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In: Accounting

In the Fundamentals of Oil and Gas Accounting book; Which oil and gas assets are subject...

In the Fundamentals of Oil and Gas Accounting book;

Which oil and gas assets are subject to impairment testing for successful effort companies?

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Expert Solution

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.



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