Oil and Gas Exam 2

Are long-lived assets tested for impairment on a annual basis?

no, only test for impairment when 1/6 of the indications for impairment are present.

What are the 6 indicators of impairment?

• Market price drops significantly

• usage changes significantly in the extent or manner in which asset is being used

• significant or adverse change in legal factors

• excessive costs incurred over the amount than orginally thought

• historical or projected operating cash flow losses associated with the asset.

• asset is more than 50% likely to be sold or disposed of before end of useful life.

The recoverability test used the ________ future net cashflows to decide if impairment needs to be recorded/ measured.

un-discounted

In measuring for impairment, use the _______ future net cashflows to determine the amount of impairment loss.

discounted

Since production in oil and gas industry lasts well into the future, we must predict future ______

production

What is the risk adjusted reserve number

various categories of reserves are adjusted down to show level of risk associated with each type of reserve.

What is the risk adjusted factor (RAF)

the number that is applied to reserve estimates

______ reserves have biggest downward risk adjustment, and there for the _______ RAFS

riskiest, lowest

What is depreciation

spread expense recognition for fixed assets over a period of time.

Proved Property (lease-hold acquisition costs)

all costs incurred to obtain the lease (lease bonus, internal costs, legal fees). They are amortized over proved reserves

The two categorires of proved reserves are

• Proved developed: will produce from existing wells

• proved undeveloped: those we plan to produce from in the future

Wells and equipment are amortized over.

Only proved developed reserves.

Proved undeveloped reserves are excluded from amortizing wells and equipment because additional costs are needed for production

How do you calculate the amount of reserves you have economic interest in

1. Take gross proved reserves and multiply by each WI %

2. Take that number and multiply by the royalty %

3. Net the gross and royalty numbers to get the amount of WI bbls.

What is the formula for unit-of-production method DD&A

(Book value @ end of period / Est reserves @ beginning of period) * production for period

• Book value @ end of period: total balance in the account less what you’ve amortized

• est reserves @ beg of period: reserve est @ end of last year + current production

• production for period : total number of barrels of oil or cubic feet of gas

What is the JE to record DD&A expense

Debit to DD&A expense (proved prop)

Debit to DD&A expense (wells & equip)

Credit to Accumulated DD&A (proved prop)

Credit to Accumulated DD&A (wells & equip).

When calculating DD&A for proved reserves..

Proved reserves calculation will include proved developed and proved undeveloped reserves.

When calculating DD&A expense for wells and equipment you include…

only proved developed reserves

When calculating DD&A on a field-wide basis if a field is not proved/ not producing

Ignore it when calculating DD&A expense.

For joint production of oil and gas, how do you convert MCF to BOE

You take the MCF amount and divide it by 6 to get BOE. Add this BOE to the bbls that are given to you.

When support equipment is used for multiple cost centers, how is it depreciated?

You use straight line depreciation to calculate depreciation per year, then allocate the depreciation based on the % each cost center uses.

Abandonment of a proved well (NOT the last well on the lease.

• No gain or loss is recognized when an individual proved well is abandoned (as long as other wells on the lease remain).

• Credit Wells & Equipment to remove the abandoned well’s cost.

• Debit Accumulated DD&A – Wells & Equipment to remove the related accumulated depreciation.

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Abandonment of the last well on a lease — Accounting Treatment

• Remove all remaining asset balances:

  • Credit Proved Properties for the capitalized cost

  • Credit Wells & Equipment for the capitalized cost

• Remove related accumulated DD&A:

  • Debit Accumulated DD&A – Proved Properties

  • Debit Accumulated DD&A – Wells & Equipment

• Record the plug (balancing amount):

  • If credits > debits → record Lease Abandonment Expense

  • If debits > credits → record Gain on Lease Abandonment

Should amortization always be computed using a common unit of measure based on relative energy when oil and gas reserves are produced jointly? If not, under what circumstances would amortization not be based on units of energy? What basis would be used.

·       Same Relative proportion: if the relative proportion of oil to gas is expected to be the same, amortization can be computed using only one of the materials

·       Dominant mineral: if one material clearly dominates, then amortization may be completed using only the dominant material.

What is the appropriate accounting treatment for drilling costs?

They are capitalized into the WIP account until deemed successful or unsuccessful

What is the appropriate accounting treatment for G&G costs

they are expensed into the “G&G expense” account

What is the appropriate accounting treatment for production costs

they are expensed into the “operating expense” account

What are the two exceptions for amortization being computed using a common unit of measure based on relative energy when oil and gas reserves are produced jointly?

·       Same Relative proportion: if the relative proportion of oil to gas is expected to be the same, amortization can be computed using only one of the materials

·       Dominant mineral: if one material clearly dominates, then amortization may be completed using only the dominant material.

Full cost accounting says we capitalize…

all costs necessary to acquire, explore, and develop oil and gas reserves — regardless of whether the efforts are successful or unsuccessful.

Under the full cost method, what is the accounting treatment to record G&G costs

you will capitalize the costs into the “G&G expense (asset) account and credit cash

Under the full cost method, what is the accounting treatment for the acquisition of property

you will debit “unproved property” and credit cash

Under the full cost method, what is the accounting treatment for lease maintenance, and what type of cost is lease maintenance?

ease maintenance is treated as a cost to carry and retain unproved property. Under the full cost method, it is capitalized by debiting Unproved Property and crediting Cash because it adds value by keeping the lease active.

Under the full cost method, what is the accounting treatment for a dry-hole contribution?

A dry-hole contribution is capitalized as part of the cost of acquiring or retaining mineral interests. Record it by debiting Unproved Property – Test Well Contribution and crediting Cash.

Under the full cost method, what is the accounting treatment for a delay rental payment?

A delay rental payment is capitalized as a cost to carry and retain unproved property. Record it by debiting Unproved Property – Delay Rental and crediting Cash.

Journal Entry:

• Debit Unproved Property – Delay Rental

• Credit Cash

Under the full cost method, what is the accounting treatment for an abandoned lease? Ex. lease b is determined to be dry and is plugged for $30,000

Under the Full Cost Method, costs associated with an abandoned lease (including plugging costs) are capitalized as part of the full cost pool. Record the plugging cost by debiting Wells in Progress (WIP) or Wells and Equipment and crediting Cash.

Example:
Lease B is determined to be dry and is plugged for $30,000.

Journal Entry:

• Debit Wells in Progress (WIP) 30,000

• Credit Cash 30,000

Under the full cost method, what is the accounting treatment for an exploratory dry hole once it is deemed completed?

Under the Full Cost Method, an exploratory dry hole is capitalized, not expensed. Once drilling is completed and the well is determined to be dry, the cost is reclassified from WIP (Wells in Progress) to an Exploratory Dry Hole asset.

Journal Entry:

• Debit Exploratory Dry Hole Asset

• Credit WIP (Wells in Progress)

What is the accounting treatment under the Full Cost Method to record the abandonment of a lease?

Under the Full Cost Method, when an unproved lease is abandoned, its cost is reclassified into the amortization base. Record this by debiting Abandoned Leasehold Costs and crediting Unproved Property. The abandoned leasehold costs are then added to the amortization base for DD&A.

Journal Entry:

• Debit Abandoned Leasehold Costs (asset)

• Credit Unproved Property

What is the equation for the Units of Revenue method under Full Cost accounting?

Where:

• Current Gross Revenue = Current Year Production × Average Selling Price

• Estimated Future Gross Revenues = Estimated Proved Reserves × Average Selling Price

Gathering system

Saltwater disposal system

Severance taxes

Direct production costs are

directly related to a specific lease or well. Costs that would not be incurred if the lease didn’t exist. fuel, direct labor, contract labor, well repairs

indirect production costs include

service multiple leases or wells must be allocated to well or lease through a cost driver. Ex) field offices, supervisor costs, support services.

If inventory is recorded, it is subject to what rule?

The lower of cost or market rule. Should be reported on the BS to the lower of what it costs to produce or the net realizable value at the end of the reporting period.

In order to be reported on the BS, producer of oil must measure quantities of oil that have been produced but not yet transferred to the buyer @ end of reporting period. the equation to record this is

Beginning inventory + production - sales= Ending inventory

Gas linefill is the

estimated amount of gas in the system at any given time. This is permanent inventory and is usually constant overtime

Inventory is recorded at cost of producing products and getting them to condition and location for sale, includes things like…

direct labor, workovers, repairs, fuel, DD&A expense or corporate OH. Basically direct and indirect costs

Lower cost of market method

ending inventory needs to be booked at the lower of cost or NRV. NRV is the estimated selling price minus transportation and disposal costs

When making a decision to complete a well, you want to know if

incremental costs to complete the well will exceed the future net cash flows expected to be received from the sale

When making a decision to complete the well, there are costs that are considered “sunk” and should be ignored, these costs are

acquisition and drilling costs

What is the formula for the payback method, what does it measure. What are the disadvantages of this method.

initial investment / net cash inflow = payback period.The shorter the payback period the better. Disadvantages are it ignored cashflows after payback period, it ignroes TVM

What is the NPV method and what are the disadvantages

shows whether future net cash flow from an investment will yield a positive NPV when cashflows are discounted using rate of return. Disadvantage: does not allow ranking of projects

What is the equation for the profitability index, what does it measure, what are the disadvantages

NPV of future cash inflows/ initial cash outlay.

proportion of present value of dollars returned to dollars invested, if profitability is greater than 1, project is acceptable.

The higher the PI, the better

Internal Rate of Return (IRR)

• Discount Rate the is required to generate a NPV of 0. The higher IRR, the better the investment.

• Can be compared to the firm’s cost of capital.

• Incorporates time value of money, usually uses a spreadsheet to calculate IRR.

When analyzing projects, which method does not permit ranking of several competing investment options

NPV (net present value method)

What is a disadvantage of the payback method

it ignores the TVM and ignores cashflows after the payback period.

The IRR method

is the discount rate where there NPV of the project is = to 0

What is an Asset Retirement Obligation (ARO)

Legal requirement to return a site to its previous condition. Legally enforceable resulting from laws set in the area.

What is an obligation event

This occurs when environment is disturbed. liability should be recognize. when drilling and equipping land has taken place, this constitutes and obligation event.

GAAP says long-lived assets must be tested for impariment if assets are

on the BS @ higher than the amount they’re worth, you must test for impairment. CV= cap cost - Accum DD&A

Asset groups

in O&G companies, this is done by fields

What are the indicators for impairment?