Oil and gas producing activities are those activities that involve the acquisition of mineral interests in properties, exploration, development, and production of crude oil, including condensate and natural gas liquids, and natural gas. Specialized GAAP does not address refining, marketing, or transportation issues. The successful efforts method of accounting adheres to a traditional historical cost basis.
This post overview the recommended treatment of oil and gas activities as per ASC 932. [Note that this treatment is recommended, but not required]. Have a read! Source: FASB Accounting Standards Codification Industry 932 [Extractive Industries—Oil and Gas]
Property acquisition costs, whether the property is proved or unproved, are capitalized as incurred. For other costs incurred under this method, a direct relationship between the costs incurred and specific reserves discovered is required before costs are permitted to be capitalized. Under the successful efforts method, costs that cannot be directly related to the discovery of specific oil and gas reserves are expensed immediately as incurred, analogous to research and development. Oil and gas producing companies are also subject to the requirements of ASC 410 regarding the recognition of asset retirement obligations.
The use of the successful efforts method is preferred, but not required by GAAP. An oil and gas producing company is permitted to use, as an alternative to the successful efforts method, a prescribed form of the full cost method permitted by the SEC.
All enterprises are required to disclose the method used for accounting for costs incurred and the method of disposition used for capitalized costs.
The SEC requires additional disclosures for publicly traded companies and also provides guidance (SAB 106) on ensuring that the expected cash flows associated with asset retirement obligations are not double-counted in making computations under the full cost method.
For an enterprise that uses the full cost method of accounting, assets being depreciated, depleted, or amortized are considered to be in use in the earning activities of the enterprise and, consequently, do not qualify for interest capitalization. However, assets employed in ongoing exploration or development activities but that are not yet engaged in earning activities and not presently being depreciated, depleted or amortized, are subject to interest capitalization.
Exploratory wells or tests that are in progress at the end of the period present unique accounting issues. If, subsequent to the end of the period, but before the financial statements are issued, a well or test is found to be unsuccessful, the incurred costs, less salvage value, are expensed. Retroactively restated financial statements are not permitted.
The costs of the special types of assets used in oil and gas producing activities are capitalized when incurred. Some examples include:
- Mineral interests in properties (a) Unproved—Properties with no proved reserves (b) Proved—Properties with proved reserves.
- Wells and related equipment and facilities
- Support equipment and facilities
- Uncompleted wells, equipment, and facilities
Costs associated with drilling exploratory wells or exploratory-type stratigraphic wells are capitalized until it is determined that the well has proved reserves at which time the capitalized costs are reclassified to wells and related equipment and facilities. If, however, proved reserves are not found, the capitalized drilling costs of the well are charged to expense.
When drilling is completed if it is determined that the well has reserves but those reserves cannot be classified as proved, the reporting enterprise will continue to capitalize drilling costs if (1) the reserves found are sufficient to justify completion of the well as a producing well and, (2) the reporting enterprise is making sufficient progress assessing the reserves and the economic and operating viability of the project.
These costs are amortized as reserves are produced and, along with lifting (production) costs, are classified as costs of production. Periodically, unproved properties are evaluated for impairment. The impairment model used for drilling and mineral rights is not the same model set forth in ASC 350 for intangible assets, but rather, is based on the level of established reserves (ASC 932-350-50). If impaired, a loss is recognized.
Acquisition costs incurred to obtain oil and gas properties through purchase, lease, etc., are capitalized.
Geological and geophysical costs, unproved properties’ carrying costs, and the costs of dry hole and bottom hole contributions are expensed. Drilling costs are capitalized until a determination has been made as to the success of the well. If successful, these costs are transferred to uncompleted wells, related equipment, and facilities. The cost of drilling, less residual value, is charged to expense if proved reserves are not found.
Development costs are incurred in order to:
- Get access to and prepare well locations
- Drill and equip development wells
- Set up production facilities
- Provide better recovery systems
These costs are capitalized as uncompleted equipment and facilities until drilling or construction is completed.
The cost of support equipment is capitalized and depreciated. This depreciation, along with other operating costs, is allocated to exploration, development, or production costs, as appropriate.
Production involves different costs ranging from lifting to field storage. These costs, together with depreciation, depletion, and amortization of capitalized acquisition, exploration, and development costs, are part of the cost of the oil and gas produced.
Unproved properties are reclassified to proved properties upon discovery of proved reserves. When proved reserves are found, the costs capitalized as uncompleted wells, equipment, and facilities are reclassified as completed wells, equipment, and facilities. Capitalized costs are amortized or depleted by the unit of production method. Estimated residual values must be considered when determining amortization and depreciation rates.
Any information that becomes available between the end of the period and the date when the financial statements are issued is to be considered in the evaluation of conditions existing at the balance sheet date. With respect to the costs of a company’s wells, related equipment, facilities, and the costs of related proved properties, the provisions for impairment as outlined in ASC 360 are applicable.