Chapter10: Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Appendix 10: Oil and Gas Accounting
Chapter 1 characterized the establishment of accounting and reporting standards as a political process. Standards, particularly changes in standards, can have significant differential effects on companies, investors and creditors, and other interest groups. The FASB must consider potential economic consequences of a change in an accounting standard or the introduction of a new standard. The history of oil and gas accounting provides a good example of this political process and the effect of possible adverse economic consequences on the standard-setting process.
There are two generally accepted methods that companies can use to account for oil and gas exploration costs. The successful efforts method requires that exploration costs that are known not to have resulted in the discovery of oil or gas be included as expense in the period the expenditures are made. requires that exploration costs that are known not to have resulted in the discovery of oil or gas (sometimes referred to as dry holes) be included as expenses in the period the expenditures are made. The alternative, the full-cost method allows costs incurred in searching for oil and gas within a large geographical area to be capitalized as assets and expensed in the future as oil and gas from the successful wells are removed from that area., allows costs incurred in searching for oil and gas within a large geographical area to be capitalized as assets and expensed in the future as oil and gas from the successful wells are removed from that area. Both of these methods are widely used. Illustration 10A-1 compares the two alternatives.
Using the full-cost method, Shannon would capitalize the entire $20 million which is expensed as oil from the two successful wells is depleted. On the other hand, using the successful efforts method, the cost of the unsuccessful wells is expensed in 2011, and only the $4 million cost related to the successful wells is capitalized and expensed in future periods as the oil is depleted.p. 535
In 1977 the FASB attempted to establish uniformity in the accounting treatment of oil and gas exploration costs. A standard was issued requiring all companies to use the successful efforts method.31