OT02085 - Oil Industry accounting: successful efforts and full cost methods of accounting

As noted in OT02030, the accounting standard specific to expenditures incurred in the exploration for and evaluation of oil and gas is - for preparers using IFRS, FRS 101 or FRS 102 (see OT 02003) - IFRS 6 Exploration for and Evaluation of Mineral Resources.

An entity is required to develop an accounting policy for its exploration and evaluation expenditure. IFRS 6 permits an entity to continue to apply its previous accounting policy by exempting it from the requirement of IAS 8.11 and 8.12 to refer to other IFRSs and the Framework for Preparation and Presentation of Financial Statements. The accounting policy adopted must still meet the requirement of IAS 8.10 that it is both relevant and reliable.

In practice, there are two broadly acknowledged methods for accounting for exploration and evaluation expenditure which are used, namely the successful efforts and full cost methods.. It should be noted that these were detailed in the withdrawn Statement of Recommended Practice Accounting for Oil and Gas Exploration, Development, Production and Decommissioning Activities (‘the SORP’) but variants may exist.

The salient features of each method are given below.

Successful efforts method

  • A method of accounting for oil and gas exploration and development activities whereby exploration expenditure which is either general in nature or relates to unsuccessful drilling operations is written off. Only costs which relate directly to the discovery and development of specific commercial oil and gas reserves are capitalised, and are depreciated over the lives of these reserves. The success or failure of each exploration effort is judged on a well-by-well basis as each potentially hydrocarbon-bearing structure is identified and tested.

Full cost method

  • A method of accounting for oil and gas exploration and development activities whereby all costs associated with exploring for and developing oil and gas reserves are capitalised, irrespective of the success or failure of specific parts of the overall exploration activity. Costs are accumulated in cost centres known as “cost pools” and the costs in each cost pool are written off against income arising from production of the reserves attributable to that pool.
  • The SORP described a cost pool as being a cost centre, used as a basis for accumulating depreciable capitalised exploration, appraisal and development expenditure. The cash flows from fields within a pool must be affected by the same factors and, therefore the fields within a pool would possess, to a significant degree, common characteristics in at least one of the following factors: geological area, interdependence of infrastructure, common economic environment or common development of markets.

In both cases, as indicated in OT02030, an entity shall apply the IFRS to exploration and evaluation expenditures that it incurs (IFRS 6.3) but, in accordance with IFRS 6.5, the IFRS does not apply to exploration and evaluation expenditures incurred:

  • Before the exploration for and evaluation of mineral resources, such as expenditures incurred before the entity has obtained the legal right to explore a specific area.
  • After the technical feasibility and commercial viability of extracting a mineral resource are demonstrable.

The full cost method, in comparison to the successful efforts method of accounting, causes more costs to be deferred in the exploration and evaluation phase and the subsequent amortisation (and any impairment) charge to be higher.