1. Chapter 15: Oil & Gas Accounting
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Chapter 15: Oil & Gas Accounting
Full cost (FC) versus successful efforts (SE) accounting
Standards setting
Reserve recognition accounting
SFAS No. 69
Chapter 15
Oil & Gas Accounting

2. Conceptual Differences Between FC & SE
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Conceptual Differences Between FC & SE
Both methods are allowed under GAAP
Both present as assets only the costs incurred in exploration and development
Basic difference is the size of the cost center used in the capitalize/expense decision for exploration costs
Under FC, the largest possible cost center is the country or even a continent, and all costs of finding oil and gas reserves would be capitalized regardless of whether a specific local effort is successful.
Under SE, the smallest possible cost center is the property (lease), reservoir, or field (most SE companies use the field), and all costs of that well would be expensed unless oil and gas reserves are found.
SE embodies finite uniformity: if exploration is unsuccessful, exploration costs are expensed; however, when successful exploration occurs, costs are capitalized.
Chapter 15
Oil & Gas Accounting

3. Accounting Theory ( 5th edition) Wolk, Tearney & Dodd
Copyright June, 2000
Trends
SE accounting was the only method used prior to the late 1950s and early 1960s
Problems with application of the historical cost model led to increasing use of FC model in late 1960s
Problem with application of FC model: frustration with a historical cost concept that penalizes enterprises for exploration efforts that result in no discoveries and does not reward those efforts that result in discoveries with recognition of the value discovered
Chapter 15
Oil & Gas Accounting

4. Accounting Theory ( 5th edition) Wolk, Tearney & Dodd
Copyright June, 2000
Full Cost Accounting
Results in a smoothing of reported income because costs that are written off in the current period under the SE method are capitalized and amortized against revenues of a number of future periods
Generally, the larger, more mature and fully integrated enterprises in the oil and gas industry use SE, while the smaller, less integrated enterprises use FC
Chapter 15
Oil & Gas Accounting

5. Standards Setting in Oil & Gas
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Standards Setting in Oil & Gas
AICPA commissioned ARS (1964)
ARS 11 (1969) published recommending use of SE accounting, not FC
APB’s Committee on Extractive Industries
Reviewed ARS 11 and published its report 1971
Accounting and Reporting Practices in the Petroleum Industry reviewed in public hearing
Favored SE method
Chapter 15
Oil & Gas Accounting

6. Standards Setting in Oil & Gas
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Standards Setting in Oil & Gas
Federal Power Commission issued order which required the FC method
APB’s Committee on Extractive Industries was unable to finalize its paper
FASB formation begins
Just prior to the APB’s public hearing, the Federal Power Commission issued Order No. 440, which required the FC method for mineral leases acquired after October 6, 1969
Chapter 15
Oil & Gas Accounting

7. Standards Setting in Oil & Gas
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Standards Setting in Oil & Gas
1972, SEC proposed that those enterprises that do not follow SE should disclose what net income would have been under that method ... later retreated from proposal
1973 foreign oil embargo
The Energy Policy and Conservation Act of 1975
Chapter 15
Oil & Gas Accounting

8. Standards Setting in Oil & Gas
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Standards Setting in Oil & Gas
FASB worked closely with the SEC
Issued a discussion memorandum in 1976
Held a public hearing in the spring of 1977.
July 1977, the FASB issued an exposure draft, which required the SE method of accounting
SEC issued ”Securities Act Release No. 5861,” which proposed to amend regulations to incorporate the accounting standards set forth in the exposure draft in the event a statement of financial accounting standards was not issued ...
Chapter 15
Oil & Gas Accounting

9. Standards Setting in Oil & Gas
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Standards Setting in Oil & Gas
December SFAS No. 19 required SE and eliminated FC.
Bending to political pressure
The SEC effectively circumvented SFAS No. 19 in ASR 253, which permitted either FC or SE
As a result, SFAS No. 25, which suspended the mandatory SE provisions of SFAS No. 19, was issued in February 1979
Chapter 15
Oil & Gas Accounting

10. Accounting Theory ( 5th edition) Wolk, Tearney & Dodd
Copyright June, 2000
Survey of all financial analysts involved with the oil and gas industry
Conducted primarily to determine whether analysts favored FC or SE
Over 40 percent responded
They overwhelmingly favored the SE method
83% of the analysts thought that the value of recoverable reserves should be disclosed in financial reports.
Response suggests the historical cost model simply does not provide adequate information to decision makers.
Chapter 15
Oil & Gas Accounting

11. Reserve Recognition Accounting (RRA)
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Reserve Recognition Accounting (RRA)
Perceived failure of the historical cost method led the SEC to advocate RRA
August 1978, the SEC issued Release , which ushered in RRA on an experimental basis for three years
Chapter 15
Oil & Gas Accounting

12. Accounting Theory ( 5th edition) Wolk, Tearney & Dodd
Copyright June, 2000
RRA Valuation Method
Estimate the timing of future production of proven reserves, based on current economic conditions
Estimate future revenue by using estimate from (1) and applying current prices for oil & gas, adjusted only for fixed contractual escalations.
Estimate future net revenue by deducting from the estimate in (2) the costs to develop and produce the proven reserves
Determine the PV of future net revenue by discounting the estimate in (3) at 10 %
Chapter 15
Oil & Gas Accounting

13. Accounting Theory ( 5th edition) Wolk, Tearney & Dodd
Copyright June, 2000
SFAS No. 69
Represents an attempt by the FASB to combat the standards-overload problem
Is not applicable to enterprises that are not publicly traded nor to publicly traded
Requires the disclosure of financial information outside the basic financial statements or notes
Chapter 15
Oil & Gas Accounting

14. SFAS No. 69 Required Disclosures
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
SFAS No. 69 Required Disclosures
Proven oil and gas reserve quantities
Capitalized costs relating to oil & gas-producing activities
Costs incurred in oil & gas property ...
Results of operations for oil & gas-producing activities
A standardized measure of discounted future net cash flows relating to proven oil and gas reserves.
Chapter 15
Oil & Gas Accounting

15. Chapter 15: Oil & Gas Accounting
Accounting Theory ( 5th edition)
Wolk, Tearney & Dodd
Copyright June, 2000
Chapter 15: Oil & Gas Accounting
Full cost (FC) versus successful efforts (SE) accounting
Standards setting
Reserve recognition accounting
SFAS No. 69
Chapter 15
Oil & Gas Accounting