Petroleum Accounting

ACCOUNTING Methods in the petroleum industry

CLASSIFICATION OF COSTS INCURRED costs incurred in oil and gas producing activities classify into four categories: Acquisition costs. Exploration costs. Development costs. Production costs.

(1) ACQUISITION COSTS Acquisition costs These costs are incurred by companies to acquire rights to explore, drill and produce undiscovered natural resource such as oil and gas, or an already discovered resource. Usually, property is leased and special royalty payments paid to the owner.

(1) ACQUISITION COSTS They Include: (1) Lease bonuses. (2) Options to purchase or lease properties. (3) Brokers' fees. (4) Recording fees. (5) Legal costs. (6) Other costs incurred in obtaining mineral rights.

(2) EXPLORATION COSTS As soon as (he company has the right to use the property, exploration costs are needed to find oil and gas. Exploration involves identifying areas that might warrant examination, and examining areas that may contain oil and gas reserves.

Exploration costs include: (1) Costs of geological or geophysical studies. (2)The costs of the machines that used in exploring oils. (3) The cost of exploring drilling.

(3) DEVELOPMENT COSTS These costs are incurred in preparing proved reserves for production. Development involves drilling and equipping development wells and service wells. Also, the cost of acquiring, constructing and installing production facilities for extracting , treating, gathering, and storing oil and gas

(4) PRODUCTION COSTS These costs are incurred to operate and maintain wells and related equipment and facilities. It includes costs of lifting the oil and gas to the surface and in gathering, treating and storing the oil and gas. Production costs include depreciation of equipment and operating costs or support equipment and facilities and other costs of operating and maintaining wells and related equipment and facilities

Preliminary exploration costs. Preliminary exploration costs are the costs which incurred before signing a contract (lease) with the host country. The company has not the right to drill before signing a contract (lease), but it can make a preliminary exploration to know whether there is oil and gas reservoirs or not. These costs include: The cost of acquiring the preliminary exploring permission. The cost of the preliminary exploring jobs.

methods of financial accounting for petroleum activities (1) Successful Efforts (2) Full cost

The basic differences between full costing and Successful Efforts costing

The basic differences The principle difference between full costing and successful efforts costing is whether costs that cannot be directly related to the discovery of specific oil and gas reserves should be carried forward to future periods as costs of oil and gas reserves generally.

Full cost Under the full cost method most of the costs are capitalized. Full costing regards the costs of unsuccessful acquisition and exploration activities as necessary for the discovery of reserves. All of those costs are incurred with the knowledge that many of company's prospects will not result directly in the discovery of reserves.

Full cost However, the company expects that the benefits obtained from chose prospects that do prove successful together with the benefits from past discoveries will be adequate to recover the costs of all activities, both successful and unsuccessful, and will result in an ultimate profit.

Full cost Thus all costs incurred in oil and gas producing activities are regarded as integral to the acquisition, discovery, and development of whatever reserves ultimately result from the efforts as a whole, and are thus associated with the company's reserves.

Full cost Establishing a direct cause - and - effect relationship between costs incurred and specific reserves discovered is not relevant to full costing.

Successful Efforts Under successful efforts costing, however, except for acquisition costs of properties, a direct relationship between costs incurred and specific reserves discovered is required before costs are identified with assets; costs of acquisition and exploration activities that are known not to have resulted in the discovery of reserves are charged to expense.

Successful Efforts Although many variations exist within the successful efforts method, two principal approaches can be identified. One approach relies on a relatively “narrow " area of interest" as a cost center. Cost center might be a lease, field, or reservoir. All costs incurred within that cost center are capitalized; if the area of interest is abandoned, the costs are charged to expense: if the area of interest proves successful, the capitalized costs are amortized as the reserves are produced.

Successful Efforts The second approach does not rely on a cost center for capitalization purposes; the accounting treatment is determined by the nature of the costs at the time they are incurred. For ex ample , all exploration costs except the cost of exploratory wells are charged to expense when incurred: the costs of exploratory wells are capitalized as "construction - in - progress " or “wells - in - progress ".

Successful Efforts The successful efforts method has only the cost of successful efforts capitalized as oil and gas properties. Amortization is computed by lease (or property) or certain aggregations of properties. The cost centre is either the lease or the well. This method distinguishes between the costs of possibility areas and abandonment areas, as the costs of the abandonment areas are expensed.

The distinguishing features of the successful efforts and the full cost methods centre around which costs are to be capitalized and the method by which these costs should subsequently be amortized.

In the following table, we summarize the accounting treatment of the four basic types of costs incurred by oil and gas companies

Cost items SE FC E C Geological and Geophysical Costs (G&G) Acquisition costs Exploratory dry hole Exploratory well, successful Development dry hole Development well, successful Production costs