Overview of Oil & Gas Accounting

 Preamble and significance of oil and gas accounting in

evaluation of investment proposals. (Session I)
 Historical development of Oil and gas accounting
methods. (Session I)
 Salient Features of Oil & Gas Accountancy. (Session I)
 Definition of key Terms. (Session I)
 Segregation of costs incurred. (Session I)
 SCM vs. FCM. (Session II-Outline)-
 Details and Tutorial on SCM & FCM (Session III)
 Depreciation, Depletion & Amortization. (DDA).
(Session IV-)+ Tutorial
Overview of oil & Gas Accounting
 Ceiling test & order of drilling& interest capitalization.
-Detail (Session V)+ Tutorial
 Accountancy for site.
restoration/surrender/abandonment of properties&
conveyances. -Detail (Session VI)
 Impairment of assets and Accounting policies
commonly applied to oil & gas accounting. Detail
(Session VI)+ Tutorial
 Accounting Practices followed by Leading Oil & Gas
Companies. -Detail (Session VII)
 Disclosures about Oil & Gas producing activities.
(Session VII)
Overview of oil & Gas Accounting

 Accounting for Joint Ventures. (Session VIII)

 Accounting for Oil & Gas Sales Revenue and
transportation. (Session IX)
 Taxation issues. (Session X)
 Differences between policies followed in US and UK.
(Session XI)
 Guidance note issued by ICAI. (Session XI)
 Critical analysis of Accounts of an Up Stream oil
Company. (Session XII)
 Contentious/un resolved/creative Accountancy issues
(Session XII)
Preamble
 Predominance of US accounting standards.-seven
sisters
 Framework of accounting in US & U.K –SEC, COPAS,
FASB,UK -OIAC
 ICAI Guidance note differs with above two in some of
the treatments. Ex –Carry forward of EWIP two years,
abandonment costs, abandoned portion of side tracked
wells, long term investments
 Company may apply either but should do so consistently.
 Scope & Coverage of these accounting frameworks.
-Search, acquisition of property rights or properties,
construction, drilling and production activities
Characteristics/salient features of
Oil & gas producing activities.
 Highly regulated environment: Regulated by
Governments world over as also very severe &
restrictive environmental regulations.
 Capital intensive: Huge cash out goes up front,
uncertainty about assured success.
 Un-conventional accounting: No relation between
cost and value of underlying assets, Matching
concept not being adhered to-most expenditures do
not yield assets as also value of discoveries are
recognized overtime as hydrocarbons are produced.
Historical development of
accounting methods.
 Reasons for separate rules: deviation from matching
costs, underlying value of asset not being reflected,
taxation rules in force for petroleum companies,
expenditure in dry holes, assets being wasting ie non
regenerative.
 Prior to 1977 AICPA had issued a study in 1969,however
this could not be approved, study pointed towards
approval of SCM.
 In wake of 1975 oil crises Federal energy conservation
Act was passed in US and SEC was mandated to
prescribe or approve accounting standard prepared by
FASB.
Historical development of
accounting methods
 In response FASB produced ( 1977) statement 19 ,
which permitted mainly the SCM to be applicable
after December 1978.
 In between in August 1978 SEC permitted
accounting either as Per ASR 257 SCM or ASR 258
FCM. Resultantly FASB revised through statement
25 allowing usage also of FCM
 In 1981 SEC felt the inadequacy of both the
methods, require a separate accounting method
which could place on the balance sheet principal
value of the asset i.e. oil & Gas reserve and
accordingly produced a standard called Reserve
revenue accounting.
Historical development of
accounting methods
 RRA recognized asset to be reserve inclusive of future
estimated production discounted at 10 percent.
 RRA not being successful to address the concerns
,FASB again brought out statement 69 which essentially
provides for disclosure requirements pertaining to
reserves, capitalized costs, results of operations
,standard for measurement of future cash flows.
 Summary position SEC ASR 257 or FASB SFAS 19 SEM
as well as SEC ASR 258 FCM are the approved
methods by FASB or SEC-no change is also envisaged.
Historical development of
accounting methods
 COPAS-Council of petroleum accountant societies was
formed in US-no authority as FASB or SEC ,but
pronouncements of COPAS are accepted. Highest level
being procedures followed by bulletins and
interpretations.
 The official position regarding application of various
pronouncements in the US is :Listed companies which
are registered with the Securities and Exchange
Commission (SEC) in the United States may follow
either the full cost method prescribed by the SEC or the
successful efforts method. Each of these methods are
explained in Regulation SX Rule 4-10 of the SEC, the
provision relating to SEM are the same as SFAS 19.
Historical development of
accounting methods
 For unlisted companies as things stand today in the United
States, there are no prescribed methods of accounting to
follow and technically they may follow any method with any
variation.
 Nevertheless, in practice it is seen that most companies
adopt either SE or FC Method, but since it is not mandatory
for non listed companies, accounting practices vary
significantly between companies in the way the methods
are applied.
 In India both the National Oil Companies follow SEM for
accounting of costs. RIL uses FC with country as the cost
centre.
 Remember there are also variations within SEM or FCM
practiced by various companies
Historical development of
accounting methods
 The choice of accounting method is mainly dependent
on the size of the company and scale of the company's
operations.
 It is generally seen that all the major oil companies, with
few exceptions apply the successful efforts method .
 It is only in case of small ventures, start up ventures,
where writing off of unsuccessful exploration expenses
in one year would create a considerable adverse impact
on the financials for a year, that FC method is adopted.
Successful Efforts Method
(SCM)
 Successful Efforts Method (SCM): Fundamentally, the
Successful efforts method tries to establish a direct
relationship between costs incurred and the identification of
reserves and suggests capitalization of such direct costs.
 Since it is difficult to establish a relationship between
preliminary exploration expenditure like G&G costs etc.,
such costs are written off.
 Other predevelopment costs, such as cost incurred on
acquisition of property are initially capitalized until either
determination is made that it does not contain oil and gas
reserves or the property is surrendered at which time the
asset is written off.
 All capitalized costs relating to producing property are
amortized as the reserves underlying those properties are
produced. Other costs are expensed when incurred.
Full cost method (FCM)
 Full cost method :Under the full cost method, all costs
incurred in acquiring, exploring, and developing properties
within a relatively large geopolitical cost center are
capitalized when incurred and are amortized as the
reserves in that cost center are produced.
 The capitalization is however, subject to the limitation that
the capitalized costs do not exceed the value of those
reserves.
 FC Method regards all costs as necessary for ultimate
production of reserves. All costs are incurred with the
knowledge that, it may not directly result in finding and
developing reserves.
 However, the management expects that benefits obtained
from successful ventures will be adequate to recover costs
of all activities both successful and unsuccessful and to
yield a profit.
 Thus all costs incurred are regarded as integral to the
operation of the company and there by associated with the
company's proved reserves.
ACCOUNTING FOR OIL&
GAS COSTS
 The operations carried out by any upstream oil and gas
companies can be segregated into acquisition,
exploration, development and production. Regulation
SX-4-10of the SEC classifies costs incurred in oil and
gas producing activities into 5 categories.
 Acquisition of property costs.
 Exploration.
 Development.
 Production.
 Support facilities and equipment costs
ACCOUNTING FOR OIL AND
GAS COSTS
 The fundamental issue surrounding the accounting by
oil and gas producing companies concerns the question
as to what constitutes an asset and hence ;
 what costs should be capitalized and what should be
expensed (in the year of occurrence),
 method by which these assets should be valued and
 the limitation to their value established and the method
by which these capitalized costs should be subsequently
amortized.
ACCOUNTING for Acquisition
costs
 Activities: Before an oil company decides to drill for oil, it
usually evaluates areas where oil and gas reservoirs
might be economically discovered and developed.
 After suitable areas have been identified, the oil
company approaches the owner who owns the rights to
any oil and gas in these areas for exploration,
development and production of the underground
minerals on the property.
 In most parts of the globe, whoever owns the land
usually owns both the surface rights and the mineral
rights to the land.
 In India, however, the mineral rights are owned by the
Government.
ACCOUNTING for Acquisition
costs
 Costs: These are costs incurred in acquiring the right to
explore, drill and produce oil and natural gas by
obtaining a mineral lease.
 They include lease bonus, brokers fees, legal costs and
all costs incurred in obtaining a mineral lease.
 These also include cost of temporary occupation of the
land including crop compensation paid to farmers .
 In India, an oil company wishing to undertake survey and
exploration activities has to initially obtain a Petroleum
Exploration License (PEL) and upon development ML
ACCOUNTING for Acquisition
costs
 Accounting treatment:
 Under SEM acquisition costs are capitalized as
unproved property costs.
 Impairment reviews are done periodically and if proved
reserves are discovered, capitalized acquisition costs are
depleted over proved reserves if not, the loss on
impairment is taken to the Profit and Loss Account.
 Under full cost method acquisition costs are capitalized
under a large geographical cost centre (known as a cost
pool) and costs are depleted on the basis of the same.
The cost centre may be countrywide, region, area of
common geology, etc.
 In India, the treatment of the exploration license fee and
fee for mining lease will depend upon the nature of
activity being undertaken in that area. If Under PEL only
survey work is done than treatment as that of survey and
if exploratory wells are drilled than treatment as that of
exploratory wells.
ACCOUNTING for Exploration
costs -Activities
 After the acquisition of land, oil companies generally
perform Geological and Geophysical (G&G) work to
evaluate the likelihood that specific areas may have
prospects of containing oil or gas reserves.
 Costs- Principal types of exploration costs are:
 G&G costs including costs incurred to gain access to
properties to conduct G&G studies, salaries and expenses
of geologists, geophysical crews, etc.
 Dry hole and bottom hole contribution
 Drilling and equipping exploratory and exploratory type
stratigraphic wells
 Carrying and retaining costs of undeveloped property such
as delay rentals, property taxes etc.
 Depreciation and applicable operating cost of support
equipment and facilities.
ACCOUNTING for Exploration
costs -Treatment
 Accounting treatment:
 The costs relating to G&G studies, dry hole and bottom
hole contributions and costs of undeveloped properties
are expensed under the successful effort method in US.
 Under the full cost method these are capitalized in the
relevant cost pool.
 If the study of the seismic survey indicates that the
structure will yield hydrocarbons, the Exploration
Company starts drilling an exploratory well in the chosen
site.
 The cost of drilling exploratory and exploratory type
stratigraphic test wells are initially capitalized as part of
incomplete well cost, equipment and facilities pending
determination under both successful and full cost
methods.
ACCOUNTING for Exploration
costs -Treatment
 If in a subsequent period, the well is determined to have
proved reserves, the capitalized well costs become part
of the enterprise's related equipment and facilities and is
depleted over the proved developed reserves under the
successful effort method or else the capitalized well
costs net of any salvage value are charged off in the
accounts as dry holes.
 Under full cost method, the cost capitalized is included
as part of a larger geopolitical cost centre and amortized,
as reserves in that cost centre are produced irrespective
of whether proved reserves are found or not.
ACCOUNTING for Exploration
costs -Treatment
 Purchase of G&G data: Sometimes oil and gas operators
purchase a library of G&G data. ' library may relate to a
specific area of interest, basin, or trend, or it may be a
library of information relating to other areas.
 The costs exploration data purchased is charged to
expense at the time the costs are incurred.
 Nevertheless, some successful efforts companies treat
such costs as deferred charges if the information is
expected to be used over a period.
 If the costs can be allocated to specific areas, the related
costs may be charged to expense when the information
is used.
 If costs cannot be identified with information relating to
specific areas the deferred costs is amortized over their
estimated useful life useful straight-line amortization.
ACCOUNTING for Exploration
costs -Treatment
 Three-dimensional seismic costs:
 3-D Seismic Survey costs is generally expensed when
incurred und successful efforts method like any other
survey cost. But there may be circumstances when
these may be capitalized when 3-D studies are carried
out to enhance or evaluate proposed development of a
proved field.
 To qualify for capitalization, the 3-D surveys should meet
the criteria of development activities. These costs are
then included as of the cost of an enterprises wells and
related equipment and facility and should be amortized
by unit-of-production method.
ACCOUNTING for Exploration
costs -Treatment
 Deferral of costs in case of exploratory well whose drilling
is complete but the out-come is not immediately
ascertained
 An accounting problem faced by companies using the
successful efforts method is relating to the determination
of the extent of deferral of costs applicable to an
exploratory well that has been drilled but whose outcome
is not ascertained
 The costs of drilling an exploratory well are capitalized as
part of the enterprise's incomplete wells, equipment and
facilities pending determination of whether the well has
found proved reserves.
 This determination is normally made soon after the
drilling is complete as the capitalized costs are either
charged to expense or re-classified as part of the
enterprise's wells and depleted accordingly
ACCOUNTING for Exploration
 An exploratory well may be determined to have found oil
and gas reserves on completion of drilling, but
classification of the reserves as proved depends on
whether a major capital expenditure can be justified
which, in turn, depends on whether additional exploratory
wells find sufficient quantity of additional reserves.
 This situation will arise when exploratory wells are
drilled in a remote area for which production would
require constructing a trunk pipeline.
 In that case, the cost of drilling the exploratory well shall
continue to be carried as an asset pending determination
of whether proved reserves have been found only as
long as both of the following conditions are met
 the well has found a sufficient quantity of reserves to
justify its completion as a producing well if the require
capital expenditure is made.
 drilling of the additional exploratory wells is under way: or
firmly planned for the near future
ACCOUNTING for Exploration
 All other exploratory wells that find oil and gas reserves.
 In all other cases, under US GAAP, it is permitted to
carry the cost of such exploratory wells for not more than
one year, following completion of drilling. If, after a year
has passed, a determination that proved reserves have
been found cannot be made, the well shall be assumed
to be impaired, and its costs shall be charged to expense
 UK: Unless further appraisal of the prospect is firmly
planned or underway, expenditure incurred on
exploration and appraisal activities may be carried
forward pending determination for a maximum of three
years following completion of drilling in an offshore or
frontier environment where substantial development
costs may need to be incurred or for a maximum of two
years in other areas. Any undetermined costs carried
forward beyond these limits are to be disclosed.
ACCOUNTING for Exploration
 Subsequent to the appraisal of a field, expenditure
incurred in establishing commercial reserves may be
carried forward only as long as there exists a clear
intention to develop the field.
 Clearly the intention is to prohibit the indefinite deferral of
the costs of exploratory wells on the hope that some
event totally beyond the control of the company will
occur which will result in reclassification of reserves as
proved
 In certain circumstances in case of national oil
companies, the determination as to whether the reserves
found by an exploratory well are proved takes a longer
time due to reasons like Absence of Infrastructure,
Paucity of Funds for further exploitation, Non-availability
of equipments, Logistics, Insurgency activities, Priorities
of the Government etc.
ACCOUNTING for Exploration
 ICAI Guidance note;
 No proved reserves found than charge to P&L net of
salvage value
 Cost of EWIP should not be carried of beyond 2 years
from date of completion of drilling unless;
 Reasonably demonstrated that wells have proved
reserves and the field in which wells are located has
been planned ,in that case cost of E W could be carried
forward with out time limit.
ACCOUNTING for Development
 Activities: Development costs are incurred to obtain access
to proved reserves and to provide facilities for the
extraction, treating, gathering and storing the oil and gas.
This also requires drilling and equipping developmental
wells to construct and install production equipments.
 Costs
 Costs incurred to gain access and to prepare well locations
for drilling, clearing the ground, drainage, building roads,
etc.
 Cost incurred for drilling and equipping development wells
including development type stratigraphic wells including
cost of platforms and well equipment.
 Cost incurred for acquiring, constructing and installing
production facilities.
 Cost incurred for providing improved recovery systems
 Depreciation and applicable operating costs of support
equipment and facilities
ACCOUNTING for Development
 Accounting treatment:
 Under the successful effort method the development
costs are capitalized and are depleted over proved
developed reserves on a field by field basis.
 Under the full cost method the development costs are
capitalized and depleted under the cost pool basis.
 Under the successful and full cost method followed in the
UK, all development costs are capitalized and depleted
over the commercial reserves.
ACCOUNTING for Production
 Activities: These activities involve the lifting of the
hydrocarbons to the surface and in gathering, treating,
processing and storing the oil and gas.
 These are costs incurred to operate and maintain wells,
related equipment and facilities.
 The production function comes to a stop when the
hydrocarbons enter the delivery point ie. at the outlet on
the production storage tank or at the first point at which
oil, gas or gas liquids are delivered to a main pipeline, a
common carrier, refineries or a marine terminal.
ACCOUNTING for Production
 Cost: These costs are incurred to operate and maintain
the enterprise's wells and related equipment facilities
and other costs and include
 Labor costs to operate wells and equipments
 Repair and maintenance, work over costs
 Production taxes such as Cess, Royalty etc.
 Costs of materials, supplies, fuel and other services
utilized in operating the wells related equipment and
facilities.
 Insurance on property
ACCOUNTING for Production
 Accounting treatment:
 All production expenses under both successful and full
cost method are charged to expense when incurred.
 The costs incurred on creating production facilities are
capitalized.
 Cess and Royalty: These are recorded when the revenue
on which they are based is recorded. These are
recovered from the purchasers and they are treated as
reimbursed costs.
 Indirect production costs are all costs that are not closely
related to the production of oil and gas on specific leases
and are not controllable at the lease level.
 These indirect costs are accounted for in much the same
way as overhead costs. In general the costs of a function
or activity are accumulated and then apportioned or
allocated to individual properties on a reasonable basis.
For example on the basis of direct labor hours/costs,
number of wells, time of equipment use, volume of
service rendered, volume of production.
ACCOUNTING for surface
equipments &facilities
 The cost of acquiring or constructing support equipment
and facilities used in Oil and Gas producing activities is
capitalized.
 In order to be able to carry' out the aforesaid activities,
all oil producing companies would require support
equipment and facilities.
 These would be in the nature of field service units, camp
facilities, godowns (for stores and spares), workshops
(for equipment repairs), transport services (trucks,
helicopters for offshore rigs) catering facilities etc.
 The expenses relating to the operation of such support
facilities and activities are allocated to those activities
receiving the benefits.
ACCOUNTING for surface
equipments &facilities
 Thus costs of depreciation, taxes, repairs, and operation of
equipment (such as seismic equipment, construction and
grading equipment, drilling equipment, vehicles, repair shops,
warehouses, supply points, camps and division, district, or field
offices) may relate in whole or in part to exploration,
development or production activities and would accordingly be
allocated to the four main activities i.e., acquisition, exploration,
production and development in an appropriate basis.
 In practice, these overheads would be allocated on the basis of
appropriate cost accounting principle which are consistently
applied.
 For example cost relating to catering services could be
apportioned on the basis of the number of people working in
each of the activities e.g. drilling engineering cost on the basis
of rig days, mud logging cost on the basis of logging hours etc.
SEM
 Acquisition costs- capitalized as unproved reserves. If
proved reserves found then add to amortization base
(property) and amortize as per DDA on the basis of
production and charge to P&L. If no proved reserves
found- charge to P&L.
 Exploration costs: Non drilling charge to P&L, drilling
exploration costs-capitalize temporarily. If proved reserves
found add costs to amortization base (wells & equipments)
and amortize as per DDA on the basis of production and
charge to P&L. If no proved reserves found-charge to P&L.
 Development costs: add costs to amortization base
(wells & equipments) and amortize as per DDA on the
basis of production and charge to P&L.
 Production costs: charge to P&L
SEM
 Rs 2 crore spent on G &G.
 Payment of Rs 10000 for 1 acre of land (50 acres) for
commencing exploration activity.
 On this land spent Rs 50 crore on drilling a well which
yielded no oil.
 On this well spent another Rs 60 crore on drilling of a
successful well.
 Spent Rs 100 crore on creation of surface facilities such
as GGS etc on this land.
 Rs 5 crore spent on taking out production from this field.
 FCM
 Exploration non drilling costs & Acquisition costs
:Temporarily capitalized as un proved property. If
reserves found –add to amortization base and amortize
as per DDA on the basis of production and charge to
P&L. If no reserves found then also capitalize as
impaired or abandoned costs- add to amortization base
and amortize as per DDA on the basis of production and
charge to P&L.
 Drilling exploration costs+ development cost: add to
amortization base and amortize as per DDA on the basis
of production and charge to P&L
 Production costs: charge to P&L
SEM vs. FCM
Particulars SEM FCM

G&G E C
Lease ACQ C pending C
Costs determination
Expl. Drilling C pending C
costs determination
Development C C
costs
Prod costs E E
Cost pool property Country
Particu Unit Assam KG WELL RJ India
lars WELL+ 2
+1
G&G Rs 5 7 10 50 72
Exp D Rs 15 14 20 60 109
Status SUCC SUCC DRY Dr UP
DD Rs 25 21 46
PC Rs 35 31 66
ER Barrel 100 200 300
PDR Barrel 95 170 265

PUDR Barrel 5 30 35
 Balance sheet under SEM
 Assets ASSAM KG RJ INDIA
EXP DRILL. 15 14
DEV COSTS 25 21
PROD PROP 40 35 75
EXP DRILL. 60
EXP WIP 60 60
PROFIT & LOSS
SURV.COSTS 5 17 50 72
Prod COSTS 35 31 66
DRY WELLS 20 20
Depletion 4.2 4.2 8.4
 Calculation of depletion field wise

 ASSAM
 Depletion rate=Acc Expl + Devlop costs/PDR
 40/95=.42
 DePL charge=.42*prod during the year=4.2

 KG
 35/170=.21
 DePL charge=.42*prod during the year=4.2
 BALANCE SHEET UNDER FC
 ASSETS
 SURVEY COSTS 72
 EXPL DRILLING 109
 DEVLOP COSTS 46
 PROD PROPERTY 227
 PROFIT & LOSS ACCOUNT
 PROD COSTS 66
 Depletion 22.8
 DEPL=ACC EXPLO+DEL COSTS/PDR*P