1. Successful Efforts Method (SEM) and Full Cost Method (FCM) of Accounting for Oil and Gas Producing Activities

2. Functions/Segments of Oil and Gas Industry
Exploration and Production (E&P)
Transportation
Refining and Gas Processing
Marketing and Distribution
An independent oil company is one involved primarily in only E & P activities
An integrated oil company is one involved in E & P activities as well as at least one of the other functions.

3. E&P Activities Acquisition activities Exploration Activities
Development Activities
Production Activities

4. Acquisition activities
Involve activities carried out for acquisition of rights to explore, develop and produce oil and gas

5. Exploration activities
Prospecting activities conducted in the search for oil and gas
Ariel, geological, geophysical, geochemical, topographical and seismic surveys
analysis, studies and their interpretation
Investigations relating to subsurface geology
Structural test drilling
Drilling of exploratory and appraisal wells

6. Development activities
Purchase, shipment or storage of equipment and materials used in developing oil and gas accumulations, completion of successful exploration wells
Drilling, completion and testing of development wells
Drilling, completion and recompletion of service wells
Laying of gathering lines
Construction of offshore platforms and installations
Installations of separators, tankages, pumps, artificial lifts and other producing and injection facilities required to produce, process and transport oil or gas

7. Production activities
pre-wellhead activities (lifting the oil and gas to the surface, operation and maintenance of wells, extraction rights, etc.)
Post-wellhead activities (gathering, treating, field transportation, field processing, etc., up to the outlet valve on the lease or field production storage tank, etc.)

8. Costs Associated with E&P Activities
Acquisition Costs
Exploration Costs
Development Costs
Production Costs

9. Acquisition Costs
Costs incurred in acquiring property, i.e. costs incurred in acquiring the rights to explore, drill and produce oil and natural gas
Lease bonus, brokers’ fees, legal costs, cost of temporary occupation of land, crop compensation paid to farmers
Costs of obtaining Petroleum Exploration License (PEL) and Mining Lease (ML)
For onshore E & P activities PEL and ML are issued by State Government on recommendations of Central Government
For offshore E & P activities, PEL and ML are issued by Central Government

10. Exploration Costs Costs incurred in exploring property
Costs of surveys and studies (like aerial, geological, geophysical, geochemical, and seismic surveys)
Costs of environment clearance, defense clearance, etc.
Salaries and other expenses of geologists, etc.
Costs of carrying and retaining undeveloped properties, such as delay rental, maintenance of land, annual license fees in respect of PEL

11. Development Costs
Costs incurred in preparing proved reserves for production, i.e. costs incurred to obtain access to proved reserves and to provide facilities for extracting, treating, gathering, and storing oil and gas
Costs of clearing ground, draining, road building, gas lines and power lines to the extent necessary in developing the proved oil and gas reserves
Costs to drill and equip development wells and service wells including costs of platforms and well equipments such as casing, tubing, pumping equipment, etc.

12. Development Costs
Costs to acquire, construct and install production facilities such as lease flow lines, separators, treaters, heaters, manifolds, measuring devices and production storage tanks, natural gas cycling and processing plants and utility and waste disposal systems
Depreciation and applicable operating cost of related support equipment and facilities in connection with development activities, and annual license fees in respect of ML

13. Production Costs
Costs incurred in lifting oil and gas to the surface and in gathering, treating, and storing oil and gas
Pre-wellhead costs: Costs of labour, repairs and maintenance, materials, supplies, fuel and power, property taxes, insurance, royalty, etc., in respect of lifting the oil and gas to the surface, operation and maintenance including servicing and work-over of wells
Post-wellhead costs: Costs of labour, repairs and maintenance, materials, supplies, fuel and power, property taxes, insurance, etc., in respect of gathering, treating, field transportation, field processing, including cess up to the outlet valve on the lease or field production storage tank, etc.

14. Accounting Methods for Oil and Gas Producing Activities
Technical and theoretical problems
Characteristics:
- high risk
- high investment
- lack of correlation between the expenditure incurred and the value of resulting reserves
- long time span between the points when costs are first incurred until benefits are received

15. Accounting Methods for Oil and Gas Producing Activities
All production costs are charged as an expense of the period
All development costs are capitalized
Treatment of acquisition costs and exploration costs
Successful Efforts Method/Full Cost Method
Different results on earnings, return on investment and book value
Fundamental accounting issue: Whether to capitalize or expense acquisition and exploration costs

16. Successful Efforts Method (SEM)
Rationale: expenditures providing no future economic benefits should be expensed
Only those costs lead directly to discovery of oil and gas are capitalized
Direct relationship is required between costs incurred and reserves discovered
Costs that do not result in discovery of reserves (dry hole costs) are charged as expenses of the period
Treatment is similar to Research and Development Costs

17. Successful Efforts Method (SEM)
acquisition costs, (2) drilling exploration costs and (3) development costs should be treated as capital work-in-progress when incurred
All costs other than these should be charged as expense of the period
When the well is ready to commence commercial production, the costs referred to (2) and (3) corresponding to proved developed oil and gas reserves should be capitalized as ‘producing properties’ from capital work-in-progress to the gross block of assets
All acquisition costs should be capitalized from capital work-in-progress to the gross block of assets

18. Successful Efforts Method (SEM)
acquisition costs, (2) drilling exploration costs and (3) development costs should be treated as capital work-in-progress when incurred
All costs other than these should be charged as expense of the period
When the well is ready to commence commercial production, the costs referred to (2) and (3) corresponding to proved developed oil and gas reserves should be capitalized as ‘producing properties’ from capital work-in-progress to the gross block of assets
All acquisition costs should be capitalized from capital work-in-progress to the gross block of assets

19. Successful Efforts Method (SEM)
If the cost of drilling exploratory well relates to a well that is determined to have no proved reserves,
then such costs net of any salvage value are transferred from capital work-in-progress and charged as expense of the period

20. Full Cost Method (FCM)
First corporation to use FCM was Belco Petroleum in 1957
The philosophy behind FCM is that costs of acquisition, exploration and development are necessary for the production of oil and gas.
Because there is no known way to avoid unsuccessful costs in searching oil and gas, FCM considers both successful as well as unsuccessful costs incurred in the search for reserves as a necessary part of costs of finding oil and gas
Dry-holes are an inevitable part of exploration effort
Both, successful and unsuccessful costs are capitalized, even though unsuccessful costs have no future benefits

21. O & G Ltd. began its operation on April 1, 2009, with the acquisition of a lease in KG Basin. During the first year the following revenue was earned and costs were incurred:
Revenue Rs.2,45,000
Acquisition costs related with dry-holes Rs.4,00,000
Acquisition costs related with successful wells Rs.1,00,000
Exploratory dry-hole costs Rs.18,00,000
Exploratory successful wells Rs.5,00,000
Development costs- resulted in dry-holes Rs.25,000
Development costs- resulted in development wellsRs.75,000
Production costs Rs.75,000
Depreciation and depletion under SEM Rs.70,000
Depreciation and depletion under FCM Rs.2,90,000

22. Profit and Loss A/c Expenses SEM Rs. FCM Revenues Acquisition costs
Exploratory dry-hole costs
Production Costs
D & D
4,00,000
18,00,000
75,000
70,000 -
2,90,000
Revenue
Net loss
2,45,000
21,00,000
1,20,000
23,45,000
3,65,000

23. Partial Balance Sheet Liabilities Assets SEM Rs. FCM Acquisition costs
Exploratory dry-hole costs
Development costs
Exploratory successful wells
D & D
1,00,000 -
5,00,000
7,00,000
70,000
6,30,000
18,00,000
29,00,000
2,90,000
26,10,000

24. Industry Practices Companies following SEM:
Oil and Natural Gas Corporation Ltd.
Oil India Ltd.
BG Energy Holdings Ltd.
Cairn Energy Plc.
Hindustan Oil Exploration Co. Ltd.
Chevron Oil Ltd.
BP Plc.

25. Industry Practices Companies following FCM: Reliance Industries Ltd.
Essar Oil Ltd.
Gujarat State Petroleum Corporation Ltd.
Niko Reources Ltd.
Joshi Technologies