In: Accounting
In the Fundamentals of Oil and Gas Accounting book;
Which oil and gas assets are subject to impairment testing for successful effort companies?
Impairment Considerations Related to O&G Assets
Companies that engage in O&G exploration and development can
account for their operations by using either the successful-efforts
method or the full-cost method. The fundamental difference between
these two methods lies in their treatment of expenses related to
the exploration of new O&G reserves. The accounting method used
will directly affect how net income and cash flows are
reported.
Under the successful-efforts method, costs related to the successful identification of new O&G reserves may be capitalized while costs related to unsuccessful exploration efforts (i.e., drill efforts that result in a dry hole) would be immediately recorded on the income statement. Conversely, the full-cost method allows E&P companies to capitalize nearly all costs related to the exploration and location of new O&G reserves regardless of whether their efforts were successful.
Measurement of Impairment Loss
A company that applies the successful-efforts method will test an
asset group for impairment by using the two-step process detailed
in ASC 360. Under step 1, the company will perform a cash flow
recoverability test by comparing the asset group’s undiscounted
cash flows with the asset group’s carrying value. The carrying
amount of the asset group is not recoverable if it exceeds the sum
of the undiscounted cash flows that are expected to result from the
use and eventual disposition of the asset group.
If the asset group fails the cash flow recoverability test, the company will perform a fair value assessment under step 2 to compare the asset group’s fair value with its carrying amount. An impairment loss would be recorded and measured as the amount by which the asset group’s carrying amount exceeds its fair value.
Recognition of Impairment Loss
An impairment loss for a proved property asset group will reduce
only the carrying amounts of the group’s long-lived assets. The
loss should be allocated to the long-lived assets of the group on a
pro rata basis by using the relative carrying amounts of those
assets; however, the loss allocated to an individual long-lived
asset of the group should not reduce the asset’s carrying amount to
less than its fair value if that fair value is determinable without
undue cost and effort. For unproved properties, if the results of
the assessment indicate impairment, a loss should be recognized by
providing a valuation allowance. Under the successful-efforts
method, companies are prohibited from reversing write-downs.
Timing of Impairment Testing and Impairment Indicators
Under the full-cost method, a full-cost ceiling test must be
performed on proved properties each reporting period. Further,
unproved properties must be assessed periodically (at least
annually) for inclusion in the full-cost pool, subject to
amortization.