Petroleum accounting for tangible and intangible costs


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Petroleum accounting for tangible, intangible cost and materials transfers under IFRS, joint operation agreement and production sharing agreement.

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  • We suggest in this paper a framework to improve some accounting practices for how recognizing tangible assets or intangible assets that are maintained joint venture and what is the impact on corporate accounts under successful effort method, how the moveable assets be controlled and reported. Also, in our below discussion, we don’t say which practice is correct or incorrect because the practices are depend on many factors such as contractual terms, legal factor, local GAAP and management philosophy or manner, we only provide a guidance for how to recognizing the joint venture assets in oil and gas exploration and production industry. We start referring to the some provisions of IFRS 6, IASs,.IAS framework, US GAAP, PSC, and JOA that can help us in the below suggestion.
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Petroleum accounting for tangible and intangible costs

  1. 1. Accounting petroleum practices for tangible and intangible costs and materials transfers under IFRS, US GAAP, Joint Arrangement and Production Sharing Hamdy Rashed, CMA; CAPM Bsc of Accounting and Auditing, , E-mail:, Website:  Dated on June 1, 2012AbstractWe suggest in this paper a framework to improve some accounting practices for how recognizingtangible assets or intangible assets that are maintained joint venture and what is the impact oncorporate accounts under successful effort method, how the moveable assets be controlled andreported. Also, in our below discussion, we don’t say which practice is correct or incorrect becausethe practices are depend on many factors such as contractual terms, legal factor, local GAAP andmanagement philosophy or manner, we only provide a guidance for how to recognizing the jointventure assets in oil and gas exploration and production industry. We start referring to the someprovisions of IFRS 6, IASs,.IAS framework, US GAAP, PSC, and JOA that can help us in the belowsuggestion.Keywords: Tangible and Intangible costs; Joint Venture Assets, Petroleum Accounting for matrial transfers.In US taxation the distinction between intangible value shall be expensed. Support Equipment andand tangible cost is very important for tax Facilities that are used in oil and gas producingpurposes, whereas integrated oil producer is activities shall be capitalized their depreciationallowed to expense 70% of domestic Intangible and applicable operating costs become anDrilling Cost IDC and capitalize 30% of it to be exploration, development or production cost asamortized over 60 months but the foreign IDC appropriate.should be amortized over 10 years, Also, IFRS 6requires to classify E&E assets into tangible and However, exploration for and evaluation ofintangible according to the nature of the assets mineral resources are excluded from scope ofacquired. IAS 16 and IAS 38, par 8-12 of IAS 8 require the companies to disclose their accountingAs per SFAS 19, par 19 and 26 the cost of policy for exploration for and evaluation ofexploration equipments and facilities shall be mineral resources. Also, And IFRS 6 par 15-16pending determination of proved reserve. require companies to classify the explorationMeans, the well has found proved reserves even and evaluation assets to tangible or intangiblethough the well has not been completed as according to the nature of assets acquired. Howproducing well, those costs will be part of well we could classify the E&E assets andthat shall be amortized or depreciated over their development costs into tangible and intangibleuseful life. If the well found no proved reserves, costs. The following provisions of IAS 16, IASthe capitalized costs and net of any salvage 38, IAS 2, IFRS 6, IAS 31, FAS 19, and JOA 1 
  2. 2. and PSC can help us to identify which costs that G&G cost, 3) exploratory drilling, 4) trenching, should be categorized under tangible and 4) sampling, 5) and study for evaluating intangible costs and how they should be treated technical feasibility and commercial viability of when they incurred and in the subsequent extracting oil/gas. Company shall determine period. accounting policy to determine what costs that shall be expensed in the same year when it is‐ Per IAS 16 par 6 the property, plant and incurred, what costs shall be capitalized equipment is defined as follow “Tangible items temporarily until proved reserves found or that; a) are held for use in the production or expensed when proved reserves not found. The supply of goods or services, for rentals to others expenditures that are related to development or for administrative purposes; b) are expected activity shall not be recognized under E&E to be used during more than one period.” assets, it shall be recognized as per the guidance of IAS 38. Also, using tangible assets to develop‐ IAS 16 par 7 indicates that cost of property, an intangible assets does not change a tangible plant and equipments are recognized only if; a) assets into intangible assets. there is probable future economic benefits associated with item will flow to company; b) ‐ IAS 31 par 13-17, 30-37 & 48-50 the company cost of those items can reliably measured. has option to choose either proportionate consolidation or equity method. Per IFRS 11‐ IAS 16 par 8, and IAS 2 par 6 indicates that the that is effective in Jan 2013 the Company that spare parts and servicing equipments should be has jointly controlled operations will be treated considered as inventory and recognized in as joint operations that need to be used income statement when they are consumed. As proportionate consolidation method. Venturer per the above indication, may combine its share of each of the assets,‐ IAS 38 par 21, 65, 66 and 71 and IAS 16 par 49 liabilities, expenses, and income of jointly indicates that intangible assets shall be controlled operations with similar its items. For recognized if only there is likelihood that the materials and equipments transfers between expected future economic benefit will flow to venture and joint venture or between joint company, and the cost of intangible assets can ventures and another joint venture, any gains or be reliably measured. Also, any costs expensed loss recognized for transfers from venture to before shall not be capitalized into intangible joint venture, venture shall be recognized its costs. The cost of intangible assets comprises the portion of such gain or loss that is billed to other following attributable costs: 1) services or partners, but gains or loss generated by transfer materials used or consumed for generating the from joint venture to ventuerer, gains or loss intangible costs, 2) G&A overhead that is shall not be recognized by venture until it is directly attributable to generate intangible asset resold to third party. and 3) depreciation of property, plant and ‐ IAS Framework recommend to recognize assets equipments that are used for development if the following criteria are met: activities are considered part of cost of o Probable to provide future economic intangible assets. benefits‐ IFRS 6 par 15-16 & 9-10 & 25 indicates that the o The entity is able to own the benefit or following costs shall be considered as initial control it by restricting other entities to costs of Exploration and Evaluation (E&E) have access to the benefit. Assets; 1) acquisition of rights to explore, 2) 2 
  3. 3. o Past event was occurred to provide the disposed surplus or obsolete inventory as long as entity a right to receive the benefits. it is in accordance with procedure approved by management committee, but it requires controls‐ FAS 19 par 11.b, 11.c, 17.d, 21.b, 21.c, 22, 24.a- over the material inventories and any overage or c, 25, 26, 36 and RBA 43 all those paragraphs shortage of materials inventory by amount not indicate that support equipment and facilities exceeding US$100,000 needs approval of shall be capitalized and their depreciation shall management committee. Also, many of PSCs be allocated appropriately to exploration, indicates that the moveable assets are development, and production costs. The cost of automatically and gradually entitled to host exploration, development and production shall government when the cost of those assets are not include the expenditure to acquire support recovered by cost oil or when the contract is equipment and facilities. Well equipment or terminated whichever is earlier and the operator equipping wells include casing, tubing, pumping has the fully right to use those assets free of equipment, wellhead assembly and other charge by government even if the assets titled to tangible drilling costs that have been installed in the government but has no right to dispose them development wells shall be capitalized even if without governmental approval after the title the development well is dry. Well equipment or transfer date. equipping wells include casing, tubing, part of wellhead and centralizers that have been After showing the provisions of IFRS and IASs, installed in exploratory wells shall be pending FAS, JOA and PSC, We can understand the determination of proved reserves, if the proved following: reserves are found, they should be capitalized, but if not, they should be expensed. For unused drilling materials and supplies and materials Tangible Cost used for operation they should be presented as inventory, and shall be capitalized as above if 1- Quantities of drilling materials and supplies that they are taken out of stock and installed in the are expected to be installed for more than well well. and purchased as long lead materials are supposed to be considered as drilling materials‐ Many of Joint Operation Agreement does not inventory until they are consumed in the wells, allow the operator to dispose significant and the consumption will reduce the inventory materials, supplies and equipment inventory and be charge to cost of wells as tangible drilling held in respect of joint venture without an costs such as the following materials agreement of other partners who generally have pre-emptive rights, and operator and non- i. Casing operators have the right to include their share of ii. Tubing the inventory in their own accounts. iii. Wellheads iv. Packer‐ Some Production Sharing Contracts such as of v. Centralizers Tanzania’s, Kurdistan’s require the contractor to exclude any accumulated materials surplus and Characteristics of drilling well costing is similar their costs may not be recoverable costs. to job order costing system and the drilling However, other PSC such as Lybian PSC may materials inventory it can be similar as Just-In- accept the inventory surplus and considered it as Time Inventory. How first question is should we recoverable cost, or credited the accounts by the record the purchased drilling equipments and 3 
  4. 4. materials from third party for joint venture warehouse or inventory account for recordingproperty as an inventory or be directly charged the purchased drilling materials and the well costs? a. The installed tangible equipments andThe cost of purchased drilling materials are materials shall be recorded as tangibleeither a) to be charged directly to tangible drilling costs of exploratory well and will bedrilling costs or to purchases account that are pending determination of proved reserves.considered as part of tangible drilling well cost,or b) to warehouse or inventory account as  If Oil/gas reserves are found, the tangiblecontraaccount or control account rather than drilling costs will be capitalized even thefinancial account to charge the well by the well has not been completed for productionmaterials consumed. For determining which and the management does not decided toaccounting entry is suitable for recording the impaired its whole costs. If the managementcost of purchased drilling materials, we need to does not use inventory joint account, theknow either the characteristics of drilling unused remaining material and equipmentsmaterials and supplies inventory is similar as JIT will be immaterial, and can be capitalizedinventory or not. The objective and desirability too.of management needs to be identified either; a)  If the oil/gas reserves are not found or themanagement considered the drilling materials of management decided to impaired thejoint venture are desirable, b) management seeks previous wells, the tangible drilling coststo reduce the joint venture drilling materials shall be expensed. If the management doesinventories to minimal level, c) Accordance to not use inventory joint account, the unusedtechnical management experience, the drilling materials and equipments will bematerials forecasts are reliable, d) According to immaterial and can be expensed too.technical and logistic experience, materialsexpected and ordered insignificantly vary from b. The tangible drilling costs of developmentwhat is installed, e) Lead time between well will be capitalized, either the result ispreparation proposed well plan and required to dry or success. if the company does useget materials ready to start drilling is adequately inventory joint account, the unused drillingat reasonable level, means, company can obtain materials will be capitalized too.any materials from any other suppliers withinshort time without causing drilling stoppage, f) c. If the total unused drilling materials ismanagement seeks to reduce the carrying and significant for each well, the unsued drillinghandling costs of joint venture inventory, or g) materials should be treated as inventorymanagement seeks to reduce the investment in under current assets rather than well costs. Ifjoint venture inventory and in space to store the Company start using the direct charge toinventory, h) Management does change their well cost method and then it discovered theplan significantly from time to time, i) the cost unused drilling materials is significant,of inventory is recovered or paid by cost oil. All management shall credit the well cost bythe above criteria can help us either to record the evaluated unused items and charge thepurchased materials directly to the well cost or inventory account, it is necessary to do thatto warehouse/inventory account. If the above because the management may decided tocriteria meet, it is preferred to use direct charges transfer some materials to anotherto well cost. If not, it is preferred to use the property/block/lease. 4 
  5. 5. d. Maintaining inventory account in joint they fully charged to well cost or seismic costs venture accounts and bill it as inventory in or operating costs or to fixed assets account that JIB to other partners and in Statement of is depreciated over its economic life to the well Expenditures and Receipts to the host costs, seismic costs or production costs based on government is required in many Joint the usage basis? Operation Agreement and Production Sharing Agreements as long as the remaining If those equipments are brought for specific well unused materials inventory is not recoverable and will not be charged to any other well or can by cost oil. If those materials inventory is not be used in another block/property/lease, they recoverable, it is preferred to charge them to should be charged to tangible cost of well, but well costs.  at the end of the well if no proved reserves e. Capitalized tangible drilling costs of were found, those equipments should be development wells will be depleted over the expensed at salvage value with the economic life of well. remaining cost of wells because there will be no future economic benefit flow to entity2- Tangible property, plant and equipments that are from this well. expected to be served more than one year and for several activities or blocks such as  If proved reserves have been discovered, those costs should be capitalized and i. drilling rig, reclassify them to Services equipment and ii. vehicles, facilities or other property, plant and iii. trucks, equipment account as long as even the well iv. building, was not completed for production because v. tanks and storage there would be future economic benefit vi. servers flow to entity from the well from the well. vii. Engine, electric motor viii. Pumping unit and surface pump b. If those equipments are brought for several ix. Linepipe activities or several blocks/properties/leases, x. Separator, Heater, Treater they should be charged to service equipment and xi. Meter Run facilities/property, plant and equipments that is xii. Seismic equipment classified as separate caption in financial statements by net value, are supposed to be considered as property, plant and equipments or Service equipment and  If the management decided to facilities (Fixed Assets) until they are used for relinquish/abandon the license or sell the specific wells or seismic campaign, or activities license to third party and no need to keep and their depreciation will be calculated and those assets, those items should not be allocated to several activities or blocks based on expensed as long as those licenses are hold- its needs charges basis such as rig operating for-sale and when relinquishment or hours, passage of time, miles, acreage or/and abandonment or sell is happened the cost of working labor hours basis. The depreciation property, equipments and plant should be costs will be charged to intangible drilling cost, expensed by net carrying amount along seismic cost or operating/production costs. How with the remaining pending cost in E&E, those equipments should be charged? Should development assets, oil and gas assets and acquisition costs because there would be no 5 
  6. 6. more future economic benefit flow to entity and be reliably measured. But such costs can be from the licenses. attributed to different activities as followc. Services equipment and facilities/property, plant a. The below costs will be considered as and equipments are charged to intangible intangible costs that are presented in financial development or exploration costs or operating statements under E&E assets and capitalized costs by depreciation method. until the license is relinquished, sold or full impaired or it will be depleted and amortizedd. Tax regulations can provide guidance for based on depletion of reserves over the capitalizing such costs. In some country’s economic life of license taxation, company is required to disclose and record for depreciating assets that exceed the  Acquisition of rights to explore amount of $300, $500 or $1000. Therefore, some companies intend to establish b. The following costs will be considered as capitalization policy to categorizes the assets intangible costs that are presented in financial either to property, plant, and equipments/service statements under E&E assets and expensed in equipment and facilities or to well costs or be the same period which is incurred if the expensed. company apply successful efforts method or to be capitalized if the company apply fulle. Also, the allowable charges that are required by cost method. PSC, Most of PSCs ask contractor to apply Generally Accepted Accounting Practices to  G&G studies for identifying the reservoirs recover the cost when the assets are purchased or stratigraphic traps of petroleum or on usage of such assets, the assets shall be  G&A/Overhead that is related to recognized even if the title of assets have been exploration activities transferred to host government as long as a) the PSC provides the contractor a right to use and c. The following costs will be considered as transfer those materials to another intangible drilling costs for exploratory or block/property/lease within the same country; b) development wells (Development wells the government cannot dispose those assets drilled after discovered the commercial oil without having prior notice of contractor’s reserves area). consent c) the contractor is able to restrict other contractors the benefit obtained from those i. Acquisition of drilling rights assets, d) and those assets have not been handed ii. G&G costs for identifying the well site over or submitted to host government, but if location those criteria were not met, the company should iii. Cementing and Cementing services derecognize the assets and stop computing the iv. Electronic logging depreciation and amortization, it shall recognize v. Mud logging, chemicals and mud log the impairment of the abandoned assets. services vi. Perforating vii. Acidizing, Fracturing, Swabbing viii. Plugging and abandoning costs Intangible Cost ix. Sampling of rocks or liquid driven out from3- Intangible assets are assets that expect to well generate future economic benefit to the company x. Drilling rig rate 6 
  7. 7. xi. Labor and materials used or consumed for depleted or amortized over the economic drilling the well life of the well. xii. Depreciation of equipments used for drilling wells Materials Transfers xiii. Drill stem testing 4- For materials and equipments transfers between xiv. Drilling bits venture and joint venture or between joint xv. Fuel, Water, Power and lubricants ventures and another joint venture, those xvi. Preparation of well site location materials are transferred at either fair value or xvii. Rigging up carrying cost with considering the localxviii. Removal of drilling rig regulations, production sharing contract and xix. Restoration of land and damages paid to joint operation contracts. surface owner xx. Cost of activity in relation to evaluating the a. Transfers from venture to joint venture technical feasibility and commercial viability of oil/gas.  If the drilling materials or equipments are received by transferee at fair price which is xxi. Intangible costs of drilling water supply or higher or lower than carrying cost, injection well if the water to be used for Company shall recognize only the gain that drilling exploration or development well or is attributed to other venture as long as the for injection. risk and ownership was significantlyxxii. Any other drilling costs that are classified delivered to joint venture and recognize the under tangible drilling costs. full loss. (e.g. If operator transfer or sell a drilling Those costs will be temporarily capitalized materials by fair price of $10 and it is recorded in under exploratory drilling costs which is operator’s inventory at cost of $8. Also, vehicle was sold to joint venture by amount of $20 and its presented under E&E assets as intangible assets historical costs is $40 and accumulated depr is $10. and And operator’s portion of joint account is 40% and the current purchases of joint venture inventory is  if the proved reserves has not been found, $50 and current purchases of assets $100 and accum. those costs are immediately expensed and Depr is $10), the following entry will be as closed in the income statement follow.  If the proved reserves has been found, those  If the company have joint accounts ledgers costs will be capitalized even the well has that are separate from corporate ledgers and not been completed for production until the cutback entry is made manually. management decided either to close the Dr. Joint Venture inventory $10 well and impair the costs, therefore, the cost Or Dr. Joint well cost $10 will be expensed or the reservoir will be Dr. Joint Venture property, plant and equipment $20 developed and classify the intangible Dr. Corporate-accumulated depreci and amortiza $10 drilling costs from E&E intangible asset to Dr. recognized loss from sold assets $10 development intangible assets which will be Cr. Corporate-Inventory ($ 8.0) Cr. Corporate-property, plant and equipment ($40.0) depleted or amortized over the economic Cr. Corp Interco Inv adj gain ($ 0.8) life of well. Cr. Corp-recognized gain from sold materials ($ 1.2) To record the asset and materials transfers to joint venture  All the intangible drilling costs of development wells will be capitalized, and Dr. Corporate Inventory $24.0 Dr. A/R – Non operator $36.0 7 
  8. 8. Dr. JV-accumulated depreci and amortiza $10.0 lower than carrying cost loss shall beDr. Corporate – PP&E $48.0 recognized by operator. Joint venture Cr. Joint Venture inventory, or ($ 60.0) Cr. Joint well cost (60.0) should recognize the loss, operator and Cr. JV PP&E ($120) nonoperator shall record their portion of Cr. Corp-accumulated depreci and amortize ($ 4.0) fair priced items and their share of loss tooTo record cutback entry in their own accounts.  If the drilling materials or equipments are  If the drilling materials or equipments are received by joint venture at carrying cost received by venture at carrying cost and and materials or equipment considered as materials or equipment considered as condition A materials/equipment as it is condition A materials/equipment, there is required by JOA or PSC, there is no gain or no gain or loss shall be recognized by loss shall be recognized by venture. venture.b. Equipment or materials purchased from joint c. Transfers from joint venture to another joint venture by operator or non-operator venture  If the drilling materials or equipments are  If one joint venture sell the drilling received by operator at fair price which is materials or assets to another at price higher higher than carrying cost gain shall be than its cost and gain profit. The profit shall unrecognized by operator until it is resold be recognized in the transferor’s book, and to independent party. And the purchasing the purchases at fair price is recorded in cost that should be recorded in operator’s transferee’s book. The difference between own account at fair price minus deferred fair price and costs of PP&E is recorded in gain of operator’s portion (Carrying cost accumulated depreciation and amortization plus gain attributed to other owners). If we in transferee’s books and for drilling took the previous example for materials and materials, it is recorded in deferred gain. assume the transfer from joint venture to venture, the accounting entry will be  If one joint venture sell the drilling materials or assets to another at price lowerDr. Corporate Inventory 9.2 than cost, the loss shall be recognized in theDr. Deferred gain of sold materials 0.8 Cr. Joint Venture inventory, or (8) transferor’s book which is shared by Cr. Joint venture well cost (10) partners based on pro rata basis, and the Cr. Recognized gain from sold materials or assets (2) transferee shall recognize the assets at theTo record the materials transfer to operator/non-operator fair price.Dr. Corporate Inventory 16.8 d. Transfers from joint venture to independentDr. A/R – Non operator 25.2 third partyDr. Deferred gain of sold materials 4.0Dr. Recognized gain from sold materials 2.0 Cr. Joint Venture inventory, or (42.0) Any gain or loss from selling assets or drilling Cr. Joint well cost (40.0) materials to independent party, the gain or loss Cr. Deferred gain of sold materials ( 0.8) shall be recognized in joint venture accounts andTo record cutback entry each partner of joint venture shall recognize their gain or loss based on pro rata basis.  If the drilling materials or equipments are received by operator at fair price which is 8 
  9. 9. If the Company apply proportionate ‐ SFAS 19consolidation method, it is required to make ‐ Yemen PSCcutback entries and the venturer records its share ‐ Kurdistan PSCof each assets, liabilities, expenses and revenues ‐ Libya PSCinto Corporate accounts by preparing cutback ‐ IRS regulations.entries. And no need to gross up the assets orliabilities for preparing the consolidatedfinancial statements and no need to eliminate theintercompany transactions for materials andequipment transfers and eliminate anyunrecognized gain and loss because based on theabove entries, venturer’s corporate accounts andfinancial statements will reflect the actualresults.Lease Assets and consignmentMost of Oil and gas exploration and productioncompanies entered into consignment PO such assupplying drilling bits or contract and LeaseAgreement for lease a vehicles, the consignmentis not recorded in consignee’s book until thematerials have been used/consumed, therefore, itis charged directly to well costs. Consigneemaintain a separate records or register for theconsignment or control account forconsignment. Consignment are supposed eitherto used, transferred to other blocks or re-exported or returned back to consignor. For theleased assed, many of oil and gas companiesentered into operating lease agreement withother subcontractors to lease an assets such asvehicle and the operating lease (rental charges)is expensed.References ‐ IFRS 6 ‐ IAS Framework ‐ IAS 1 ‐ IAS 2 ‐ IAS 16 ‐ IAS 38 ‐ IAS 31 9