Accounting for Entities with Oil and Gas Producing Activities Based on the AICPA Audit and Accounting Guide
Chapter 1 Overview of the Industry... 1 Learning Objectives... 1 The Industry s History... 1 Development of the Oil Industry... 1 Development of the Natural Gas Industry... 2 Prices for Oil and Gas... 2 Recent Developments in the Oil and Gas Industry... 3 Origin and Accumulation of Oil and Gas... 4 Oil and Gas Reserves... 5 The SEC s Definition of Proved Reserves... 6 The Society of Petroleum Engineers Definitions of Reserves... 7 Determination of Reserves... 8 Operations in the Upstream Petroleum Industry... 9 Oil Sands... 10 Sources of Capital and Organizational Structure of Oil and Gas Entities... 10 Joint Interest Arrangements... 11 Limited Partnerships... 11 Royalty Trusts... 11 Other Sources of Capital... 12 History of Accounting for Oil and Gas Producing Activities... 12 International Standards of Accounting for Oil and Gas... 13 Review Questions... 15 Review Answers... 17 Chapter 2 Primary Business Activities of the Industry... 19 Learning Objectives... 19 Acquisition of Mineral Interests... 19 Important Provisions in Lease Contracts... 20 Frequently Encountered Transactions for Transferring Mineral Interests... 22 Documents and Files Relating to Mineral Interests... 23 Basic Concepts of Prospecting and Exploration Activities... 24 Prospecting and Exploring for Potential Hydrocarbon-Bearing Structures... 25 Other Significant Aspects of Exploration Activities... 26 Drilling and Development... 27 The Drilling Contract... 28 Completing the Well or Plugging and Abandoning the Well... 28 Developing the Reservoir... 29 The Regulatory Environment... 29 Production... 29 Workovers... 30 Enhanced Recovery Methods... 30 Review Questions... 32 Review Answers... 33 Chapter 3 Accounting for Common Oil and Gas Ownership Arrangements... 35 Learning Objectives... 35 Ownership Arrangements... 35 Ownership Arrangements Mineral Interests... 35 Other Arrangements... 35 Accounting Models... 36 Variable Interest Model ( Variable Interest Entities Subsections of FASB ASC 810-10)... 36 Voting Interest Model... 36 Special Considerations... 36 LLCs... 36
Partnerships... 37 General Guidance on the Consolidation, Equity, and Cost Methods... 37 Consolidation Method... 37 Equity Method... 38 Cost Method... 39 Review Questions... 40 Review Answers... 41 Chapter 4 Successful Efforts Method and General Accounting for Oil and Gas Activities... 43 Learning Objectives... 43 General... 43 Accounting for Acquisition, Exploration, and Development Costs... 45 Acquisition Costs... 45 Exploration Costs... 45 Development Costs... 46 Interest Capitalization... 46 Amortization of Capitalized Costs... 46 Impairment Tests for Capitalized Costs... 47 Unproved Properties... 47 Proved Properties... 48 Conveyances... 49 Accounting for Production... 50 Revenue... 50 Inventory... 51 Operating Expenses... 52 Asset Retirements, Environmental Liabilities, Abandonments, Involuntary Conversions, Expropriations, and Joint and Several Liabilities... 52 AROs... 52 Environmental Liabilities... 53 Abandonments... 53 Involuntary Conversions... 53 Expropriations... 54 Joint and Several Liability Arrangements... 54 Lease Arrangements... 55 Discontinued Operations and Asset Held for Sale Considerations... 55 Goodwill and Business Combinations... 56 Goodwill Impairment... 57 Derivative Commodity Contracts... 57 Fair Value Measurement... 59 Definition of Fair Value... 59 Application to Nonfinancial Assets... 60 Application to Liabilities and Instruments Classified in a Reporting Entity s Shareholders Equity... 60 Valuation Techniques... 61 Present Value Techniques... 62 The Fair Value Hierarchy... 62 Fair Value Disclosures... 63 Disclosure Requirements for Oil and Gas Entities... 64 General... 64 Accounting Policy Disclosures... 64 Suspended Well Disclosures... 65 FASB ASC 932 Disclosures... 65 Other Disclosure Matters... 68 Additional Disclosures for Entities Following the Full Cost Method of Accounting... 68 SEC Disclosures Subpart 1200 of Regulation S-K... 69 Exchange Offer Disclosures... 70 Review Questions... 71 Review Answers... 73 ii
Chapter 5 Full Cost Method of Accounting for Oil and Gas Activities... 75 Learning Objectives... 75 General... 75 Accounting for Acquisition, Exploration, and Development Costs... 76 Capitalization of Interest... 76 Amortization of Capitalized Costs... 76 Excluded Costs... 77 Impairment Tests for Capitalized Costs... 78 Cost Center Ceiling Test... 78 Applications Involving a New Country... 80 Accounting for Production... 81 Asset Retirements, Environmental Liabilities, Abandonments, Involuntary Conversions, and Expropriations... 81 Abandonment of Unevaluated (Unproved) Properties... 81 Revisions and Settlements of AROs... 81 Fair Value Measurements... 82 Lease Arrangements... 82 Conveyances... 82 Discontinued Operations... 82 Goodwill... 83 Goodwill Property Disposals... 83 Other Matters... 84 Management Fees and Other Income... 84 Commodity Derivative Activities... 84 Disclosure Requirements... 84 Additional Disclosure Requirements for Full Cost Entities... 84 Review Questions... 86 Review Answers... 87 Chapter 6 Accounting for International Oil and Gas Activities... 89 Learning Objectives... 89 Overview... 89 International Contractual Arrangements... 90 Concessions... 90 Production Sharing Contracts... 90 Service Contracts... 91 Other Arrangements... 91 Royalty, Production Taxes, and Income Taxes... 91 Royalty... 92 Production Tax... 92 Income Tax... 92 Reporting International Proved Reserves... 93 Asset Retirement Obligations in International Operations... 94 The Foreign Corrupt Practices Act of 1977... 95 Review Questions... 96 Review Answers... 97 Chapter 7 Tax Considerations... 99 Learning Objectives... 99 General... 99 Income Taxes... 99 Intangible Drilling and Development Costs... 99 Depletion... 100 Common Temporary Differences... 101 Conveyances... 102 Accounting for Temporary Differences in Asset Acquisitions... 102 FASB ASC 740-10 Uncertain Tax Positions... 103 iii
Net Operating Losses Valuation Allowances... 103 Other Common Tax Matters... 103 Ad Valorem and Severance Taxes... 103 EOR Credit (Section 43)... 103 Credit for Production of Oil and Gas from Marginal Wells (American Jobs Creation Act of 2004).. 104 Deduction for Income Attributable to Domestic Production Activities... 104 International Operations... 104 U.S. Foreign Tax Credit... 104 Taxes in Foreign Jurisdictions... 105 Review Questions... 106 Review Answers... 107 Chapter 8 Auditing... 109 Learning Objectives... 109 Overview... 109 Planning Related Auditing Considerations... 110 Objectives of the Auditor... 110 The Importance of Exercising Professional Skepticism... 110 Audit Planning... 110 Audit Risk... 111 Determining Materiality and Performance Materiality When Planning and Performing an Audit... 111 Use of Specialists... 112 The Use of Assertions When Identifying and Assessing the Risks of Material Misstatement... 113 Understanding the Entity, Its Environment, and Identifying and Assessing the Risks of Material Misstatement... 114 Risk Assessment Procedures... 115 Industry, Regulatory, and Other External Factors... 115 Nature of the Entity and Its Operations... 115 Understanding of Internal Control... 118 Assessment of Risks of Material Misstatement and the Design of Further Audit Procedures... 119 Assessing the Risks of Material Misstatement... 119 Designing and Performing Further Audit Procedures... 120 Auditing Accounting Estimates and Related Disclosures... 122 Evaluating the Sufficiency and Appropriateness of the Audit Evidence Obtained... 123 Written Representations from Management... 123 Evaluating Misstatements Identified During the Audit... 123 Additional Audit Considerations... 124 Audit Documentation... 124 Audit Evidence... 124 Communication With Those Charged With Governance... 125 Additional Considerations for Specific Audit Areas... 125 Oil and Gas Properties Acquisition, Exploration, and Development Activities... 125 Depreciation, Depletion, and Amortization... 128 Impairment... 128 Oil and Gas Property Conveyances... 129 Production... 130 Payables... 135 Asset Retirement Obligations... 136 Tax and Other Regulatory Matters... 137 Derivatives and Hedging Activities... 137 Auditing Fair Value Measurements... 138 Other Audit Considerations... 138 Statement of Cash Flows... 138 Commitments and Contingencies... 138 Risks and Uncertainties... 139 Related Parties... 139 Supplementary Oil and Gas Reserve Disclosure Considerations and Related Procedures... 139 iv
Reserve Quantity and Value Disclosures... 139 Supplementary Oil and Gas Reserves Procedures... 141 Review Questions... 143 Review Answers... 145 Chapter 9 Internal Control Considerations... 149 Learning Objectives... 149 Introduction... 149 Definition of Internal Control and Internal Control Framework... 149 Internal Control Framework... 149 Internal Control Over Financial Reporting... 150 Internal Control Considerations for Audit of a Nonpublic Entity... 150 Reporting Requirements for a Public Entity... 151 Evaluating the Effectiveness of Internal Control by Management... 152 Components of Internal Control... 152 Common Control Activities for Oil and Gas Entities... 153 Acquisition of Mineral Interests... 154 Exploration and Development Activities... 155 Exploration, Development, and Production Nonoperator... 158 Production... 159 Other Control Areas... 161 Computer-Based Controls... 162 Control Over Financial Statement Disclosures Specific to Oil and Gas Entities... 163 Control Over Compliance With Tax and Regulatory Requirements... 164 Review Questions... 165 Review Answers... 167 Appendix A Guidance Updates... 169 Appendix B Clarified Auditing Standards and PCAOB Standards... 173 Appendix C Summary of the Successful Efforts and Full Cost Methods of Accounting... 179 Appendix D Sample Management Representations for Entities With Oil and Gas Producing Activities... 183 Appendix E International Financial Reporting Standards... 187 Glossary and Other Commonly Used Industry Terms... 195 Index of Pronouncements and Other Technical Guidance... 211 Index... 215 v