Fair Value Measurement in the Oil and Gas Industry Essay

Introduction

Different companies in different countries that venture in the exploration & production industry have been known to rely on some diversified methods and approaches when it comes to the assessments and accounting for risks and impairments that are predominant in the process of exploring oil and gas and the development of business. The procedure of accounting that is put into practice will affect the direct reporting of the net income and the cash flows. Today, the two most profound and most applicable methods are the Full Cost Method or the method of Successful-Efforts. These methods have been assimilated into most parts of the world for their effectiveness standards. In this point of view, this paper will discuss that ought to be put into consideration by an Exploration & Production (E&P) company to assess and account in the impairment process of its assets in Oil and Gas (O&G) by using the procedures of either the full-cost mechanism or the successful efforts mechanism.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Save 25%

The Method of Successful-Efforts is founded on guidelines established in the ASC 360-10-35 and ASC 932-360-35 articles (Deakin, 2009). Additionally, the Method of Full Cost practices are well defined in the S-X guidelines and FRC Regulations. The E&P companies that employ either of these methods in their O&G assessment of assets impairment focus on addressing the following four major factors that are profoundly inherent in the business practices.

The Impairment Timing, Testing, and Indicators of Impairment

Timing when an impairment analysis is done is critical in the sense that it allows the company to determine the recoverability of proved properties in an asset group (Deakin, 2009). The amounting should be conducted whenever a critical change of circumstance or event showcases that a given specific level of recoverability of the value vested in the given company's O&G properties, or amounts carried by a particular asset group, may not be achievable. Additionally, when using the method of full-cost, a company is mandated to perform a full-cost ceiling test before the time when the company's financial analysis and reporting is done. Periodically assessments in this method are required to facilitate inclusion of the full-cost pool and, more importantly, subject the unproved properties to amortization (Aven & Vinnem, 2005).

Measurement of Impairment Loss

In determining the quantity of Impairment Loss of an asset group using the successful-efforts method, and as detained in the ASC 360, a standard process involving two critical steps is performed. The first step consists of performing a recoverability test. This test is done by determining and comparing the carrying value to undiscounted cash flows of the company's asset group. If the latter exceeds the former, the asset group is not recoverable (Ingraffea., 2014). In this case, a fair value assessment, which constituted the second step, is performed. This action gives the asset group's fair value, which is then compared to its carrying amount.

The level of Impairment Assessment

The assessment of asset group impairment can take place at different levels. As such, the determination of the specific level at which the practice should take place is an essential factor in strategic management. One of the most important aspects that a company that uses the successful-efforts method must reflect on is whether the property to be assessed is proved or unproven. Proved properties differ significantly from the proved ones, especially the assessment categorization or grouping. With regards to the full-cost method, companies that apply this particular approach must account for impairment using a cost-center level, which is established significantly on a country-by-country basis.

Recognizing the Loss of Impairment

The identification of loss of impairment for either proved, or unproved properties is critical. For instance, when using the successful-efforts method for assessment of justified property asset group, a decrease in the impairment loss long-lived assets of the group can only be established on the carrying amounts (Ingraffea al., 2014). On the other hand, if an assessment through this method points out the presence of impairment, a valuation allowance is facilitated to recognize the loss. The revision of write-downs for E&P business organization that apply the successful-efforts method is critically interdicted. Aimed at ensuring that property values carried forth by an E&P Company does not exceed the recoverable amount, as well as categorically identify the constructs of establishing the amount recoverable of given assets, the IAS 36 present the critical guidelines for impairment loss recognition. IAS 36 stipulates that an exception of when the revaluation decrease treatment is imposed in a different accounting setting, the identification of impairment loss, in the accounted loses or profits, should be established immediately. Timing, in this case, is thus a critical factor that managers must keep in mind.

Similarly, when using the successful-efforts method, and depending on how it relates to value asset, the impairment loss can be treated as either an expense or a revaluation decrease. When using the full-cost method in recognition of an impairment loss, most companies ought to consider decreasing the full-cost asset pool-carrying value. The value in excess is noted in the records for future reference, especially when determining the disbursal charges for the operations in progress. In reflecting on this aspect, in a managerial context, is strategically essential in the sense that it presents cost-effective advantages to the company. Similar to the case of using the successful-efforts method, the revision of write-downs for companies that use the full-cost method is critically a prohibited practice (Ingraffea., 2014).

Conclusion

Conclusively, the E&P industry is a significant dynamic area of business venture. However, it is today one of the most lucrative investments across the global business arena. The complexity and global influence associated with the process of exploring oil and gas and development have led to the establishment of policies, guidelines and profound strategic measures that aim at ensuring effective management of exploration and production practices as well as proper control over oil and gas resources. The need to ensure that the above-discussed factors are kept in tabs is unequivocal (Aven & Vinnem, 2005). Profound reflection of these factors only ensures the sustainability of O&G companies in the contemporary competitive E&P industry.

References

Aven, T., & Vinnem, J. E. (2005). On the use of risk acceptance criteria in the offshore oil and gas industry. Reliability Engineering & System Safety, 90(1), 15-24.

Deakin III, E. B. (2009). An analysis of differences between non-major oil firms using successful efforts and full cost methods. Accounting Review, 722-734.

Ingraffea, A. R., Wells, M. T., Santoro, R. L., & Shonkoff, S. B. (2014). Assessment and risk analysis of casing and cement impairment in oil and gas wells in Pennsylvania, 2000-2012. Proceedings of the National Academy of Sciences, 111(30), 10955-10960.