Corporate Liquidation and Reorganization Pertemuan 25-26 Mata kuliah : F0074 - Akuntansi Keuangan Lanjutan II Tahun : 2010
AICPA Accounting Standards Executive Committee Oil and Gas Accounting Background and Accounting Methods
Oil & Gas Accounting Background • 1950’s and 1960’s: Diversity in practice in accounting for oil and gas activities. Two methods - Full Cost and Successful Efforts • 1970’s: FAS No. 19, “Financial Accounting and Reporting for Oil and Gas Producing Activities,” is issued. Prescribes SE method be followed • SEC issues several Accounting Series Releases that allow companies to follow either method and provide guidance on applying the different methods • FAS No. 25 issued. Makes the SE method of accounting preferable, but not mandatory.
Two Types of Accounting Methods • FULL COST - Basic Concept • All costs associated with property acquisition, exploration and development activities shall be capitalized by country-wide cost center. • SUCCESSFUL EFFORTS - Basic Concept • Costs associated with property acquisition, exploration and development activities shall be capitalized if they directly result in the finding or development of proved reserves. Costs not directly resulting in proved reserves shall be expensed.
AICPA Accounting Standards Executive Committee Acquisition and Retention Costs
Acquisition and Retention Costs • Acquisition Costs • Retention / Holding Costs • Delay Rentals • Ad Valorem Taxes • Shut-in Royalties • Legal Costs for Title Defense • Maintenance of Land and Lease Records • Disposition of Capitalized Acquisition Costs • Impairment • Abandonment • Transfer (Reclassification) to Proved Property
The Lease Agreement Mineral interest owner (fee owner or lessor) leases E&P rights to the working interest owner (lessee), the lease agreement: • Defines the lessee and lessor • Clearly defines the leased property • States the consideration (“bonus”) paid by lessee to lessor • States the amount of royalty retained by the lessor (e.g.,1/8 of production sales proceeds) • States the “primary term” (e.g., three years) • Calls for annual “rentals” or delay rentals if drilling has not yet commenced or production established • Contains a clause perpetuating the lease if oil or gas production is established
Types of Mineral Interests • Fee interest • Mineral interest • Working interest (Operating Interest) • Royalty interest (Non-operating Interest) • Overriding royalty interest (Non-operating) • Net profits interest (Non-operating) • Production payment (Non-operating) • Farm-out • Free well agreement • Reversionary or carried (a.k.a. Disproportionate or promoted interests) • Unitization
Accounting for Acquisition and Retention Costs – Successful Efforts Method • Lease acquisition (CAPITALIZE DIRECT ACQUISITION COSTS) • Bonus payments, advance payments, options • Retention Costs (EXPENSE AS INCURRED) • Delay rentals, property taxes, defense costs, shut-in royalties • Disposition of capitalized acquisition costs • Impairment • Abandonment • Transfer to proved properties
Accounting for Acquisition and Retention Costs – Full Cost Method • Lease acquisition (CAPITALIZE DIRECT ACQUISITION COSTS) • Bonus payments, advance payments, options • Retention Costs (CAPITALIZE RETENTION COSTS) • Delay rentals, property taxes, defense costs, shut-in royalties • Disposition of capitalized acquisition costs • Impairment and Abandonment
Impairment – Acquisition CostsSuccessful Efforts and Full Cost • Assess periodically (at least annually) • Triggering Events include dry hole(s), little time left on primary term, development not in the budget • May amortize costs in a group of properties if individually insignificant • Accounting Differences: • Successful Efforts (FAS No 19) – impairment charged to exploration expense • Full Cost (SEC Reg. S-X 4-10) – impairment included in the amortization base (full cost pool) and amortized prospectively
AICPA Accounting Standards Executive Committee Exploration and Development Costs
Exploration Costs Defined • Costs incurred to find proved reserves, including identifying areas that may warrant examination, examining specific areas, and drilling exploratory wells and exploratory stratigraphic type test wells • Costs may be incurred prior to obtaining the lease • Include costs of: • Carrying and retaining undeveloped properties • Topographical or geophysical studies and salaries related to these studies
Development Costs Defined • Obtain access to proved reserves • Provide facilities for extracting, treating, gathering, and storing oil and gas • All phases of drilling development wells (from preparing well locations to placing on production) whether tangible (having salvage value) or intangible (a tax term of not having salvage value, such as making a hole) • “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.” • “Provide improved recovery systems”
Accounting for Exploration and Development Costs • Exploration Costs • Successful Efforts – Expense all exploration costs as incurred, except those applicable to exploratory wells that result in discovery of proved reserves (i.e. capitalize successful exploratory wells and expense exploratory dry holes) • Full Costs – Capitalize • Development Costs • Successful Efforts - Capitalize • Full Cost - Capitalize
Exploration and Development Costs - Illustration Site Well D 1 Discovery, exploratory well establishes offset sites C and E as proved.* E 2 Offset, development producing well. Well 2 proves Site F.* F 3 Offset, development producing well. Assume data does not prove Site G.* B 4 Step-out,exploratory producing well on unproved drill site. Assume data proves Site A. C 5 Offset, development producing well. A 6 Offset, development dry hole. Costs remain capitalized as dev. costs. Well is plugged. G 7 Offset, exploratory dry hole. Costs are expensed (SE). Well is plugged. *Proving a site means that geological and engineering data indicate with reasonable certainty that the site has sufficient reserves to economically justify (at current prices) drilling the site. Usually a successful well and G&G data prove only sites offsetting the successful well’s site. The data may or may not prove all offset locations.
What if . . . Case 4-1: G&G Library • What if a company buys a library of G&G data on many geographic areas, with an estimated useful life of 3 years? Must the cost be expensed under SE? • Example: XYZ Co. pays $10,000 for seismic studies of undeveloped acreage in the Gulf of Mexico • The Rule [Oi5.109 aka FAS 19, par. 18 ] • “Geological and geophysical costs, costs of carrying and retaining undeveloped properties, and dry hole and bottom hole contributions shall be charged to expense when incurred.” • Guidance/Accounting • Seismic studies to enhance or evaluate development of a proved field may be capitalized as development costs. If seismic study relates to exploration activities, expense as incurred. Seismic related to both exploration and development activities should be allocated between development costs (capitalized) and exploration costs (expensed). Full Cost companies capitalize all costs.
What if . . . Case 4-2: Development / Exploratory Well • What if a development well is drilled below the proved reservoir, looking for deeper reservoirs, yet unproven, and finds no new reserves? Are the added costs exploratory? • Example: XYZ Co. spends $1 million to access proved reserves at 10,000 feet and continues down to another stratigraphic region, spending another $400,000 to go to 15,000 feet, only to find no proved reserves. Development • Rule [Oi5.401 aka FAS 19, par. 274 ] • A “development well is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be proved.” • Comment: A portion of a well (hole) can be a “development well” and the remaining portion of the hole is an exploratory well for accounting purposes. • Accounting for the example above • Under Successful Efforts, XYZ expenses the $400,000 (spent to explore below the proved horizon) as unsuccessful exploratory well costs and capitalizes the $1 million as development costs. 10,000 ft, Exploratory 15,000 ft,
What if . . . Case 4-3: At first you don’t succeed… • What if a twin (replacement) exploratory well is needed? Are the costs of the abandoned first well expensed as unsuccessful? • Example: Drilling problems require XYZ Co. to stop short with exploratory well #1, and immediately start over with a nearby “twin” well which successfully discovers the reservoir. Is the $700,000 spent on well #1 unsuccessful exploration cost? Successful Twin • FAS 19 does not specifically address this case. • Arguably, it’s just another cost overrun of drilling “the well”. • Accounting for the example above • Follow established accounting for such cases. • Likely expense the $700,000.
Variations of Case 4-3 • Side tracking (preferable to expense the unsuccessful costs) • Producing well re-entered and drilled deeper (an exploratory cost to be expensed if unsuccessful) • Exploratory well finds no reserves at target formation, drilling continues and discovers a deeper reservoir (capitalize all costs as successful exploratory well) • Exploratory well finds no reserves at target formation, plugged back to shallower discovery (preferable to expense the costs of drilling beyond the shallower discovery). • Exploratory well is a multi-lateral well • Wells can be described as vertical (traditional), directional, horizontal, or multi-lateral Side tracking Multi-lateral well
What if . . . Case 4-4: Well in Progress at End of Reporting Period • What if an exploratory well is in-progress at year-end whereby success cannot be determined at that time? What if it’s found to be dry soon thereafter? Are costs expensed as of period-end? • Example: XYZ Co. spent/accrued $400,000 for well in progress at period-end. After period-end XYZ spent $200,000 more but found no reserves. Deemed a dry hole prior to issuance of financial statements. • Rule [Oi5.130 / FAS 19, par 39 ] paraphrased: • Use information available before financial statements are issued to evaluate conditions at balance sheet date. • Rule [Oi5.130 / FIN 36, par 2] paraphrased: • If such information indicates well was unsuccessful, expense costs as of period-end, net of any salvage value • Accounting for the example above: • Expense the $400,000 as of period-end. Expense the $200,000 in the next period (the period incurred). Well in progress at year-end ?
AICPA Accounting Standards Executive Committee Amortization of Proved Property Costs
What is DD&A? • Oil & gas property costs are “amortized” using a “unit of production” method whereby. . . • Amortization Base x production / beginning of year (BOY) reserves = amortization expense • $200,000 net book value x 10,000 bbls / 100,000 bbls = $20,000 amortization
What is DD&A?, continued • Federal income tax law and regulations call for: • “Depreciation” of capitalized well equipment cost (over a stated life or on the unit of production basis), • “Depletion” of capitalized property acquisition costs (on a unit of production basis), and • “Amortization” over 60 months of certain other costs, such as intangible drilling costs that are not immediately deducted • Financial reporting (FAS No.19 and Regulation S-X Rule 4-10) requires all costs be “amortized” on the unit of production method
Amortization - Simple Example • Amortization Base (NBV) • Capitalized Costs, end of period $1,200,000 • Less prior accumulated amortization (200,000) • $1,000,000 “Base” • Production (quantity sold) for the period 30,000 bbls “P” • Oil & Gas reserves at period’s beginning: • Latest reserve estimate (end of period) 270,000 bbls “R” • Add production for the period (above) 30,000 bbls “P” • 300,000 bbls “R+P” • Amortization = Base x P / (R +P) = $100,000
Calculating Amortization – Oil and Gas Produced • What if both oil and gas are being produced? How is amortization calculated? • Example: Production (P) is 4,000 bbls and 6,000 mcf • Successful EffortsRule (Oi5.129 / FAS 19, par 38) paraphrased: • Convert to common unit of measure [boe or mcfe] based on relative energy content,but… • OK to use either oil or gas if it dominates or if P of oil to P of gas is expected to remain relatively constant (answers about the same) • Full Cost Rule (Rule 4-10[c](3)(iii) paraphrased: • Same as for SE but allowed to use “gross revenue” method of P$/R$ Example solution: 4,000 bbl + 6,000 mcf x 1/6 = 5,000 boe; or 4,000 bbl x 6 + 6,000 mcf = 30,000 mcfe
Successful Efforts Amortization • Costs grouped by field usually • Field’s property acquisition costs amortized over total proved reserves (developed and undeveloped) • Field’s “well equipment and development” costs (including IDC) amortized over proved developed reserves (excluding undeveloped reserves)
What is a Field? • Oi5.403 / FAS 19, par. 272 • “An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature or stratigraphic condition or both.” • Reservoirs may be separated laterally or vertically. • Geological structure is not intended to include an entire “basin”, “trend”, “play”, “area of interest”, etc. • A reservoir is a “porous and permeable underground formation containing a natural accumulation of producible oil or gas . . . separate from other reservoirs.”
Developed vs. Undeveloped Proved Reserves • Proved oil and gas reserves are • estimatedquantities which “geological and engineering data demonstrate with reasonable certainty to be recoverable in the future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made.” (excerpt from SEC S-X Rule 4-10) • Developed reserves are those expected to be recovered through existing wells, using existing equipment and operating methods • Undeveloped reserves (PUDs) are those expected to be recovered from: • New wells on undrilled acreage, or • Existing wells requiring major expenditure
Full Cost Amortization • Broader parameters for capitalized oil & gas costs • Governed by SEC S-X Rule 4-10(c) • Amortized costs are grouped by country, not field • Amortization base includes all acquisition, exploration, and development costs, including future development and abandonment costs • Includes company internal costs directly identified with acquisition, exploration and development activities (not G&A or production) • Some costs may be temporarily excluded from amortization • Amortized over total proved developed and proved undeveloped reserves
AICPA Accounting Standards Executive Committee Disposition of Oil & Gas Assets
Dispositions - Successful Efforts • Accounting - Successful Efforts • General Rules: • No gain if - • Pooling of assets in a joint venture • No gain, but a loss may be recognized if - • Recovery of costs is in doubt or future performance is required • Gain or loss if not described above
Dispositions – Full Cost • Accounting - Full Cost • General Rule: • No gain or loss calculated • Exception - Significantly alters the relationship between costs and reserves
Sale of Entire Unproved Property • Full Cost • Credit proceeds to cost pool . . . • Successful Efforts • If impaired individually, recognize gain or loss • If in an impairment group, no gain or loss recognition • except to the extent sales price exceeds original cost
Sale of Part of an Unproved Property • Full Cost • Credit proceeds to cost pool . . . • Successful Efforts • Recovery of remaining cost is uncertain, so treat sales proceeds as a recovery of cost… • Except to the extent sales price exceeds • original cost (if in an impairment group) • carrying value net of impairment (if individually assessed for impairment)
Sale of Entire Proved Property • Successful Efforts • Recognize Gain or Loss • Full Cost • Credit sales proceeds to full cost pool • unless DD&A rate significantly distorted (greater than 10%)
Sale of Part of a Proved Property (or Amortization Group) • Successful Efforts • Recognize Gain or Loss • Option: Do not recognize gain or loss (asset retirement) if amortization rate not significantly changed • No gain recognized if significant continuing involvement, however loss may be recognized • Apportion book value based on fair values • Full Cost • Credit sales proceeds to full cost pool • unless DD&A rate significantly distorted (greater than 10%)
Example – Sale of Part of a Proved Property – No continuing involvement • Rule: Oi5.138(j) [FAS 19 par. 47j]: Recognize gain or loss. Allocate cost between portion sold and portion retained on the basis of fair values. XYZ Company sells half of a 2% ORRI in a proved property with a NBV of $10,000 for $1 million. • Accounting: [selling 50%, FV of sold = FV of retained] • Cash $1,000,000 • Proved property costs [$10,000 x 50%] $5,000 • Gain on sale $995,000
Example – Sale of Part of a Proved Property – Continuing involvement • Accounting: • Gain or loss? $100m x [40m / (40m + 120m)] = $25m cost • $40m proceeds - $25m cost = $15m gain. Do not recognize. Cash $40,000 Property cost $40,000 XYZ Company sells a 10% ORRI carved from a working interest on proved property with a NBV of $100,000 and a remaining FV of $120,000 for $40,000. • Rule: Oi5.136(b), .138(j), .138(k), & .138(a): May recognize loss, but no gain. .138(j): Calculate using relative fair values
AICPA Accounting Standards Executive Committee Impairment of Oil & Gas Assets
General Rules – Comparison Between Successful Efforts and Full Cost Element Successful Efforts Full Cost • Authoritative Guidance • Performance Criteria • Price and Cost Assumptions • Grouping • FAS No. 144 • Trigger event • Management’s internal pricing • Usually field-level • Regulation S-X 4-10 • Quarterly • Constant (based on year end prices) • Country by country • Property Types • Income Tax Considerations • Presentation and Disclosure • Proved properties only • Typically excluded • Component of Income from continuing operations presented either separately or disclosed in notes • Proved properties only • Included • Component of Income from continuing operations presented either separately or disclosed in notes
General Impairment Rules Full - Cost Property Type Successful Efforts • Proved • SFAS 144 • S-X 4-10(C)(4) “Ceiling Test” - If country-wide costs less deferred taxes exceed discounted after-tax cash flows at current pricing (plus costs not being amortized), write-off excess • Unproved • FAS No. 19 and S-X 4-10; judgmental, systematic amortization, based on lease terms, dry holes, and drilling intent • S-X 4-10(C)(3)(II)(1) and (C)(4) “Asset Impairment” as for successful efforts and reclassify impairment to amortization base (reducing ceiling)
Assessing Impairment – Step 1 • Assess impairment when events or circumstances indicate the asset carrying amount may not be recoverable. • Usually quarterly because mere passage of time is an indicator. • Types of “Trigger Events”: • Passage of time • Decrease in prices • Higher than anticipated development costs • Decrease in reserve estimates (“downward revisions”) • Environmental issues • Adverse political; legislative; or regulatory changes
Assessing Impairment - Step 2 • Compare carrying amount to undiscounted, expected future cash flows (UEFCF) • If carrying amount exceeds UEFCF, go to Step 3.
Assessing Impairment - Step 3 • Write off carrying amount in excess of fair value • No requirement to get an appraisal • No specific guidance in determining FV • Usually fair value reflects discounted, expected future cash flows • Discount rate is usually greater than 10% when applied to truly expected future cash flows
Example FAS No. 144 Impairment Analysis for Proved Properties Step 1 - Assumed occurrence of trigger event • Determination of NBV Field A Field B Field C • Capitalized cost of proved properties $ 5 $ 20 $10 • Accumulated DD&A (2) (8) (3) • Liability for plugging & abandonment nil (2) (1) • Net book value $ 3 $ 10 $ 6 Step 2 - Comparison against undiscounted cash flow • Recognition test • Future UEFCF before taxes $ 4 $ 8 $ 8 • Impairment loss no yes no • Measurement of impairment • Fair value (Discounted Expected Future Cash Flows) (5) • Impairment $ 5 Step 3 - Measurement of impairment
Full Cost Ceiling Test • CEILING COMPONENTS: • Present value of of future cash flows from proved reserves • Current sales prices and cost rates as of the balance sheet date • Proved reserves (no probable or possible reserves) • Future revenues less (operating, development, and P&A) costs • Future net revenues are discounted at 10% per annum • Current capitalized costs of properties not amortized • Cost of unproved properties not being amortized • Cost of unusually significant development projects not being amortized
Full Cost Ceiling Test • CEILING COMPONENTS (continued) • Lower of cost or fair value of unproved properties amortized • Usually zero if unproved properties are excluded from amortization since impaired costs moving into amortization base have a fair value of zero • Income tax effects of the first three components • Exemptions for purchased property and favorable events prior to auditor’s report
Full Cost Ceiling Test - Other Topics • Ceiling Test Exemption for Proved Purchased Property: • SAB Topic 12D, Question 3: Explains how ASR 258 ceiling exemption can be obtained • Request temporary waiver from SEC • Registrant requesting waiver should be prepared to demonstrate the additional value exists beyond a reasonable doubt • Subsequent Events: • SAB Topic 12D, Question 3 • Ceiling test write-down avoided if: • Additional proved reserves added before audit report • Price increases become known before audit report