Accounting in the Oil and Gas

The oil and gas business is a dominant, global industry that benefits all aspects of our lives. The
extractive industry symbolizes global commerce on an immense scale. The continuing growth in
the demand for energy in the world markets has driven oil and gas companies to invest
significantly to maintain and increase their annual production.

Two Approaches

1. Full Cost Accounting vs. Successful Efforts Accounting

Full cost accounting is a method of accounting for oil and gas exploration and development
activities whereby all the costs associated with exploring for and developing oil and gas reserves
are capitalized, irrespective of the success or failure of specific parts of the overall exploration
activity. Costs are accumulated in cost pools known as cost centers and the costs in each cost
pool are written off against income arising from production of the reserves attributable to that
cost pool.

Successful efforts accounting is a method of accounting for oil and gas exploration and
development activities whereby exploration expenditure which is either general in nature or
relates to unsuccessful drilling operations is written off. Only those costs which relate directly to
the discovery and development of specific commercial oil and gas reserves are capitalized and
are depreciated over the lives of these reserves. The success or failure of each exploration effort
is judged on a well-by-well basis as each potentially hydrocarbon-bearing structure is identified
and tested.

1. Kos Perakaunan Penuh vs Usaha yang berjaya Perakaunan

Perakaunan kos sepenuhnya adalah satu kaedah perakaunan untuk aktiviti penerokaan dan
pembangunan minyak dan gas di mana semua kos yang berkaitan dengan meneroka untuk dan
membangunkan rizab minyak dan gas dipermodalkan, tanpa mengira kejayaan atau kegagalan
bahagian-bahagian tertentu aktiviti penerokaan keseluruhan. Kos terkumpul dalam kolam kos
dikenali sebagai pusat kos dan kos dalam setiap kolam kos dihapus kira terhadap pendapatan
yang terbit daripada pengeluaran daripada rizab boleh dikaitkan dengan kolam kos.

usaha yang berjaya perakaunan adalah satu kaedah perakaunan untuk aktiviti penerokaan dan
pembangunan minyak dan gas di mana perbelanjaan eksplorasi yang sama ada bersifat umum
atau berkaitan dengan operasi penggerudian tidak berjaya dihapuskan. Hanya kos yang berkaitan
secara langsung kepada penemuan dan pembangunan rizab minyak dan gas komersial tertentu
dipermodalkan dan disusutnilai sepanjang kehidupan rizab ini. Kejayaan atau kegagalan setiap
usaha penerokaan dinilai secara baik demi juga setiap struktur berpotensi hidrokarbon-bearing
dikenalpasti dan diuji.
2. Classification of Costs

There are different classifications of costs incurred by oil and gas companies such as:

Pre-license costs are costs incurred prior to the acquisition of a license to explore for oil
and gas in a particular location. Pre-license costs include the acquisition of speculative
seismic data and expenditures related to the subsequent geological and geophysical
analysis of that data.

License acquisition costs are costs incurred to acquire or lease a property including cost
of lease bonuses and options to purchase or lease properties, brokers fees and legal and
other related costs.

Exploration and evaluation costs are costs incurred after obtaining a license but before a
decision is taken to develop a field or reservoir. Exploration costs include costs of
geological and geophysical studies, holding underdeveloped properties, drilling,
equipping and testing exploration and evaluation wells. Evaluation costs include those
costs incurred in determining the size and characteristics of a reservoir discovered during
the exploration phase and then evaluating its commercial potential.

Development costs are costs incurred after a decision has been taken to develop a
reservoir which include the costs of drilling, equipping and testing development and
production wells, production platforms, down-hole and wellhead equipment, pipelines,
production and initial treatment and storage facilities, utility and waste disposal systems,
and improved recovery systems and equipment.

Operating costs are the costs of producing oil and gas which include costs of personnel
engaged in the operation of wells, equipment and facilities, repairs and maintenance of
producing facilities, and materials, supplies, fuel and services used in such operations.

3. Initial treatment of costs pending determination

For companies using full cost accounting, expenditures on pre-license, license acquisition,
exploration, evaluation, and development activities including enhanced oil recovery and
extended life projects should be capitalized. All capitalized costs should be recorded within an
appropriate cost pool when incurred, except that certain costs may be held outside cost pools
pending determination. Costs of individual license interests may be held outside cost pools until
the existence or otherwise of commercial reserves is established. These costs will not be
depreciated pending determination, subject to there being no evidence of impairment.

Full cost pools should be classified in the balance sheet as tangible assets while expenditures
held outside full cost pools should be classified as intangible assets-exploration expenditure.
For companies using successful efforts accounting, all pre-license, license acquisition,
exploration and evaluation costs should be initially capitalized (including those costs which may
fall to be written off in the same period) in well, field or general exploration cost centers as
appropriate, pending determination. Expenditures incurred during the various exploration and
development phases should be written off unless commercial reserves have been established or
the determination process has not been completed.

Expenditures incurred prior to the acquisition of a license and the costs of other exploration
activities which are not specifically directed to an identified structure should be written off in the
period. Expenditures incurred on the acquisition of a license interest should be initially
capitalized on a property-by-property basis. Exploration and appraisal costs should be
accumulated on a well-by-well basis pending evaluation. After appraisal, if commercial reserves
are found then the net capitalized costs incurred in discovering the field should be transferred
into a single field cost center.

4. Accounting for depreciation

All expenditures carried within each cost pool (for full cost accounting) or each field (for
successful efforts accounting) should be depreciated on a unit-of-production basis by reference to
quantities.

The cost basis of the unit of production calculation should be the cost incurred to date together
with the estimated future development costs of obtaining access to all the reserves included in
the unit of production computation. The unit of production basis should be the ratio of oil and
gas production in the period to the estimated quantity of commercial reserves on a pool-by-pool
basis or field-by-field basis at the end of the period plus the production in the period.

Where both oil and gas exists in material quantities, it is necessary to use an appropriate
conversion factor so that the aggregate reserves and production can be expressed in common
unit. The quantities or units both for commercial reserves and production should consistently
either include or exclude any quantities of oil and gas consumed in operations.

Changes in cost and reserve estimates do not result to prior year adjustments. When estimates are
revised, the carrying amount should be depreciated using the revised estimates from the date of
revision.

5. Impairment tests

For companies using the full cost method, an impairment test should be made if events or
changes in circumstances indicate that the net book value of expenditure in each cost pool, less
any provisions for decommissioning costs and deferred revenue-related taxes, may not be
recoverable from the expected future net revenue from oil and gas reserves attributable to the
companys interest in that pool. A cost pool is a cost center used under the full cost method of
accounting as a basis for accumulating depreciable capitalized exploration, appraisal and
development expenditure. The impairment test should be carried out on a pool-by-pool basis and
that costs held outside the cost pools are subject to a separate review for impairment.
For companies using successful efforts accounting, an impairment test should be made if events
or changes in circumstances indicate that the net book value of expenditure in each cost center,
less any provisions for decommissioning costs and deferred revenue-related taxes, may not be
recoverable from the expected future net revenue from oil and gas reserves attributable to the
companys interest in that field. A field is an area of a single reservoir or multiple reservoirs all
grouped on or related to the same individual geological structural feature. The impairment test
should be carried out on a field-by-field basis and that costs held pending determination are
subject to a separate review for impairment.

6. Decommissioning costs

Decommissioning is the process of closing and abandoning wells, of dismantling of wellhead,

production and transport facilities and of restoring production areas in compliance with license
requirements, and the relevant laws and regulations.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires provision to be made
for a present obligation whether it is a legal or constructive obligation. The provision for
decommissioning costs should be to the extent that the company is obliged to fix the damage
already caused to the environment. The amount of provision should be recorded at the present
value of the costs expected to be required to settle the obligation.

7. Crude oil trading

Aside from selling their own oil production, companies with upstream operations often engage in
trading crude oil cargoes in which they can either, take delivery and sell the physical oil
obtained, or the cargo can be re-sold without taking delivery.

The generally accepted accounting treatment is that crude oil trading activity should be excluded
from upstream segment turnover. The net profit or loss on crude oil trading should be included in
other operating income. The related gross sales and costs of crude oil trading activity should be
disclosed in the notes to the financial statements.

8. Royalties.

The accounting treatment for government and other royalties payable depends on the type of
royalty arrangement. The first type of arrangement is when the reporting company is obliged to
dispose of all the relevant production and pay over that proportion of the aggregate sale for the
reporting period which represents the royalty liability after deducting conveying and treating
costs. The net royalty payments are considered as a production cost or tax. The reported turnover
should include all invoiced sales and the net royalty payments should be charged to cost of sales.

The other arrangement is when the royalty holder has a direct interest in the basic production and
may make an independent conveying, treating and sale arrangements. The accounting treatment
in this type of arrangement will require that the value of production representing such royalty be
excluded from turnover and accounted for as cost of sales.
9. Joint arrangements

IFRS 11 Joint Arrangements introduced two primary changes. First, is that there will be only two
types of joint arrangements joint ventures and joint operations with the latter more commonly
applicable in the oil and gas industry. Second is the application of the equity accounting method
for joint venture arrangements.

10. Revenue recognition

There is a new development in the revenue recognition practices of oil and gas companies with
the issuance of IFRS 15 Revenue from Contracts with Customers.

The application of IFRS 15 will require oil and gas companies to change the way they evaluate
most of their transactions. Although in general, it is not expected that the new revenue
recognition standard to significantly impact the revenue recognition practices for most types of
arrangements that are common in the industry. However, there is a need to evaluate how the
standard may affect certain contracts and financial reporting processes.

Arrangements entered into by oil and gas companies are more often too complex that will require
determining whether the counter-parties to contracts are customers or collaborators.
Collaborative arrangements are outside the scope of IFRS 15. However, goods and services
provided to counter-parties by oil and gas companies are within the scope of the standard.

Another difficulty in the application of IFRS 15 in oil and gas companies is the evaluation and
determination performance obligations in long-term supply agreements. In a fixed-price contract
to sell a commodity over multiple periods involving multiple performance obligations, the
reporting company will need to determine the stand-alone selling prices of each performance
obligation in order to allocate the transaction price.

The determination of the performance obligations and the allocation of the transaction prices will
establish the pattern of revenue recognition.