential upside value of the Renard Project through the expansion of the resource estimate and through long-term diamond price growth. Neither of these factors is currently incorporated into the preliminary assessment from which the undiscounted future cash flow analysis is derived.

Without an estimate of future undiscounted cash flows, other methods must be used to estimate fair value. Management believes that using an estimate of “in-situ” value for its advanced projects is a reasonable way to estimate fair value. The in situ method is a broad metric of project value, which uses an estimate of carats contained in the project and an estimate of carat value, factored to account for extracted value. A factor is applied to provide a risk adjusted expectation of value and also adjusts for value recovered and capital expenditures, operating costs and income tax expenses. The three advanced projects are all located within the Rae Craton in Nunavut and have approximately equivalent emplacement ages. Management has enough information to make a reasonable estimate of the contained carats for each project based on information available to date. Using a low-average-high range estimate of per carat values and a simple range of probabilities, combined with a low factor, a low and high estimate of fair value for each project was calculated. While these estimated fair values exceeded the current carrying values of the Aviat and Qilalugaq properties, the estimated fair values calculated for the Churchill Project were lower than its current carrying value. Accordingly, the Company wrote-down the carrying value of the Churchill Project by $6.8 million during the year ended April 30, 2009.

The Company uses the guidance set out in AcG-11 as the basis for determining whether its grass-roots properties should be written off. Paragraph 16 AcG-11 sets out factors that may indicate the need for a write-down:

• unfavourable changes in the property or project economics;
• an inability to access the site;
• environmental restrictions on development;
• an inability to create an efficient distribution mechanism; and
• political instability of the region in which the property is located.

Paragraph 18 AcG-11 states: “In addition to the above general presumption, there should be a presumption of impairment in the carrying amount of property, plant and equipment and intangible assets of enterprises in the development stage engaged in extractive operations when any of the following conditions exist:

• the enterprise’s work program on a property has significantly changed so that previously identified resource targets or work programs are no longer being pursued;
• exploration results are not promising and no more work is being planned for the foreseeable future; or
• remaining lease terms are insufficient to conduct necessary studies or exploration work.

Using these conditions as a guideline for estimating whether an impairment exists on its grass-roots properties, and based on the Company’s plan to further evaluate and advance these properties by analyzing results received to-date, management has determined that the carrying values of its grass-roots resource properties as of April 30, 2009 and as of the report date are not impaired.

Asset retirement obligations

Asset retirement obligations are the estimated costs associated with reclamation of the Company’s resource properties and are recorded as a liability at fair value. The liability is accreted over time through periodic charges to operations. In addition, asset retirement costs are capitalized as part of each asset’s carrying value at its initial discounted value and are amortized over the asset’s useful life. In the event the actual costs of reclamation exceed the Company’s estimates, the additional liability for retirement and remediation costs may have an adverse effect on the Company’s future results of operations and financial condition. The Company’s asset retirement obligation relates to activities at its Renard Project in Quebec. At this time, the potential asset retirement obligations in respect of the Company’s exploration camps cannot be reasonably estimated.

Stock-based compensation

The Company’s current market price and the volatility of the Company’s market price will affect the estimates made for stock-based compensation. The volatility of the Company’s stock price and the stock price at the grant date have the most significant impact on the estimate of fair value of stock-based compensation. The Company expenses stock-based compensation for its corporate and administrative employees and capitalizes stock-based compensation expense for its exploration and technical staff.

Stock-based compensation is accounted for using the fair value based method. Under the fair value based method,compensation cost is measured at fair value of the options at the date of grant and is expensed over the vesting period of the award. The Company estimates the fair value using the Black- Scholes option pricing model. The key assumptions used in the Current Year were: a risk-free interest rate of 1.9% (Comparative Year: 4.0% ~ 4.3%), a dividend yield of 0% (Comparative Year – 0%), an expected volatility of 86% ~ 92% (Comparative Year: 46% ~ 92%) and expected term of stock options of 3 ~ 5 years (Comparative Year: 2 ~ 5 years). In the Current Year, the Company granted 3,478,500 stock options with a weighted average exercise price of $0.10 and an estimated fair value of $138,000. In the Comparative Year, the Company granted 3,272,265 stock options with a weighted average exercise price of $0.63 and an estimated fair value of $1,104,000.

The Company also uses the Black-Scholes option pricing model to value other share compensation. No warrants were issued during the Current or Comparative Years.

Future income tax assets and liabilities

Future income tax assets and liabilities are measured using statutory rates that are expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The Company recorded a future income tax liability as part of the acquisition of Ashton and Contact and made certain assumptions with respect to the values of certain of Ashton and Contact’s tax pools and loss-carryforward balances. Differences in the actual tax rates applied and in the timing of the settlement of temporary differences could have a material impact on the Company’s reported tax assets and liabilities.