Oil and Gas Accounting Exam 3 Flashcards

Different countries have different laws and regulations for calculating depreciation. The property must have a fixed useful life which must be over a period of one year. Explanations may also be supplied in the footnotes, particularly if there is a large swing what is dd&a in the depreciation, depletion, and amortization (DD&A) charge from one period to the next. Required, calculate the DD and A on a property by property basis and on a country wide basis. Wells whose outcome is unknown may be either capitalized or expensed .

• These costs, which include geological and geophysical survey costs, are expensed immediately under the SE accounting method which directly impacts the income statement.
• To get a real world example of this NAV model, click here to view a sample video on how to set up the revenue side in a NAV analysis for XTO Energy.
• A dry hole or surrendered lease for an unproductive hole cannot possibly be an asset.
• Estimated future decommissioning costs of well sites, net of estimated salvage values, are to be included in the cost base used to calculate DD&A.

An additional argument in support of the SE method is that it is less prone to manipulation than the FC method for the purpose of misstating company performance. Under the FC method, executive and management could influence the profit reported for a company thereby increasing their performance-based compensation . • Acquisition Costs – pertain to surface and mineral lease acquisition including, but not limited to, the cost of leasing or purchasing the property, signature bonuses, legal costs and broker fees. The most important point about Oil & Gas LBO models, ironically, is that oil & gas leveraged buyouts rarely happen.

DD&A means Depreciation, Depletion, and Amortization

At the time Oil Company acquires an interest in an unproved property, it is exactly equal to the costs. Because of time, certain events occur which may lead to questions on whether the value of the unproved property still equals to the cost , less than the cost or greater than the cost .

• I.e only the cost of the successful operation will be capitalized while the other costs will be written off into P and L account.
• What makes depletion similar to depreciation is that they are both cost recovery system for tax reporting and accounting.
• As a result, it is difficult for an investor to determine the success of a company’s drilling efforts.
• It is an accounting technique where you allocate the costs of natural resources to depletion over the period making up the assets life.
• The yearly depletion cost is based on the units extracted or used for a given time period.

Depreciable property is otherwise known as a depreciable asset, this is an asset that can be depreciated following the Internal Revenue Service rules. When depreciated, the value of the asset is regarded as business expenses over its useful life, this is deducted from the tax return of the business. The unit of revenue method can be used instead of the unit of production method.

The Difference Between Cost Depletion and Percentage Depletion

The good news is that while bank and insurance modeling is almost a different game entirely, oil & gas modeling is more like a variation on a game you’re already familiar with. The Accumulated Depreciation account had a balance of $144,000 after the current year’s depreciation of $36,000 had been recorded. Determine the amount that will be reported under total liabilities for Company A and B considering the two revenue recognition policies for Year 1 and Year 2. Financial fixed assets cannot be amortized, their losses can however be transferred.

• EBITDAR—an acronym for earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs—is a non-GAAP measure of a company’s financial performance.
• ______ must be estimated and included in the costs being amortized to avoid distortion of the DD&A rate, and the estimation should be based on _____.
• Future development costs needed to convert proved undeveloped reserves into proved developed reserves should be included in the costs being amortized.
• The planned, gradual reduction in the recorded value of a tangible asset over its useful life is referred to as depreciation.
• The Successful Effort Method of accounting is where only those costs that lead to discovery of oil reserves are capitalized.
• You project expenses either on a production-linked basis (e.g. Production, Taxes, Transportation, DD&A) or a non-production-linked basis (Stock-Based Comp., Derivative Gains / , etc.).

DD & A is the systematic allocation of the capitalized costs of an asset over its useful life. It is concerned with the matching of capitalized exploration, appraisal, and development costs with the production which give rise to reserve. Critics of the FC method believe that it inflates a company’s current earnings as the unsuccessful costs are capitalized.

What is Depreciable Property?

You add all those up to arrive at Enterprise Value, then back into Equity Value the normal way, and calculate the company’s Implied Share Price by dividing by the diluted shares outstanding. You focus on Production and Development expenses here, both of which may be linked to the company’s production in the first place. That seems straightforward, but it gets confusing on the other financial statements because some companies apply these standards inconsistently and use a “mix” of both.

Revenue recognition is straightforward, but the expenses get tricky. You always capitalize acquisitions and development , and you always expense production. You project expenses either on a production-linked basis (e.g. Production, Taxes, Transportation, DD&A) or a non-production-linked basis (Stock-Based Comp., Derivative Gains / , etc.). Energy companies’ income statements do not have the usual Cost of Goods Sold / Gross Profit and Operating Expense distinction that you see for normal companies. If all production costs are expensed as incurred, no ____ would be recorded.

In particular, a company that extracts resources will use depletion to account for the use of these assets. The Full Cost Method of Accounting is a method in which all the costs of oil or gas acquisition, exploration and development are capitalized. All costs must be included in the accounts, whether or not they lead to the discovery of reserves, i.e. oil that is underground but not yet extracted. These costs may comprise the costs of the licences, expenditure on geological and geophysical study, exploration drilling costs, and costs of preparing the wells. Depletion can only be used for natural resources, while depreciation is allowed for all tangible assets. Unlike depreciation, cost depletion is based on usage and must be calculated every period.

The FC company, on the other hand, will amortize and recognize the costs of the unsuccessful wells later into the life of the field. This is because the FC method amortizes the costs of the unsuccessful well over a longer period (i.e. the expected life of the company’s reserves). As a result, the FC company reports a higher net income earlier in the life of the field than https://personal-accounting.org/ does the SE company. The FC method allows companies to capitalize all expenses related to locating new oil and gas reserves regardless of the outcome. A diversified oil & gas company has slightly different statements and you see more items related to its midstream and/or downstream capabilities; for a good example, click here to view Exxon Mobil’s financial statements.

Enwell Energy is a highly focused oil and gas business in a fast changing world, built to thrive in challenging but opportunity-rich times. There’s surprisingly little to say about merger models and LBO models in the oil & gas industry. You want to track the beginning and ending reserves each year, the annual production volume, and the average price for each commodity; typically you use the same low/mid/high price cases that you used in the company’s operating model.

But those make more sense for 100% stock-based deals (you wouldn’t see the impact of foregone interest on cash or interest expense on new debt for these non-financial metrics). It is widely used in oil, gas, mining, and other commodity-based sectors, and it often produces more accurate results than the standard DCF analysis. For example, if the company has undeveloped land or if it has midstream or downstream operations, you might estimate the value of those based on an EBITDA multiple (or $ per acre for land) and add them in. Then, you’d multiply the production volume times the average price each year for all commodities to get the revenue by year. The good news is that most of the same valuation methodologies you’re used to seeing – public comps, precedent transactions, and even the DCF model – still apply to oil, gas & mining companies. You start by projecting annual production on a per-commodity basis, and then assume low, mid, and high price cases for each commodity to build multiple scenarios in Excel. You might assume a modest increase over that number, especially if the company is spending a lot on finding new resources.