IFRS AND E&E

IFRS and E&E

IFRS and E&E

Accounting Standard Requirement for Oil and Gas Industry

Accounting for oil and gas producing companies has become a serious matter in the United States, as many companies have claimed that certain accounting methods reduce their incentives to search for, and produce, oil and gas. The primary written standards defining the appropriate accounting procedures or GAAP (generally accepted accounting principles) for gas exploration and production (E&P) activities include the following pronouncements by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) (International Accounting Standards Committee, 2000).

The major difference between the two main accounting methods (full cost (FC) and successful efforts (SE)) is their treatment of dry hole (i.e., unsuccessful well) exploration costs. Under SE, only those exploration costs that can be directly related to specific reserves discovered are capitalized. Exploration costs of dry holes are expensed. The capitalized costs for producing properties are amortized as the proved reserves relating to those properties are produced.

By contrast, under FC, all costs incurred in exploration within a relatively large cost center, such as a country, are capitalized when incurred. Thus, exploration costs relating to both dry holes and successful wells are recorded as assets. These capitalized costs are amortized as the reserves in the cost center are produced.

The use of two divergent methods spurred considerable debate within the accounting profession, although under both methods, all exploration costs are eventually expensed, either as dry hole costs or through amortization. In addition, the costs of development wells, whether successful or dry, are capitalized under both SE and FC and amortized over reserves when produced. Development wells are drilled within a proved area to provide facilities for producing proved reserves. The SEC in 1978 stated that traditional historical cost methods, such as SE and FC, are inherently limited in their ability to provide relevant information about E&P activities because of unique economic characteristics of the oil and gas industry. Under both methods, oil and gas properties are valued on the balance sheet at historical cost, which excludes information about the value of oil reserves (Hung, 2010, Pp. 18).

Instead of requiring either FC or SE, the SEC introduced a new oil and gas accounting method in ASR No. 253 called “reserve recognition accounting” (RRA), which was based on a valuation of proved oil and gas reserves. In light of this conflict, both FC and SE have been acceptable, with many variations on the basic FC and SE methods found in practice. Although FC firms are allowed to capitalize dry hole costs, the SEC requires them to test for impairment of their oil and gas assets on a quarterly basis. If the unamortized costs in a cost center exceed the present value of estimated future net revenues from production of proved reserves, the costs must be written down to the ceiling amount. Finally, accounting research has shown that, by comparison to SE firms, FC firms are younger, more highly leveraged, spend a larger proportion of their revenues on capital ...