This blog is written by Mr. Saif Uddin Khilji, Senior Manager Taxation Advisory Services. Please read this blog and provide your valued comments.


Differences in Oil and Gas Accounting

Companies involved in the exploration and development of crude oil and natural gas can choose between two accounting approaches: the successful-efforts (SE) method and the full-cost (FC) method. These approaches differ in how they treat specific operating expenses related to the industry.

The accounting method that a company chooses affects how its net income and cash flow numbers are reported. Therefore, it’s an important consideration when analyzing companies involved in the exploration and development of oil and natural gas.

Methods of Accounting:

E&P companies can opt for any of the two methods of accounting for the exploration and development activities:

  1. Successful Efforts Method
  2. Full Cost Method
  3. Successful Efforts Method:

This is the most commonly used method of accounting in the oil and gas industry.

Exploration Cost:

  • Exploration Cost including the geological & geophysical costs, surface lease rentals etc. are expensed as and when incurred except for the exploration well cost specific to the drilling of a well and related geophysical costs, which are initially capitalized.
  • If exploration well is successful and the reserves are determined to be present, then the cost remains capitalized.
  • If exploration well is unsuccessful then such well cost and related expenditure is also expensed.

Appraisal Cost:

  • Appraisal Cost is also expensed as and when incurred except for the appraisal well cost which is initially capitalized.
  • If appraisal well is successful and it is determined that commercially viable reserves are present for which commercial discovery notification is to be applied for to the DGPC, then such well cost remains capitalized.
  • If appraisal well is unsuccessful and it is determined that reserves are not commercially viable then appraisal well cost is also expensed.

Development Cost:

  • All the development costs are capitalized. Further, total capitalized cost for development activities is subject to amortization on Unit of Production (UoP) basis and impairment test. However, some companies follow a conservative approach and expense out the cost of unsuccessful development wells. Both approaches are acceptable industry practices.
  • Development cost of buildings and infrastructure are depreciated based on the determination of useful life of such assets.

Production Cost:

  • All production costs are expensed as and when incurred to match the revenue generated from the sale of petroleum produced.
  • Whereas, activities to increase production are capitalized.
  • An important element of production phase is to pay the production bonus to the Government.
  • Accounting treatment for these bonuses is given below:
  • Production bonus payable at the commencement of production is expensed when due.
  • Production bonus amount payable upon reaching certain accumulated level of production is accrued in proportion to production on periodic basis and the amount thereof is expensed in that period. Corresponding liability is settled upon reaching each threshold, when the payment is made to the Government.

Abandonment Cost:

  • Abandonment or decommissioning cost is capitalized at the time of capitalization of the assets for which abandonment will be required (e.g. well or infrastructure) as per the legal obligation and as per company policy. The related credit is to a long-term provision.
  • The long-term provision is made for the present value amount capitalized to complete the double entry and to recognize the abandonment liability.
  • In future years the capitalized cost is depreciated using UOP method.
  • Provision is increased every year due to unwinding of discounting made at the time of creating the provision, so that at the time of abandonment full amount (undiscounted) is available to meet the abandonment cost. The effect of unwinding and increasing the provision is charged to P&L every year as finance charges.
  1. Full Cost Method:

 Exploration Cost:

  • All costs including the geological & geophysical costs, surface lease rentals etc. are capitalized and only expensed if ultimately it is determined that there is no discovery in the entire license area and the exploration license either expires or is surrendered earlier to DGPC.

Appraisal Cost:

  • All costs are capitalized and only expensed if ultimately it is determined that there is no discovery in the entire area and the exploration license either expires or is surrendered earlier to DGPC.

Development Cost:

  • Same treatment as in Successful Efforts Method

Production Cost:

  • Same treatment as in Successful Efforts Method

Abandonment Cost:

  • Same treatment as in Successful Efforts Method

Saif Uddin Khilji