OIL, GAS, AND OTHER NATURAL RESOURCES in VS .NET

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OIL, GAS, AND OTHER NATURAL RESOURCES
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method, only those costs that lead to the successful discovery of reserves are capitalized, while the costs of unsuccessful exploratory activities are charged directly to expense Under the full cost method, all exploration efforts are treated as capital costs under the theory that the reserves found are the result of all costs incurred Both methods are widely used; however, larger companies tend to follow the successful efforts method Under income tax law and regulations, all exploration and development costs, except leasehold and equipment costs, are generally expensed as incurred Petroleum producing companies with signi cant re ning or marketing activities (called integrateds as opposed to independents ) must capitalize 30 percent of intangible well costs to be amortized over 60 months Leasehold costs are expensed by complex depletion deductions that, for independents, can exceed actual costs Equipment costs are depreciated using accelerated methods Many independent US oil- and gasproducing companies pay the alternative minimum tax
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(a) THE SUCCESSFUL EFFORTS METHOD (i) Basic Rules The following points summarize the major aspects of the successful efforts method of accounting for oil and gas property costs:
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The costs of all G&G studies to nd reserves are charged to expense as incurred Lease acquisition costs for unproved properties are initially capitalized Unproved properties
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are those on which no economically recoverable oil or gas has been demonstrated to exist Unproved properties are to be assessed for impairment at least annually If an unproved property becomes impaired because of such events as pending lease expiration or an unsuccessful exploratory well (dry hole), the loss is recognized and a valuation allowance is established to re ect the property s impairment Two approaches to impairment are used: (1) Property by property (typically used by small companies or situations involving signi cant acreage costs), or (2) a formula approach based on factors such as historical success ratios and average lease terms (typically used by larger companies with a signi cant number of smaller properties) Once proved reserves are found on a property, the property is considered proved and the acquisition costs are amortized on a unit-of-production basis over the property s producing life based on total proved reserves (both developed and undeveloped reserves) The SFAS No 25 de nition of proved reserves may be summarized as the estimated volumes of oil and gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions If both oil and gas are produced from the property, the unit is normally equivalent barrels or mcfs, whereby gas is converted to equivalent barrels (or barrels are converted to equivalent mcfs) based on relative energy content A common conversion factor is 56 mcf to 1 equivalent barrel For a property containing both oil and gas, the unit may re ect either oil or gas if: The relative property of oil and gas extracted in the current period is expected to continue in the future, or The re ected mineral clearly dominates the other for both current production and reserves Carrying costs required to retain rights to unproved properties (delay rentals, ad valorem taxes, etc) are charged to expense Exploratory wells are capitalized initially as wells-in-progress and expensed if proved reserves are not found Successful exploratory wells are capitalized, as are their completion costs (setting casing and other costs necessary to begin producing the well) Costs of drilling development wells (even the rare dry ones) are capitalized
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Costs of successful exploratory wells, along with the costs of drilling development wells on
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the lease, are amortized on a unit-of-production basis over the property s proved developed reserves on: A property-by-property basis, or The basis of some reasonable aggregation of properties with a common geologic or structural feature or stratigraphic condition, such as a reservoir or eld Once production has begun, all regular production costs are charged to expense Capitalized interest, under the requirements of SFAS 34, would also be capitalized as part of the cost of unevaluated properties during the evaluation phase (ii) Exploratory versus Development Well De nition Because Reg S-X requires that the costs of dry exploratory wells be charged to expense, whereas the costs of dry development wells are capitalized, it is important to properly classify wells Regulation S-X Rule 4-10, de nes the two categories of wells as follows: 1 Development Well A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive 2 Exploratory Well A well drilled to nd and produce oil or gas in an unproved area, to nd a new reservoir in a eld previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir Generally, an exploratory well is any well that is not a development well, a service well, or a stratigraphic test well These de nitions may not coincide with those that have been commonly used in the industry (typically, the industry de nition of a development well is more liberal than Reg S-X, Rule 4-10) This results in two problems: 1 Improper classi cation of certain exploratory dry holes as development wells (the problem occurs primarily with stepout or delineation wells drilled at the edge of a producing reservoir) 2 Inconsistencies between the drilling statistics found in the forepart of Form 10-K (usually prepared by operational personnel) and the supplementary nancial statement information required by SFAS No 69 (usually prepared by accounting personnel) (iii) Treatment of Costs of Exploratory Wells Whose Outcome Is Undetermined As set out below, SFAS No 19 effectively curtails extended deferral of the costs of an exploratory well whose outcome has not yet been determined
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