OT02190 - Oil Industry accounting: underlift and overlift
Lifting or offtake arrangements for oil and gas produced in jointly owned operations are frequently such that it is not practicable for each participant to receive or sell its precise share of the overall production during the period. For example, it will be more efficient for each participant to lift full tankers of oil rather than a certain percentage. As a result of this, some participants will have taken more than their share (overlift) and others will have taken less than their share (underlift).
The treatment of overlifts and underlifts will impact on revenue recognition. Although not specifically covered in any revenue accounting standard there are two methods for accounting for overlifts and underlifts that are commonly used in the industry. These are:
- The sales method; and
- The entitlements method.
Under the sales method the revenue recorded is the value of what the participant actually sells. This will however result in a mismatch because the participants share of the expenses recorded will be equal to its ownership share. There are two approaches used in industry to deal with this imbalance:
- Accrue or defer expenses - an overlift participant would accrue for future expenses that are not matched by corresponding future revenues and and underlift participant would defer expenses and match them with future production.
- Make no adjustment - not accounting for the effects of the imbalances has been justified on the grounds that the amounts involved are immaterial or that operating costs should be expensed as incurred as they relate to the period’s production activity and not to the revenues recognised.
Under the entitlements method revenue recorded reflects the participants share of production regardless of which participant has actually made the sale and invoiced the production. This is achieved by applying one of the following approaches in dealing with imbalances between actual sales and entitlements:
- Adjusting revenue - the excess of product sold during the period over the participants ownership share (i.e the overlift) is recognised as a liability (deferred revenue) and not as revenue in the period. The underlift party would then recognise an underlift asset and report the corresponding revenue.
- Adjusting cost of sales - this version of the entitlements method requires the cost of sales to be adjusted to take account of an asset or a liability that reflects the lifting imbalance.
Both the adjusting revenue and adjusting cost of sales method will give the same gross profit.
If companies do adopt different treatments in relation to overlifts and underlifts any differences in the amounts recorded in relation to revenue are likely result in short term timing differences.
The initial measurement of the overlift liability and the underlift asset is at the market price of the date of lifting. Subsequent measurement will depend on the terms of the joint operating agreement and the arrangements to settle the balance. For example if the joint operating agreement allows for the direct settlement in cash the balance will be remeasured to the current market price of oil at the balance sheet date with any change included in the income statement as other income/expenses.
Accounting for overlifts and underlifts may be impacted by the introduction of IFRS 15 Revenue from Contracts with Customers.
If the other parties in any arrangement set out in the Joint Operating Agreement do not meet the definition of a customer then the underlift and overlift transactions may be outside of the scope of IFRS 15.
Even if the other parties do meet the definition of a customer, it will depend on the arrangements in place to settle the overlift/underlift balance. If there is no cash settlement the arrangement may also fall outwith the scope of IFRS 15.