G L O BA L O I L & G A S C E N T E R
M A R C H 2008
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U.S. GAAP v. IFRS:
The Basics for Oil and
Gas Companies
Table of Contents
2
IFRS: Closer Than We Thought?
5
Overview of Accounting Literature
7
Unit of Account
9
Full Cost and Successful Efforts Methods Versus IFRS
12 Impairment
14 Joint Ventures
17 Inventory
18 Asset Retirement Obligations
19 Reserves and Related Information
21 Regulatory Assets and Liabilities
IFRS: Closer Than We Thought?
Much of the world is still speaking different languages when it comes to financial reporting.
Disparities in financial reporting caused by differing accounting standards may have been
tolerable when cross-border investment was a fraction of what it is today. But as capital markets
have become more global, momentum has been building for a single set of high-quality global
accounting standards that could be consistently and faithfully applied by issuers and their auditors
and understood by investors throughout the world. There is an intuitive logic supporting the notion
that capital markets benefit from using a single set of common accounting standards. A common
set of accounting standards would enable investors to compare the financial performance of
different companies in the global marketplace. In that way, investors could more easily evaluate
and compare investment opportunities.
The emergence of International Financial Reporting Standards (IFRS) as the recognized body
of global financial reporting standards has coincided with the requirement of their use in the
consolidated financial statements of listed companies in the European Union. In the two years
since the European Union mandated the adoption of IFRS, U.S.-based companies have closely
watched the developments unfold. The emergence of IFRS on domestic shores has, until
recently, been viewed only as a future possibility. Now, that far-off view is changing. Suddenly,
it seems that once distant future may be closer than anyone anticipated.
Increasingly, the dialogue throughout the marketplace has begun to question whether U.S. GAAP
ultimately will be replaced by IFRS. Most of this dialogue stems from the continued focus of the
Securities and Exchange Commission (SEC) on the international standards, beginning with its
decision in November 2007 to eliminate the U.S. GAAP reconciliation for foreign private issuers
that use IFRS. However, the SEC extended the debate to U.S. domestic companies when it issued
a Concept Release in August 2007 regarding the possibility of allowing U.S. issuers the option of
using IFRS.
Ernst & Young has publicly expressed our strong support for having a single set of high-quality
global accounting standards that all companies would use. We also have expressed our strong
view that the SEC should not only provide an option for U.S. issuers to convert their financial
reporting from U.S. GAAP to IFRS, but should go further and make a clear statement that it
will require all U.S. issuers to adopt IFRS as of a specified date in the future. Doing so would
demonstrate the SEC’s trust in the IFRS standard-setting process, provide the impetus for
needed changes, and send a clear signal to the rest of the world. The SEC is in a unique position
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to provide added momentum to realize the goal of one set of globally accepted, high-quality
accounting standards and can help to accelerate change by other standard setters and regulators
around the world.
For most companies accustomed to U.S. GAAP, a transition to IFRS would require, at the
very least, a change in mindset. Regardless of their preferences for one system over another,
if provided with the option by the SEC, some companies may believe they have little choice
but to convert to IFRS. Many oil and gas companies, especially those that operate on a global
basis, could be particularly affected because many of their global competitors may already be
reporting under IFRS. And if the larger companies decide to convert, smaller companies may
feel compelled to do the same, believing that their ability to attract customers, secure capital,
and achieve financial success on a global scale may depend on their following suit.
As companies evaluate the impact of a potential conversion, they must recognize that
conversion from U.S. GAAP to IFRS is more than an accounting exercise. In addition to the
conversion of the accounting and financial reporting from U.S. GAAP to IFRS, conversion
presents company executives with opportunities to challenge the way in which their company
is viewed and evaluated by investors, other key stakeholders, and competitors. Conversion
considerations would include assessing the effect on investor relations, corporate finance, and
structured financial products; management reporting and performance indicators for employee
compensation and benefits; and tax planning and reporting requirements.
Simplicity, Efficiency Are Key
While a conversion to a global GAAP would have varying implications depending on a company’s
operations—and we believe that IFRS is quickly becoming that “global GAAP”—there are a
number of benefits that companies would realize from adopting IFRS.
A single set of accounting standards would facilitate accounting and reporting for companies
with global operations and eliminate costly and burdensome requirements. Currently, U.S. issuers
with foreign operations must prepare their financial statements in accordance with the statutory
reporting requirements of the various countries in which they operate and also prepare statements
in accordance with U.S. GAAP for filing with the SEC. Obviously, the time and expertise required
to “translate” a company’s statements for various audiences equate to a considerable expense.
Having a single set of high-quality global accounting standards that are accepted around the world
would relieve these companies of that duplicative reporting burden.
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IFR S: C L O S E R T H A N W E T H O U G H T ?
Along the same lines, IFRS may present the potential to utilize shared service centers for
preparation of multi-national statutory accounts. While many multi-national companies
currently employ separate financial teams with specialized knowledge of local reporting
requirements, a global accounting standard would allow those functions to be centralized.
The potential reduction of real estate and full-time employees could result in significant
cost savings.
Finally, from a competitive standpoint, IFRS may help U.S. companies to better benchmark their
own performance against that of foreign peers and other domestic competitors who will also
convert to IFRS.
Conversion Not Without Challenges
For all the potential advantages that IFRS has to offer, it is by no means a perfect solution for
all companies. Accounting professionals may find certain fundamental differences between U.S.
GAAP and IFRS to be disconcerting, and a successful transition from one to the other will take
time and persistence.
Beyond the conceptual differences in U.S. GAAP and IFRS, U.S.-based companies should
also be aware of a few specific distinctions that could make for a challenging transition and
significantly alter their ongoing accounting practices. This publication is a supplement to
Ernst & Young’s U.S. GAAP v. IFRS: The Basics, which takes a top level look, by accounting
area, at where the standards are similar and also where they differ. This document discusses
some of the accounting policies and practices that are specific to the oil and gas industry under
both U.S. GAAP and IFRS. Our main objective, consistent with that of The Basics, is to provide
some insight into where oil and gas accounting policies under both sets of standards are similar
or diverge. We hope that, as the dialogue regarding the possible adoption of IFRS continues,
oil and gas companies will use this document to help identify potential changes to their
financial statements.
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Overview of Accounting Literature
The primary U.S. GAAP accounting literature for the oil and gas industry is found in FAS
19, Financial Accounting and Reporting by Oil and Gas Companies, various U.S. Securities
and Exchange Commission rules and regulations, and FAS 69, Disclosures about Oil and Gas
Producing Activities. Many other accounting standards also directly affect the accounting used
in the industry. Under IFRS, there is one standard, IFRS 6, Exploration for and Evaluation of
Mineral Resources, that provides limited guidance for all the extractive industries.
The scope of IFRS 6 is limited to accounting for the exploration and evaluation (E&E) of
mineral resources. The standard defines exploration and evaluation as “the search for mineral
resources, including minerals, oil, natural gas and similar non-regenerative resources after the
entity has obtained the legal rights to explore in a specific area, as well as the determination
of the technical feasibility and commercial viability of extracting the mineral resource.” The
standard does not “address other aspects of accounting by entities engaged in the exploration for
and evaluation of mineral resources.” In other words, IFRS 6 does not deal with the phases of
upstream operations that take place before (e.g., prospecting and acquisition of mineral rights)
or after (e.g., development, production, and abandonment) exploration and evaluation.
A company reporting under IFRS is required to apply other guidance since the scope of IFRS 6
is limited to the exploration and evaluation of mineral resources activities that are outside of the
exploration and evaluation phase. The following standards are particularly relevant to the oil and
gas industry:
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IAS 16–Property, Plant and Equipment
IAS 31–Interests in Joint Ventures
IAS 36–Impairment of Assets
IAS 38–Intangible Assets
Additional Technical Information
The Financial Reporting Group of Ernst & Young has published International GAAP® 2008,
Generally Accepted Accounting Practice under International Financial Reporting
Standards. This update to our previously published International GAAP® books includes
a specific chapter on the extractive industries. In addition to covering most of the topics
discussed in this publication in more detail, the chapter highlights the industry-specific issues
related to accounting and reporting on business combinations versus asset acquisitions,
taxation, financial instruments, and other topics.
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O V E RV I E W O F A C C O U N T I N G
L I T E R AT U R E
Accounting for Oil and Gas Activities Under IFRS
In the remainder of this document, we have discussed some of the more critical elements of
accounting for oil and gas activities under IFRS. In addition, any significant differences that
exist between U.S. GAAP and IFRS have been explained. This is not a comprehensive
list or detailed review of all the potential accounting and financial reporting matters that would
affect companies with oil and gas producing activities; rather, the following information
provides a top level overview of certain accounting matters for oil and gas activities under IFRS
and how these may differ from practices of companies reporting under U.S. GAAP.
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Unit of Account
One of the key issues in the development of accounting standards and the selection of accounting
policies is the decision about the level at which an entity should separately account for assets, i.e.,
what the “unit of account” should be. This is particularly important in the oil and gas industry,
where a key issue under any method of accounting is determining the appropriate unit of
account, or cost center or pool.
The unit of account plays a significant role in (1) recognizing and derecognizing of assets,
(2) determining the rate of depreciation or amortization, (3) deciding whether certain costs
should be capitalized, (4) impairment testing, (5) determining the substance of transactions,
(6) applying the measurement model subsequent to recognition of the asset, and (7) determining
the level of detail of the disclosures required. While the International Accounting Standards Board
(IASB) has not developed any specific guidance for determining the appropriate unit of account
in any given circumstance, guidance can be derived from existing statements. The following
matters should be considered in determining the unit of account:
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Cost of tracking an individual component versus the benefit
Materiality of the individual asset or component
Capability of the assets being used separately
Useful economic life of the components
Inseparability of economic benefit of the individual components
Substance of the transaction
Industry practice
The criteria above do not provide definitive guidance, nor should the list be considered a formal
hierarchy, in identifying the unit of account, but they can help in determining an appropriate
one under IFRS.
In practice, entities would define cost centers along geographical, political, or legal boundaries
or align them to the operating units in their organization. The following are commonly used
cost centers:
(a) The world
(b) Each country or group of countries in which the entity operates
(c) Each contractual or legal mineral acquisition unit, such as a lease or production
sharing contract
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(d) Each area of interest (geological feature, such as a field, that lends itself to a unified
exploration and development effort)
(e) Geologic units other than areas of interest (such as a basin or geologic province)
(f) The entity’s organizational units
As noted, IFRS does not provide specific guidance on determining appropriate units of account.
Nevertheless, we believe that in determining the unit of account, an entity should use the legal
rights (see (c) above) as its starting point and apply the criteria identified in the second paragraph
above to assess whether the unit of account should be larger or smaller. The other cost centers
identified in (a) and (b) above will typically result in a unit of account that is unjustifiably large
when viewed in the light of the criteria. Determining the unit of account is an area that requires a
significant amount of judgment, which should be disclosed along with other judgments that have a
significant effect on the amounts recognized in the financial statements.
Example
A company concludes, based on a number of exploratory wells, that mineral reserves
are present. However, a number of delineation wells need to be drilled to determine the
amount of reserves present in the field. The first delineation well drilled is a dry hole.
There are two ways of looking at the costs of drilling the dry hole:
ƒ The dry hole provides important information about the extent of the mineral reserves
present in the field and therefore should be capitalized as part of the field, or
ƒ The dry hole will not produce in the future and, in the absence of future economic
benefits, the costs should be expensed immediately.
This example suggests assets or actions that have no value or meaning at one level may actually
be valuable and necessary at another. An individual dry hole would not generally be considered
a separate unit of account and recognized as an asset because (1) individual wells are typically
not capable of being used separately, (2) their economic benefits are inseparable, (3) the wells
are similar in nature, and (4) the substance of the matter can only be understood at the level of
the project as a whole.
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Full Cost and Successful Efforts Methods
Versus IFRS
Full Cost
Under U.S. GAAP, the full cost method requires that all costs incurred in prospecting, acquiring
mineral interests, exploration, appraisal, development, and construction be capitalized in cost
centers. IFRS 6 would permit full cost accounting during the exploration and evaluation phases;
however, full cost accounting could not be extended beyond (either before or after) these phases.
In particular, it would be difficult to justify accounting for the development and production
phases under the full cost method. Once the technical feasibility and commercial viability of
extracting mineral resources are demonstrable, IFRS 6 requires exploration and evaluation
assets to be assessed for impairment before being reclassified outside the scope of IFRS 6, at
which point these assets would be subject to the requirements of other IFRS, namely IAS 16,
Property, Plant and Equipment, and IAS 38, Intangible Assets.
In addition, even if a company did elect to continue applying the full cost method to exploration
and evaluation phases, the requirements under IFRS 6 are distinct from those under U.S. GAAP.
For example, IFRS requires exploration and evaluation assets to be classified as tangible or
intangible according to the nature of the assets, and if impairment indicators exist, an impairment
test must be performed in accordance with IAS 36. The impairment test requirements under
IAS 36 differ from those of the “ceiling test” required under U.S. GAAP.
For these reasons, it is not possible to apply the full cost method of accounting under IFRS
without making very significant modifications to the application of the method. An entity may
want to use the full cost method as its starting point in developing its accounting policy for
E&E assets under IFRS; however, it will rarely be appropriate to describe the resulting accounting
policy as a “full cost method” because key elements of the full cost method are not permitted
under IFRS.
Successful Efforts
Under the successful efforts method, an entity will generally consider each individual mineral
lease, field, concession, or production sharing contract as a cost center. When an entity applies
the successful efforts method under IFRS, it will need to account for prospecting costs incurred
before the exploration and evaluation phase under IAS 16 or IAS 38. We would typically expect
these costs to be expensed as incurred due to the level of uncertainty of future economic benefits.
Costs incurred to acquire undeveloped mineral rights (leasehold cost), however, should be
capitalized under IFRS if an entity expects to receive future economic benefits.
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F U L L C O S T A N D S U C C E S S F U L E F F O RT S
M E T H O D S V E R S U S IFR S
IFRS 6 requires an entity to determine an accounting policy specifying which expenditures are
recognized as E&E assets and apply the policy consistently. Such accounting policy should take
into account the degree to which the expenditure can be associated with finding specific mineral
resources. The standard provides a nonexhaustive list of examples of types of expenditures that
may be included in cost at initial recognition:
(a)
(b)
(c)
(d)
(e)
Acquisition of rights to explore
Topographical, geological, geochemical, and geophysical studies
Exploratory drilling
Sampling
Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource
It is worth noting that (b) above includes geological and geophysical (G&G) costs as an example of costs that may be included in the initial measurement of E&E assets. IFRS 6 is different
in this respect from FAS 19, which generally does not permit capitalization of G&G costs.
To the extent that costs are incurred within the exploration and evaluation phase of a project,
IFRS 6 does not prescribe any recognition and measurement rules. Therefore, it would be
acceptable for such costs (1) to be recorded as assets and written off when it is determined that
the costs will not lead to economic benefits or (2) to be expensed as incurred if the outcome
is uncertain. The deferred costs of an undeveloped mineral right may be amortized over some
determinable period, they may be subject to an impairment test each period with the amount
of impairment charged to expense, or the costs may be kept intact until it is determined whether
the property contains mineral reserves. However, exploration and evaluation assets should
no longer be classified as such when the technical feasibility and commercial viability of
production are demonstrable. At such time, the assets should be tested for impairment, reclassified
in the balance sheet, and accounted for under IAS 16 or IAS 38. If it is determined that no
commercial reserves are present, then the costs capitalized should be expensed.
IFRS requires only relatively minor modifications to the successful efforts method, and
the essence of the approach—that costs are capitalized pending evaluation—is retained
under IFRS.
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Example of Capitalization of Exploration and Development Costs
(Unsuccessful Wells)
As noted, there is no IFRS accounting standard that specifically addresses the treatment
of exploration and development costs for oil and gas companies.
Under the successful efforts method of U.S. GAAP, costs relating to drilling an exploratory
or exploratory-type stratigraphic well may be capitalized pending determination of
whether the well has found proved reserves. If the well has found proved reserves, the
capitalized costs become part of the company’s wells, equipment, and facilities. If it is
determined that the well has not found proved reserves, the capitalized costs of drilling
the well are expensed, net of any salvage value. All costs to drill and equip developmenttype stratigraphic test wells and service wells are development costs and may be
capitalized regardless of whether the well is successful or unsuccessful.
This situation highlights where IFRS could result in different accounting treatments.
Under IFRS, expensing the costs of unsuccessful development wells is permitted, but
depending on the unit of account selected, these same costs could be capitalized as part
of the field costs.
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Impairment
The IASB decided that under IFRS 6, the “assessment of impairment should be triggered by
changes in facts and circumstances.” However, it also confirmed that once an entity determined
that an E&E asset was impaired, IAS 36 should be used to measure, present and disclose that
impairment in the financial statements, subject to special requirements with respect to the level
at which impairment is assessed. Although IAS 36 should be followed, IFRS 6 makes two
important modifications:
ƒ It defines separate impairment testing “triggers” for E&E assets.
ƒ It allows groups of cash-generating units to be used in impairment testing.
E&E assets should be assessed for impairment “when facts and circumstances suggest that the
carrying amount of an E&E asset may exceed its recoverable amount.” Under IFRS 6, one or
more of the following facts and circumstances may indicate that an entity should test E&E assets for impairment (the list is not exhaustive):
(a) The period for which the entity has the right to explore in the specific area has expired
during the period or will expire in the near future and is not expected to be renewed.
(b) Substantive expenditure on further exploration for and evaluation of mineral resources in
the specific area is neither budgeted nor planned.
(c) Exploration for and evaluation of mineral resources in the specific area have not led to the
discovery of commercially viable quantities of mineral resources and the entity has decided
to discontinue such activities in the specific area.
(d) Sufficient data exists to indicate that, although a development in the specific area is likely
to proceed, the carrying amount of the E&E asset is unlikely to be recovered in full from
the successful development or by sale.
Under IAS 36, an entity is required to test individual assets for impairment. However, if it is not
possible to estimate the recoverable amount of an individual asset, then an entity should determine
the recoverable amount of the cash-generating unit to which the asset belongs. A cash-generating unit
is defined by IAS 36 as the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets. In determining
appropriate cash-generating units, an entity will need to consider the following issues:
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Is there an active market for intermediate products?
Are there external users of the processing assets?
Are there fields that are operated as a complex through the use of shared infrastructure?
Are there stand-alone fields that operate on a portfolio basis?
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The IASB decided that it would allow cash-generating units to be aggregated in a way consistent
with the approach to goodwill. Therefore, an entity should determine an accounting policy for
allocating E&E assets to cash-generating units, or to groups of cash-generating units, for the
purpose of assessing such assets for impairment. Many entities applying IAS 14, Segment
Reporting, only identify one business or geographical segment, which allows them to treat the
entire company as one cash-generating unit for the purposes of impairment testing of E&E
assets. Adoption of IFRS 8, Operating Segments, will usually result in the identification of
additional operating segments, which will require a lower level of impairment testing of their
E&E assets. IFRS 8 is required to be adopted by companies on or after January 1, 2009, with
earlier application permitted. The IASB issued IFRS 8 in an effort to achieve convergence
with FAS 131.
Any impairment loss on an E&E asset that has been recognized in accordance with IFRS 6
needs to be reconsidered when there are external or internal indicators that the loss recognized
in previous periods may no longer exist or may have decreased. Therefore, in contrast to existing U.S. GAAP accounting methods, some or all of an impairment loss may be reversed. In
some circumstances, when an entity recognizes an impairment of an E&E asset, it also needs to
decide whether to derecognize the asset because no future economic benefits are expected.
If an entity concludes that, based on the evidence, no future economic benefits are expected, the
entity should derecognize the asset because (1) the asset is no longer in the exploration
and evaluation phase, and therefore outside the scope of IFRS 6, and (2) other accounting
standards would require the asset to be written off in those circumstances. Subsequent to
derecognition, the costs of an E&E asset that has been written off cannot be recognized as
part of a new E&E asset.
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Joint Ventures
Joint ventures are common in the oil and gas industry. However, not all arrangements that
are casually described as “joint ventures” meet the definition of a joint venture under IFRS.
Although joint ventures take many forms and structures, IAS 31, Interests in Joint Ventures,
defines three broad types:
ƒ Jointly controlled operations
ƒ Jointly controlled assets
ƒ Jointly controlled entities
IAS 31 emphasizes that it is the existence of a contractual arrangement that distinguishes
interests that involve joint control from investments in associates in which the investor has
“significant influence,” meaning the power to participate in the financial and operating policy
decisions of the investee but not amounting to control or joint control over those policies.
Activities that have no contractual arrangement to establish joint control are not joint ventures
for the purposes of IAS 31. In other words, if two entities, A and B, set up a third entity, C, in
which A and B each hold 50% of the equity, C will not, by virtue of the relative shareholdings
alone, be a joint venture of A and B for the purposes of IAS 31. There needs to be an agreement
for unanimous decision making on key matters—although this might automatically flow from
the general provisions of corporate law in the jurisdiction concerned.
In the absence of a contractual arrangement to establish joint control, an investment cannot be a
joint venture and should be accounted for either as an associate under IAS 28, Investments
in Associates, or as a financial asset under IAS 39, Financial Instruments: Recognition
and Measurement.
Jointly Controlled Assets and Undivided Interests
A jointly controlled asset (JCA) is the most common form of joint venture in the oil and gas
industry. JCAs involve the joint control, and often joint ownership, of one or more assets
contributed to, or acquired for, and dedicated to the purposes of the joint venture. The assets
are used to obtain benefits for the venturers, who may each take a share of the output from the
assets and bear an agreed-upon share of the expenses incurred. Such ventures do not involve
the establishment of an entity or financial structure separate from the venturers themselves,
so that each venturer has control over its share of future economic benefits through its share
in the jointly controlled asset.
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A JCA is similar to an “undivided interest,” which is “a factional ownership interest in the
entire area of the property.” The accounting for a JCA under IFRS is similar to the accounting
currently applied under U.S. GAAP. In respect of its interest in JCAs, IAS 31 requires a
venturer to recognize in its financial statements:
ƒ Its share of the jointly controlled assets, classified according to the nature of the assets
(i.e., a share in a jointly controlled pipeline should be shown within the property, plant,
and equipment rather than as an investment).
ƒ Any liabilities that it has incurred.
ƒ Its share of any liabilities incurred jointly with the other venturers.
ƒ Any income from the sale or use of its share of the output of the joint venture.
ƒ Its share of any expenses incurred by the joint venture.
ƒ Any expenses that it has incurred in respect of its interest in the joint venture.
The IASB believes that this treatment reflects the substance and economic reality and, usually,
the legal form of the joint venture. However, it should be noted that the classification of a
venture as either a jointly controlled asset or a jointly controlled entity is largely form driven.
Jointly Controlled Entities
In contrast to a jointly controlled operation or a jointly controlled asset, a jointly controlled
entity (JCE) is a joint venture that involves the establishment of a corporation, partnership, or
other legal entity in which each venturer has an interest. The entity operates in the same way as
any other entity, except that a contractual arrangement between the venturers establishes joint
control over the economic activity of the entity.
IAS 31 maintains that many jointly controlled entities are similar in substance to jointly
controlled operations or jointly controlled assets. This emphasizes the fact that, while the
economic substance may be similar, the difference in form does matter in determining the
accounting treatment. IAS 31 permits two methods of accounting for jointly controlled entities:
ƒ Proportionate consolidation, using one of two formats
ƒ The equity method
This is generally similar to the accounting that oil and gas companies may use for investments
in unincorporated legal entities involved in oil and gas exploration and production activities
under U.S. GAAP.
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JOINT VENTURES
Proportionate consolidation of jointly controlled entities remains popular under IFRS in
those countries whose national GAAP require proportionate consolidation. In countries
whose national GAAP never permitted proportionate consolidation, the equity method
remains prevalent. An entity therefore has a free choice in selecting its accounting policy,
but may wish to consider the policy adopted by its peer group and the subtle differences
between the two methods.
The IASB recently issued Exposure Draft 9, Joint Arrangements, which is intended to replace
IAS 31. Exposure Draft 9 amended IAS 31 so that proportionate consolidation of jointly
controlled entities will no longer be allowed.
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Inventory
IAS 2, Inventories, requires companies to value inventory at the lower of cost or net realizable
value. Certain types of inventories are exempted only from the measurement requirements in
IAS 2. In particular, IAS 2 does not apply to the measurement of inventories of minerals and
mineral products, to the extent that they are measured at net realizable value in accordance with
well-established industry practices, which is generally consistent with the guidance under U.S.
GAAP. In addition, the measurement requirements of IAS 2 do not apply to inventories held by
commodity broker-traders, who measure their inventories at fair value less costs to sell.
Perhaps the most significant difference between accounting for inventory under IFRS and U.S.
GAAP is that IAS 2 specifically prohibits the use of the LIFO (Last-In, First-Out) method
of accounting for inventory. Only the FIFO (First-In, First-Out) and weighted-average cost
methods may typically be used. However, an exception exists for items that are not ordinarily
interchangeable and goods or services produced and segregated for specific projects.
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Asset Retirement Obligations
Under IFRS, the general principles of IAS 37, Provisions, Contingent Liabilities and Contingent
Assets, should be followed, which require that a provision is recognized only where there is a
legal or constructive obligation to incur costs. There are specific rules under U.S. GAAP
for accounting for decommissioning costs in FAS 143, Accounting for Asset Retirement
Obligations. FAS 143 amended FAS 19 to prohibit accounting for estimated dismantlement,
restoration, and abandonment costs using a cost accumulation approach. Although the guidance
under IFRS and U.S. GAAP is similar, differences arise in practice.
The principal differences between IFRS and U.S. GAAP in accounting for provisions as they
relate to decommissioning costs or asset retirement obligations are due to the treatment of
changes in discount rates. Under IAS 37, no guidance is provided on accounting for changes
in the provision as a result of changes in cost estimates or changes in discount rates.
The International Financial Reporting Interpretations Committee (IFRIC), a group whose
role in international standard setting is comparable to the Emerging Issues Task Force’s
role in establishing U.S. GAAP, addressed this matter in IFRIC 1, Changes in Existing
Decommissioning, Restoration and Similar Liabilities. Under IFRIC 1, adjustments arising
from changes in either the estimated cash flows or the current discount rate should be added to
or deducted from the cost of the related asset, with the adjusted depreciable amount of the asset
then depreciated prospectively over the asset’s remaining useful life. Under U.S. GAAP, the fair
value of the liability is not remeasured for changes in the risk-free interest rate that was initially
used as the discount factor for the measurement of the provision.
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Reserves and Related Information
Reserves and related information are a significant element in communications by oil and gas
companies to their stakeholders. IFRS requires an entity to provide “additional disclosures
when compliance with the specific requirements of IFRS are insufficient to enable users to
understand the impact of particular transactions, other events and conditions on the entity’s
financial position and financial performance.” Currently, IFRS does not require disclosure of
reserves or other related information, though certain national standards and stock exchange
regulators do. However, such disclosures will generally be necessary under IFRS to provide
users with the information that they need to understand the entity’s financial position and
financial performance.
While disclosure of information about mineral reserves is clearly very useful, users of financial
statements should be aware that many differences exist between different jurisdictions, or even
within those jurisdictions. Therefore, comparisons between entities may be difficult at best, or
even impossible. In particular, the following points of definition are important:
ƒ Proved and probable reserves – The definition of reserves can vary greatly, e.g., UK Oil
Industry Accounting Committee’s Statement of Recommended Practice (OIAC SORP) permits
disclosure of either “proved and probable” or “proved developed and undeveloped” reserves,
whereas FAS 69 requires disclosure of “proved reserves and proved developed reserves.”
ƒ Commodity price – The quantity of economically recoverable reserves may depend to a large
extent on the price assumptions that an entity makes. Differences often arise because the entity:
y Uses its own long-term price path assumptions, which is permitted under OIAC SORP, or
y Is required to use year-end prices, which is required under FAS 69.
ƒ Royalties – Royalties payable in-kind to the government or legal owner of the mineral rights
may or may not be included within reserve valuations. U.S. GAAP excludes such royalties
from the reserve valuations.
ƒ Minority interests – Generally, “reserves” include all reserves held by the parent and its
consolidated subsidiaries. While in many jurisdictions, including under U.S. GAAP,
petroleum companies are required to disclose the reserves attributable to significant
minority interests, this is not always required.
ƒ Associates and other investments – An entity may have economic ownership of reserves
through investments in associates, equity interests, or royalty-yielding contracts. Consistent
with U.S. GAAP reporting, such reserves are generally not included in consolidated reserves,
but disclosed separately.
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R E S E RV E S
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R E L AT E D I N F O R M AT I O N
ƒ Production sharing contracts – A significant amount of judgment concerning the nature
or rights and economic interests of the entity may be required to determine whether an
entity is the economic owner of the reserves. Depending on the reserve reporting framework
to which the entity is subject, such “economic” reserves may or may not be included with
the reserves.
FAS 69 mandates the use of a 10% discount rate in estimating the standardized measure of
discounted future net cash flows projected to arise from production of reserves. IFRS does
not have a similar disclosure requirement. Accordingly, there is no discount rate that must
be uniformly used under IFRS. Rather, management must make its “best estimate” for all
significant estimates. The differences in the parameters available for use by management to
make this estimate for reserves under U.S. GAAP accounting and IFRS are significant.
20
U. S . G A A P
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IFR S: T H E B A S I C S
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OIL
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G A S C O M PA N I E S
Regulatory Assets and Liabilities
A company operating in a regulated environment is often allowed by the regulator to make
a fixed return on its investment or recoup its investment by increasing prices over a defined
period. Consequently, the future price that the regulated entity is allowed to charge its customer
may be influenced by past cost levels and investment levels. The regulated entity may also be
required to decrease future prices to reflect the current recovery of costs expected to be incurred
in the future. The anticipated recovery of current costs and incurrence of future costs in a
regulated environment are accounted for as regulatory assets and liabilities under FAS 71,
Accounting for the Effects of Certain Types of Regulation. These regulatory assets and liabilities
are classified as intangible assets under U.S. GAAP.
Regulatory assets do not meet the definition of an intangible asset under IFRS because they are
not a “resource controlled by an entity as a result of past events; and from which future economic
benefits are expected to flow to the entity.” In addition, under IFRS, the right to charge a higher
price to customers can only result in economic benefits in connection with future sales to those
customers. The economic benefits from sales to customers should be recognized in accordance
with IAS 18, Revenue, which requires delivery of the goods or services to the customers.
Under FAS 71, a liability arises when the regulator requires an entity to decrease prices
in a subsequent period. This regulatory liability, in most circumstances, would not be a
provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets—as it
is not a “present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow from the enterprise of resources embodying
economic benefits.” Instead, the entity will charge less and receive less from the individual
customers in the subsequent period to address the fact that the entity has recovered future
costs in the current period. This is because the regulatory requirement to reduce future
prices constitutes a decrease in the price charged to customers for future supplies and not
a refund to particular customers based on the amounts by which they were individually
“overcharged.” In other words, new customers who had not previously been “overcharged”
would nevertheless benefit from the lower prices, while former customers who had been
“overcharged” in the past but were no longer customers would neither get a refund nor
benefit from the future lower prices.
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AND
LIABILITIES
The IFRIC specifically addressed the topic of regulatory assets in an August 2005 publication.
In summary, the body concluded that the recognition criteria in FAS 71 are not fully consistent
with the recognition criteria under IFRS. Therefore, the special regulatory asset and liability
model of FAS 71 cannot be used under IFRS without modification and regulatory assets and
liabilities arising from performing price-regulated activities should be recognized in accordance
with the applicable standards under IFRS.
The impact of this accounting guidance may be one of the most significant changes under
IFRS for entities that have applied SFAS 71 to their operations.
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IFRS Resources
Ernst & Young offers a variety of online resources that provide more detail about IFRS as well as things to consider as you
research the potential impact of IFRS on your company.
ey.com/ifrs
Ernst & Young Online
Ernst & Young’s website contains a variety of
free resources, including:
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continuous access to important International GAAP®
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ƒ A variety of tools and publications:
y Global EYe on IFRS—access the online version
and archived issues of our bi-monthly client
newsletter.
y Technical publications—including IFRS Alert,
Developments in IFRS for financial instruments
and a variety of publications focused on specific
standards and industries.
y International GAAP® Illustrative Financial
Statements—these publications include the
consolidated financial statements for a fictitious
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company. The statements are updated annually.
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accounts.
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Auditing Standards issued by the IFAC and Ernst & Young
commentary, guidance and tools.
y International GAAP® Disclosure Checklist—shows
all the disclosures and presentation requirements
under IFRS, along with relevant guidance on the
scope and interpretation of certain disclosure
requirements. Updated annually.
y IFRS Web-based Learning—includes 24 modules
that address basic accounting concepts and
knowledge of IFRS. The modules represent 52 hours
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ƒ Ernst & Young Insights.
International GAAP®
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consistent basis.
Please contact your local Ernst & Young representative.
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