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GUIDANCE NOTE ON ACCOUNTING FOR OIL AND GAS PRODUCING ACTIVITIES
(The following is the text of the Guidance Note on Accounting for Oil and Gas Producing Activities, issued by the Council of the Institute of Chartered Accountants of India.)
INTRODUCTION
1. | Oil and gas producing industry, which is extractive in nature, involves activities relating to acquisition of mineral interests in properties, exploration (including prospecting), development, and production of oil and gas. The aforesaid activities are collectively referred to as upstream operations and form the 'Upstream Petroleum Industry'. The industry is commonly referred to as the 'E&P' industry. The peculiar nature of the industry requires establishment of industry-specific accounting principles in relation to expense recognition, measurement and disclosure.
OBJECTIVE
2. | The objective of this Guidance Note is to provide guidance on accounting for costs incurred on activities relating to acquisition of mineral interests in properties, exploration, development and production of oil and gas.
SCOPE
3. | This Guidance Note applies to costs incurred on acquisition of mineral interests in properties, exploration, development and production of oil and gas activities, i.e., upstream operations. 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. It does not address accounting and reporting issues relating to the transporting, refining and marketing of oil and gas. This Guidance Note also does not apply to accounting for: activities relating to the production of natural resources other than oil and gas, and the production of geothermal steam or the extraction of hydrocarbons as a by-product of the production of geothermal steam or associated geothermal resources.
DEFINITIONS
4. | For the purpose of this Guidance Note, the following terms are used with the meanings specified: 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. Depreciation : Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined. Depreciation also includes 'depletion' of natural resources through the process of extraction or use. Development Well : A well drilled, deepened, completed or re-completed within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. Exploratory Well : A well drilled for the purpose of searching for undiscovered oil and gas accumulations on any geological prospect. An exploratory well is a well that is not a development well, a service well, or a stratigraphic test well, as those terms are defined separately. Field : An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. There may be two or more reservoirs in a field which are separated vertically by intervening impervious strata, or laterally by local geologic barriers, or by both. Reservoirs that are associated by being in overlapping or adjacent fields may be treated as a single or common operational field. The geological terms 'structural feature' and 'stratigraphic condition' are intended to identify localised geological features as opposed to the broader terms of basins, trends, provinces, plays, areas-of-interest, etc. 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. All oil and gas reserve estimates involve some degree of uncertainty. Uncertainty depends chiefly on availability of reliable geological and engineering data at the time of the estimate and interpretation of data.
| Based on relative degree of uncertainty, oil and gas reserves can be classified as 'Proved Oil and Gas Reserves' and 'Unproved Oil and Gas Reserves'. Proved Oil and Gas Reserves : Proved oil and gas reserves are those quantities of mineral oil, natural gas and natural gas liquids which, upon analysis of geological and engineering data, demonstrate with reasonable certainty to be commercially recoverable in future from known oil and gas reservoirs under existing economic and operating conditions. Establishment of current economic conditions includes relevant historical oil and gas prices and associated costs under existing government regulations, if any. Oil and gas reserves, which can be produced economically through application of advanced recovery techniques, are included in proved classification after successful pilot testing. Proved oil and gas reserves can be classified as 'Proved developed oil and gas reserves' and 'Proved undeveloped oil and gas reserves'. 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 for supplementing the natural forces and mechanisms of primary recovery should be included as proved developed reserves only after testing by a pilot project or after the operation of an installed programme has confirmed through production response that increased recovery will be achieved. 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. Reserves on undrilled acreage should be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only if it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of advanced recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir.
| Reservoir : A porous and permeable underground formation containing a natural accumulation of producible oil or gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. Service Well : A service well is a well drilled or completed for the purpose of supporting production in an existing field. Wells in this class are drilled for the following specific purposes: gas injection (natural gas, propane, butane, or flue gas), water injection, steam injection, air injection, polymer injection, salt-water disposal, water supply for injection, observation, or injection for combustion. Stratigraphic Test Well : A stratigraphic test is a drilling effort, geologically directed, to obtain information pertaining to a specific geologic condition. Such wells customarily are drilled without the intention of being completed for hydrocarbon production. This classification also includes tests identified as core tests and all types of expendable holes related to hydrocarbon exploration. Stratigraphic test wells (sometimes called expendable wells) are classified as follows: Exploratory-type stratigraphic test well : A stratigraphic test well not drilled in a proved area. Development-type stratigraphic test well : A stratigraphic test well drilled in a proved area. Unit of Production (UOP) method : The method of depreciation (depletion) under which depreciation (depletion) is calculated on the basis of the number of production or similar units expected to be obtained from the asset by the enterprise.
5. | The definitions of certain other terms relevant for the Guidance Note are given in Appendix.
CLASSIFICATION OF E&P ACTIVITIES AND RELATED COSTS
Acquisition activities
6. | Activities carried out by an E&P enterprise towards the acquisition of right(s) to explore, develop and produce oil and gas constitute acquisition activities. Once the areas of oil and gas finds are identified, the E&P enterprise approaches the owner who owns the rights for the exploration, development and production of the underground minerals in respect of the property or area. In order to undertake surveys and exploration activities in India, an E&P enterprise has to first obtain a Petroleum Exploration License (PEL) or Letter of Authority (LOA). For engaging in development and production activities, an enterprise has to obtain a Mining Lease (ML). At present, the PEL/LOA and the ML for onshore E&P activities are granted by the State Governments upon recommendation of the Central Government and for offshore E&P activities by the Central Government.
Acquisition costs
7. | 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. These are costs incurred in acquiring the right to explore, drill and produce oil and gas including the initial costs incurred for obtaining the PEL/LOA and ML. Annual licence fees are excluded.
Exploration Activities
8. | Exploration activities cover the prospecting activities conducted in the search for oil and gas. In the course of an appraisal programme these activities include but are not limited to aerial, geological, geophysical, geochemical, palaeontological, palynological, topographical and seismic surveys, analysis, studies and their interpretation, investigations relating to the subsurface geology including structural test drilling, exploratory type stratigraphic test drilling, drilling of exploration and appraisal wells and other related activities such as surveying, drill site preparation and all work necessarily connected therewith for the purpose of oil and gas exploration.
Exploration Costs
9. | Principal types of 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: costs of surveys and studies mentioned in paragraph 8 above, rights of access to properties to conduct those studies (e.g., costs incurred for environment clearance, defence 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; costs of carrying and retaining undeveloped properties, such as delay rental, ad valorem taxes on properties, legal costs for title defence, maintenance of land and lease records and annual licence fees in respect of Petroleum Exploration License; dry hole contributions and bottom hole contributions; costs of drilling and equipping exploratory and appraisal wells; and costs of drilling exploratory-type stratigraphic test wells.
Development Activities
10. | Development activities for extraction of oil and gas include, but are not limited to the purchase, shipment or storage of equipment and materials used 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 costs
11. | Development costs cover all the direct and allocated indirect expenditure incurred in respect of the development activities including costs incurred to: gain access to and prepare well locations for drilling, including surveying well locations for the purpose of determining specific development drilling sites, clearing ground, draining, road building and relocating public roads, gas lines and power lines to the extent necessary in developing the proved oil and gas reserves; drill and equip development wells, development-type stratigraphic test wells and service wells including the cost of platforms and of well equipment such as casing, tubing, pumping equipment and the wellhead assembly; acquire, construct and install production facilities such as lease flow lines, separators, treaters, heaters, manifolds, measuring devices and production storage tanks, natural gas cycling and processing plants and utility and waste disposal systems; and provide advanced recovery system. Development costs also include depreciation and applicable operating cost of related support equipment and facilities in connection with development activities, and annual license fees in respect of Mining Lease.
Production Activities
12. | Production activities consist of pre-wellhead (e.g., lifting the oil and gas to the surface, operation and maintenance of wells, extraction rights, etc.,) and post-wellhead (e.g., gathering, treating, field transportation, field processing, etc., upto the outlet valve on the lease or field production storage tank, etc.,) activities for producing oil and / or gas.
Production Costs
13. | Production costs consist of direct and indirect costs incurred to operate and maintain an enterprise's wells and related equipment and facilities, including depreciation and applicable operating costs of support equipment and facilities. Examples of production costs are: Pre-wellhead costs: Costs of labour, repairs and maintenance, materials, supplies, fuel and power, property taxes, insurance, severance taxes, royalty, etc., in respect of lifting the oil and gas to the surface, operation and maintenance including servicing and work-over of wells. Post-wellhead costs: Costs of labour, repairs and maintenance, materials, supplies, fuel and power, property taxes, insurance, etc., in respect of gathering, treating, field transportation, field processing, including cess upto the outlet valve on the lease or field production storage tank, etc.
ACCOUNTING FOR ACQUISITION, EXPLORATION AND DEVELOPMENT COSTS
14. | There are two alternative methods for accounting for acquisition, exploration and development costs, viz., Successful Efforts Method (SEM) Full Cost Method (FCM)
Successful Efforts Method
Description
15. | Under the successful efforts method, generally only those costs that lead directly to the discovery, acquisition, or development of specific, discrete oil and gas reserves are capitalised and become part of the capitalised costs of the cost centre. Costs that are known at the time of incurrence to fail to meet this criterion are generally charged to expense in the period they are incurred. When the outcome of such costs is unknown at the time they are incurred, they are recorded as capital work-in-progress and written off when the costs are determined to be non-productive.
Arguments in favour of the Successful Efforts Method
16. | Successful efforts costing reflects the normal concept of an asset. An asset is an economic resource expected to provide future benefits. The 'Framework for the Preparation and Presentation of Financial Statements', in paragraph 49, defines an 'asset' as follows: "An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise."
17. | Paragraphs 88 and 89 of the Framework reproduced below describe, respectively, when an asset is and is not to be recognised in the balance sheet: "88. An asset is recognised 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. 89. An asset is not recognised in the balance sheet when expenditure has been incurred for which it is considered improbable that economic benefits will flow to the enterprise beyond the current accounting period. Instead, such a transaction results in the recognition of an expense in the statement of profit and loss. This treatment does not imply either that the intention of management in incurring expenditure was other than to generate future economic benefits for the enterprise or that management was misguided. 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."
18. | The Framework defines income (revenue) and expenses in terms of increases or decreases in assets and liabilities. The Framework does not provide for deferrals or accruals of costs or income based on an independently defined notion of profit or loss. Stated another way, the Framework does not provide for smoothing or normalising of earnings by deferring costs that do not meet the definition of an asset. Under the successful efforts method, those costs that clearly do not relate to future benefits are not capitalised.
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