Guidance Note on Accounting forOil and Gas Producing ActivitiesPresented by:Kumar GauravEmail: KumarGaurav1@icai.org
Contents• Introduction• Basics• Objective and Scope• Important Definitions• Activities• Accounting Methods
IntroductionOil and gas producing industry (Upstream PetroleumIndustry) is a highly capital intensive industry as a hugeamount of expenditure is required to be incurred onacquisition, exploration and development activities beforethe commencement of actual production.At the time of incurrence of expenditure,particularly on exploration activities, the result of the same is not known and alarge portion of the expenditure does not normally result in discovery of any oil and gas.
ObjectiveThis Guidance Note is to provide guidance onaccounting for costs incurred on activitiesrelating to acquisition of mineral interests inproperties, exploration, development andproduction of oil and gas.
Scope This Guidance Note also deals with other accounting aspects such as accounting for abandonment costs and impairment of assets that are peculiar to the enterprises carrying on oil and gas producing activities.• Present framework and guidance: an overview• Indian GAAP : an overview
Present framework and guidance• INDIAN GAAP Guidance Note on Accounting for Oil and Gas Producing Activities. This guidance note is under review due to convergence with IFRS.• Exclusions from respective Accounting Standards (AS)- AS-2 (Valuation of Inventories) Para 1(d)- AS-6 (Depreciation Accounting) Para 1 (ii)- AS-10 (Accounting for Fixed Assets) Para 3(ii)- AS-26 (Intangible Assets) Para 1(c)
Indian GAAP : an overview• Indian GAAP (IGAAP) Acquisition cost Exploration cost Development cost Production cost Abandonment cost
Identifying OpportunitiesGeological and geophysical departmentGeological and geophysical (G&G) surveys are used to locate and identify properties with the potential to produce commercial quantities of natural gas and oil, as well as to determine the optimal location for exploratory and developmental wells.
Seismic Surveys• An exploration method in which strong low-frequency sound waves are generated on the surface or in the water to find subsurface rock structures that may contain hydrocarbons.• The sound waves travel through the layers of the earth’s crust; however, at formation boundaries some of the waves are reflected back to the surface where sensitive detectors pick them up.• Reflections from shallow formations arrive at the surface sooner than reflections from deep formations, and since the reflections are recorded, a record of the depth and configuration of the various formations can be generated.• Interpretation of the record can reveal possible hydrocarbon- bearing formations.
Definitions• Cost Centre: Cost centre is a unit identified to capture costs based on suitable criteria such as geographical or geological factors. Cost centre is not larger than a field in case of Successful Efforts Method and under Full Cost Method, the cost centre is not normally smaller than a country except where warranted by major difference in economic, fiscal or other factors in the country.• Exploratory Well: A well drilled for the purpose of searching for undiscovered oil and gas accumulations on any geological prospect.
• Development Well: A well drilled, deepened, completed or recompleted within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.• Oil and Gas Reserves: Oil and gas reserves are those quantities of oil and gas, which are anticipated to be commercially recoverable from known accumulations from a given date forward. Proved Oil and Gas Reserves : reasonable certainty to be commercially recoverable in future from known oil and gas reservoirs under existing economic and operating conditions. This can be further bifurcated into
• Proved Developed Oil and Gas Reserves: Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of advanced recovery techniques.• Proved Undeveloped Oil and Gas Reserves: Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing well for which a relatively major expenditure is required for recompletion.• Service Well: A service well is a well drilled or completed for the purpose of supporting production in an existing field. i.e. gas injection, water injection etc
Financial aspects of Activities Acquisition Exploration Development Production Abandonment
Acquisition• Acquisition process: Obtaining of right over the area. Obtain license for mining and exploration from the Government.• Acquisition Cost: Acquisition costs cover all costs incurred to purchase, lease or otherwise acquire a property or mineral right. These include lease bonus, brokers fees, legal costs, cost of temporary occupation of the land including crop compensation paid to farmers and all other costs incurred in acquiring these rights
Exploration Exploration costs cover all direct and allocated indirect expenditure which include depreciation and applicable operating costs of related support equipment and facilities and other costs of exploration activities that are:(i) costs of surveys rights of access to properties to conduct those studies (e.g., costs incurred for environment clearance, defense clearance, etc.), and salaries and other expenses of geologists, geophysical crews and other personnel conducting those studies. Collectively, these are referred to as geological and geophysical or G&G costs;
Exploration Continued(ii) costs of carrying and retaining undeveloped properties, such as delay rental, ad valorem taxes on properties, legal costs for title defense, maintenance of land and lease records and annual license. Fees in respect of Petroleum Exploration License (iii) costs of drilling and equipping exploratory and appraisal wells; and (iv) costs of drilling exploratory-type stratigraphic test wells. All acquisition cost and exploration cost involved in drilling and equipping exploratory and appraisal wells are initially capitalized as pre-producing properties reflected under head CWIP till they are either transferred to fixed assets as producing properties or expensed in the year when determined to be dry or of no future use.
Development• Development activities for extraction of oil and gas include, activities involved in developing oil and gas accumulations, completion of successful exploration wells, the drilling, completion, re-completion and testing of development wells, the drilling, completion and re-completion of service wells, the laying of gathering lines, the construction of offshore platforms and installations, the installation of separators, tankages, pumps, artificial lift and other producing and injection facilities required to produce, process and transport oil or gas into main oil storage or gas processing facilities, either onshore or offshore, including laying of infield pipelines, the installation of the said storage or gas processing facilities.
• Development Cost: Costs incurred in preparing proved reserves for production i.e. costs incurred to obtain access to proved reserves and to provide facilities for extracting, treating, gathering and storing oil & gas.
ProductionProduction Activities:- Production activities consistof pre-wellhead (e.g., lifting the oil andgas to the surface, operation and maintenance ofwells, extraction rights, etc.,) and post-wellhead(e.g., gathering, treating, field transportation, fieldprocessing, etc., up to the outlet valve on the leaseor field production storage tank, etc.,) activities forproducing oil and/or gas.
• Production Cost: Cost incurred in lifting the oil and gas to the surface and gathering, treating and storing the oil and gas.
Abandonment Cost• The liability towards costs relating to dismantling, abandoning and restoring well sites (net of salvage value), other than those relating to Joint Ventures, are capitalized as additional cost when the well is complete and is reasonably estimated.• The abandonment cost on exploratory dry well is expensed during the year. Liability for abandonment cost is updated annually based on the technical assessment available at current costs.• The actual cost incurred on abandonment is adjusted against the liability and the ultimate gain or loss is recognized in the profit/loss, when the designated oil/gas field or a group of oil/gas fields ceases to produce.
Methods of Accounting• Successful Efforts Method• Full Cost Method
Successful Efforts Method• Expenditures for successful projects are deferred while those for unsuccessful ones are immediately expensed. Capitalized costs applicable to producing properties are amortized based on the reserves produced.• An asset is recognized in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably.• The only implication is that the degree of certainty that economic benefits will flow to the enterprise beyond the current accounting period is insufficient to warrant the recognition of an asset.”
Full Cost Method• All exploration costs are capitalized whether the projects are successful or unsuccessful. The capitalized cost is then amortized into expense as the total reserves are produced.