GUIDANCE NOTE ON ACCOUNTING FOR OIL AND GAS PRODUCING

ACTIVITIES

(The following is the text of the Guidance Note on Accounting for Oil and Gas
Producing Activities, issued by the Council of the Institute of Chartered
Accountants of India.)

INTRODUCTION
1. Oil and gas producing industry, which is extractive in nature, involves activities
relating to acquisition of mineral interests in properties, exploration (including
prospecting), development, and production of oil and gas. The aforesaid activities are
collectively referred to as upstream operations and form the ‘Upstream Petroleum
Industry’. The industry is commonly referred to as the ‘E&P’ industry. The peculiar
nature of the industry requires establishment of industry-specific accounting principles in
relation to expense recognition, measurement and disclosure.

OBJECTIVE

2. The objective of this Guidance Note is to provide guidance on accounting for costs
incurred on activities relating to acquisition of mineral interests in properties, exploration,
development and production of oil and gas.

SCOPE

3. This Guidance Note applies to costs incurred on acquisition of mineral interests in

properties, exploration, development and production of oil and gas activities, i.e.,
upstream operations. This Guidance Note also deals with other accounting aspects such
as accounting for abandonment costs and impairment of assets that are peculiar to the
enterprises carrying on oil and gas producing activities. It does not address accounting
and reporting issues relating to the transporting, refining and marketing of oil and gas.
This Guidance Note also does not apply to accounting for:

a. activities relating to the production of natural resources other than oil

and gas, and

b. the production of geothermal steam or the extraction of hydrocarbons

as a by-product of the production of geothermal steam or associated
geothermal resources.

DEFINITIONS

4. For the purpose of this Guidance Note, the following terms are used with the meanings
specified:

Cost Centre: Cost centre is a unit identified to capture costs based on

suitable criteria such as geographical or geological factors. Cost centre
is not larger than a field in case of Successful Efforts Method and under
Full Cost Method, the cost centre is not normally smaller than a country
 except where warranted by major difference in economic, fiscal or
other factors in the country.

Depreciation : Depreciation is a measure of the wearing out,

consumption or other loss of value of a depreciable asset arising from
use, effluxion of time or obsolescence through technology and market
changes. Depreciation is allocated so as to charge a fair proportion of
the depreciable amount in each accounting period during the expected
useful life of the asset. Depreciation includes amortisation of assets
whose useful life is predetermined. Depreciation also includes
‘depletion' of natural resources through the process of extraction or
use.

Development Well : A well drilled, deepened, completed or re-

completed within the proved area of an oil or gas reservoir to the
depth of a stratigraphic horizon known to be productive.

Exploratory Well : A well drilled for the purpose of searching for

undiscovered oil and gas accumulations on any geological prospect. An
exploratory well is a well that is not a development well, a service well,
or a stratigraphic test well, as those terms are defined separately.

Field : An area consisting of a single reservoir or multiple reservoirs all

grouped on or related to the same individual geological structural
feature and/or stratigraphic condition. There may be two or more
reservoirs in a field which are separated vertically by intervening
impervious strata, or laterally by local geologic barriers, or by both.
Reservoirs that are associated by being in overlapping or adjacent
fields may be treated as a single or common operational field. The
geological terms ‘structural feature’ and ‘stratigraphic condition’ are
intended to identify localised geological features as opposed to the
broader terms of basins, trends, provinces, plays, areas-of-interest, etc.

Oil and Gas Reserves : Oil and gas reserves are those quantities of oil
and gas, which are anticipated to be commercially recoverable from
known accumulations from a given date forward. All oil and gas reserve
estimates involve some degree of uncertainty. Uncertainty depends
chiefly on availability of reliable geological and engineering data at the
time of the estimate and interpretation of data.

Based on relative degree of uncertainty, oil and gas reserves can be classified as ‘Proved
Oil and Gas Reserves’ and ‘Unproved Oil and Gas Reserves’.

Proved Oil and Gas Reserves : Proved oil and gas reserves are those
quantities of mineral oil, natural gas and natural gas liquids which,
upon analysis of geological and engineering data, demonstrate with
reasonable certainty to be commercially recoverable in future from
known oil and gas reservoirs under existing economic and operating
conditions.
 Establishment of current economic conditions includes relevant
historical oil and gas prices and associated costs under existing
government regulations, if any. Oil and gas reserves, which can be
produced economically through application of advanced recovery
techniques, are included in proved classification after successful pilot
testing.

Proved oil and gas reserves can be classified as ‘Proved developed oil
and gas reserves’ and ‘Proved undeveloped oil and gas reserves’.

Proved Developed Oil and Gas Reserves : Proved developed oil and gas
reserves are reserves that can be expected to be recovered through
existing wells with existing equipment and operating methods.
Additional oil and gas expected to be obtained through the application
of advanced recovery techniques for supplementing the natural forces
and mechanisms of primary recovery should be included as proved
developed reserves only after testing by a pilot project or after the
operation of an installed programme has confirmed through production
response that increased recovery will be achieved.

Proved Undeveloped Oil and Gas Reserves : Proved undeveloped oil

and gas reserves are reserves that are expected to be recovered from
new wells on undrilled acreage, or from existing well for which a
relatively major expenditure is required for recompletion. Reserves on
undrilled acreage should be limited to those drilling units offsetting
productive units that are reasonably certain of production when drilled.
Proved reserves for other undrilled units can be claimed only if it can
be demonstrated with certainty that there is continuity of production
from the existing productive formation. Under no circumstances should
estimates for proved undeveloped reserves be attributable to any
acreage for which an application of advanced recovery technique is
contemplated, unless such techniques have been proved effective by
actual tests in the area and in the same reservoir.

Reservoir : A porous and permeable underground formation containing a natural

accumulation of producible oil or gas that is confined by impermeable rock or water
barriers and is individual and separate from other reservoirs.

Service Well : A service well is a well drilled or completed for the purpose of supporting
production in an existing field. Wells in this class are drilled for the following specific
purposes: gas injection (natural gas, propane, butane, or flue gas), water injection, steam
injection, air injection, polymer injection, salt-water disposal, water supply for injection,
observation, or injection for combustion.

Stratigraphic Test Well : A stratigraphic test is a drilling effort, geologically directed, to

obtain information pertaining to a specific geologic condition. Such wells customarily are
drilled without the intention of being completed for hydrocarbon production. This
classification also includes tests identified as core tests and all types of expendable holes
related to hydrocarbon exploration. Stratigraphic test wells (sometimes called expendable
wells) are classified as follows:

a. Exploratory-type stratigraphic test well : A stratigraphic test well not

drilled in a proved area.

b. Development-type stratigraphic test well : A stratigraphic test well

drilled in a proved area.

Unit of Production (UOP) method : The method of depreciation (depletion)

under which depreciation (depletion) is calculated on the basis of the number
of production or similar units expected to be obtained from the asset by the
enterprise.

5. The definitions of certain other terms relevant for the Guidance Note are given in
Appendix.

CLASSIFICATION OF E&P ACTIVITIES AND RELATED COSTS

Acquisition activities

6. Activities carried out by an E&P enterprise towards the acquisition of right(s) to

explore, develop and produce oil and gas constitute acquisition activities. Once the areas
of oil and gas finds are identified, the E&P enterprise approaches the owner who owns
the rights for the exploration, development and production of the underground minerals
in respect of the property or area. In order to undertake surveys and exploration activities
in India, an E&P enterprise has to first obtain a Petroleum Exploration License (PEL) or
Letter of Authority (LOA). For engaging in development and production activities, an
enterprise has to obtain a Mining Lease (ML). At present, the PEL/LOA and the ML for
onshore E&P activities are granted by the State Governments upon recommendation of
the Central Government and for offshore E&P activities by the Central Government.

Acquisition costs

7.Acquisition costs cover all costs incurred to purchase, lease or otherwise acquire a
property or mineral right. These include lease bonus, brokers’ fees, legal costs, cost of
temporary occupation of the land including crop compensation paid to farmers and all
other costs incurred in acquiring these rights. These are costs incurred in acquiring the
right to explore, drill and produce oil and gas including the initial costs incurred for
obtaining the PEL/LOA and ML. Annual licence fees are excluded.

Exploration Activities

8.Exploration activities cover the prospecting activities conducted in the search for oil
and gas. In the course of an appraisal programme these activities include but are not
limited to aerial, geological, geophysical, geochemical, palaeontological, palynological,
topographical and seismic surveys, analysis, studies and their interpretation,
investigations relating to the subsurface geology including structural test drilling,
exploratory type stratigraphic test drilling, drilling of exploration and appraisal wells and
other related activities such as surveying, drill site preparation and all work necessarily
connected therewith for the purpose of oil and gas exploration.

Exploration Costs
9.Principal types of exploration costs cover all direct and allocated indirect expenditure
which include depreciation and applicable operating costs of related support equipment
and facilities and other costs of exploration activities that are:

i. costs of surveys and studies mentioned in paragraph 8 above, rights of

access to properties to conduct those studies (e.g., costs incurred for
environment clearance, defence clearance, etc.), and salaries and
other expenses of geologists, geophysical crews and other personnel
conducting those studies. Collectively, these are referred to as
geological and geophysical or ‘G&G’ costs;

ii. costs of carrying and retaining undeveloped properties, such as delay

rental, ad valorem taxes on properties, legal costs for title defence,
maintenance of land and lease records and annual licence fees in
respect of Petroleum Exploration License;

iii. dry hole contributions and bottom hole contributions;

iv. costs of drilling and equipping exploratory and appraisal wells; and

v. costs of drilling exploratory-type stratigraphic test wells.

Development Activities

10.Development activities for extraction of oil and gas include, but are not limited to the
purchase, shipment or storage of equipment and materials used in developing oil and gas
accumulations, completion of successful exploration wells, the drilling, completion, re-
completion and testing of development wells, the drilling, completion and re-completion
of service wells, the laying of gathering lines, the construction of offshore platforms and
installations, the installation of separators, tankages, pumps, artificial lift and other
producing and injection facilities required to produce, process and transport oil or gas
into main oil storage or gas processing facilities, either onshore or offshore, including
laying of infield pipelines, the installation of the said storage or gas processing facilities.

Development costs

11.Development costs cover all the direct and allocated indirect expenditure incurred in
respect of the development activities including costs incurred to:

i. gain access to and prepare well locations for drilling, including

surveying well locations for the purpose of determining specific
development drilling sites, clearing ground, draining, road building and
 relocating public roads, gas lines and power lines to the extent
necessary in developing the proved oil and gas reserves;

ii. drill and equip development wells, development-type stratigraphic test

wells and service wells including the cost of platforms and of well
equipment such as casing, tubing, pumping equipment and the
wellhead assembly;

iii. acquire, construct and install production facilities such as lease flow
lines, separators, treaters, heaters, manifolds, measuring devices and
production storage tanks, natural gas cycling and processing plants
and utility and waste disposal systems; and

iv. provide advanced recovery system.

Development costs also include depreciation and applicable operating cost of

related support equipment and facilities in connection with development
activities, and annual license fees in respect of Mining Lease.

Production Activities

12.Production activities consist of pre-wellhead (e.g., lifting the oil and gas to the surface,
operation and maintenance of wells, extraction rights, etc.,) and post-wellhead (e.g.,
gathering, treating, field transportation, field processing, etc., upto the outlet valve on the
lease or field production storage tank, etc.,) activities for producing oil and / or gas.

Production Costs

13.Production costs consist of direct and indirect costs incurred to operate and maintain
an enterprise’s wells and related equipment and facilities, including depreciation and
applicable operating costs of support equipment and facilities. Examples of production
costs are:

a. Pre-wellhead costs:

Costs of labour, repairs and maintenance, materials, supplies, fuel and

power, property taxes, insurance, severance taxes, royalty, etc., in respect
of lifting the oil and gas to the surface, operation and maintenance
including servicing and work-over of wells.

b. Post-wellhead costs:

Costs of labour, repairs and maintenance, materials, supplies, fuel and

power, property taxes, insurance, etc., in respect of gathering, treating,
field transportation, field processing, including cess upto the outlet valve
on the lease or field production storage tank, etc.
ACCOUNTING FOR ACQUISITION, EXPLORATION AND DEVELOPMENT
COSTS

14.There are two alternative methods for accounting for acquisition, exploration and
development costs, viz.,

i. Successful Efforts Method (SEM)

ii. Full Cost Method (FCM)

Successful Efforts Method

Description

15.Under the successful efforts method, generally only those costs that lead directly to the
discovery, acquisition, or development of specific, discrete oil and gas reserves are
capitalised and become part of the capitalised costs of the cost centre. Costs that are
known at the time of incurrence to fail to meet this criterion are generally charged to
expense in the period they are incurred. When the outcome of such costs is unknown at
the time they are incurred, they are recorded as capital work-in-progress and written off
when the costs are determined to be non-productive.

Arguments in favour of the Successful Efforts Method

16.Successful efforts costing reflects the normal concept of an asset. An asset is an

economic resource expected to provide future benefits. The ‘Framework for the
Preparation and Presentation of Financial Statements’, in paragraph 49, defines an ‘asset’
as follows:

“An asset is a resource controlled by the enterprise as a result of past

events from which future economic benefits are expected to flow to the
enterprise.”

17.Paragraphs 88 and 89 of the Framework reproduced below describe, respectively,

when an asset is and is not to be recognised in the balance sheet:

“88. An asset is recognised in the balance sheet when it is probable

that the future economic benefits associated with it will flow to the
enterprise and the asset has a cost or value that can be measured
reliably.

89. An asset is not recognised in the balance sheet when expenditure

has been incurred for which it is considered improbable that economic
benefits will flow to the enterprise beyond the current accounting
period. Instead, such a transaction results in the recognition of an
expense in the statement of profit and loss. This treatment does not
imply either that the intention of management in incurring expenditure
was other than to generate future economic benefits for the enterprise
 or that management was misguided. The only implication is that the
degree of certainty that economic benefits will flow to the enterprise
beyond the current accounting period is insufficient to warrant the
recognition of an asset.”

18.The Framework defines income (revenue) and expenses in terms of increases or

decreases in assets and liabilities. The Framework does not provide for deferrals or
accruals of costs or income based on an independently defined notion of profit or loss.
Stated another way, the Framework does not provide for smoothing or normalising of
earnings by deferring costs that do not meet the definition of an asset. Under the
successful efforts method, those costs that clearly do not relate to future benefits are not
capitalised.

19. The successful efforts method reflects the volatility that is inherent in
exploring for oil and gas reserves. Those favouring successful efforts
accounting argue that this method reflects the inherent risks and volatility
that exist in the extractive industries because costs of unsuccessful efforts
are charged to expense as they occur. They maintain that the capitalisation of
unsuccessful exploratory efforts and their subsequent depreciation as
unrelated reserves are produced would result in income smoothing that hides
that volatility. Such capitalisation not only distorts the balance sheet by
including as assets costs that have no future benefits, it also distorts the
statement of profit and loss by deferring to future periods expenses that are
incurred in the current period. Income smoothing results in the reporting of
an artificial income both when the costs are deferred and throughout the
periods of depreciation.

20. The successful efforts method is consistent with the concept of

matching according to which expenses are recognised in the statement of
profit and loss on the basis of a direct association between the costs incurred
and the earning of specific items of income. However, the application of the
matching concept does not allow the recognition of items in the balance
sheet, which do not meet the definition of assets and liabilities.

21. Under the successful efforts method, the propriety of carrying forward
costs incurred and subsequently matching them against future revenues
depends on whether a specific cost can be identified with specific reserves. If
this direct relationship does not exist, the cost should be charged to expense.
If a direct association does not exist between a non-productive cost and
reserves found and developed, the cost should not be classified as an asset
because it is deemed to not provide future benefits in the form of cash flows.
Charging non-productive costs to expense is consistent with the Framework -
costs that do not result directly in future benefits are properly charged to
expense. If costs related to unsuccessful ventures are not charged to
expense, both current and future financial statements are distorted because
those costs must eventually be removed from the balance sheet and reported
in the statement of profit and loss even though they contribute nothing to
future revenues.
22. Successful efforts accounting comes closer than other cost-based
accounting methods to reflecting management’s successes or failures in its
efforts to find new oil and gas reserves. If costs of unsuccessful exploration
and development activities are capitalised rather than expensed, and carried
forward and combined with costs incurred in prior years and with costs of the
current year’s successful activities, the efficiency and effectiveness of
management is not evaluated in the statement of profit and loss because of
the income smoothing that results. Under successful efforts accounting, this
income smoothing is greatly reduced or eliminated.

Arguments against the Successful Efforts Method

23. Under the successful efforts method, the statement of profit and loss
can give a false impression of performance in terms of success in finding new
oil and gas reserves because of the effect of decisions to expand or curtail
exploration expenditure. A reduction in exploration expense resulting from
the curtailment of likely exploration would increase reported net profit in the
years in which the exploration is cut back, even though because of the
cutback in exploration few or no new reserves are added. The cutback in
reserve additions and the continuation of production results in a depletion of
the enterprise’s reserves, the source of its future profits and its long-run
success. On the other hand, an enterprise with an outstanding exploration
programme may increase its expenditures for exploration. This would almost
certainly increase the current charges to expense for unsuccessful
exploration efforts, reducing reported profit, even though the increased
exploration may result in the addition of many new reserves that will produce
future profits. Those who favour successful efforts accounting reply to this
argument by observing that the goal of accounting is to reflect faithfully
economic events. If management curtails exploration, this will be reflected in
the financial statements under successful efforts accounting. Proponents of
successful efforts accounting argue that perhaps, supplemental information
about reserve quantities and value is needed to indicate success or failure of
exploration activity.

24. Because of the charge-off of unsuccessful pre-production costs,

successful efforts accounting often results in an understatement of assets
and net income of a growing enterprise that has a successful and increasing
exploration programme. In future years, when the exploration programme
has stabilised or is actually decreasing, the deductions for unsuccessful
projects will decrease or will become stable, resulting in higher reported net
income. The understatement of income during the early years of the
enterprise’s activities may make it difficult to secure funds from either equity
issues or borrowings.

25. The successful efforts method assesses success or failure too early in a
project. Success or failure of exploration projects usually cannot be measured
until the exploration activities are completed, which may involve many years.
In the intervening years, decisions must be made about costs to be charged
to expense and costs to be capitalised. These decisions are often subjective
until the ultimate outcome is known, and different individuals will assess the
same circumstances differently. This subjectivity from incomplete knowledge
will result in different reported net income depending on the judgement of
those making the assessment.

26. The successful efforts method fails to recognise that in an E&P

enterprise, management makes its plans and allocates resources to its
search for new reserves on an enterprise-wide basis. The successful efforts
method forces the costs of unsuccessful projects to be expensed even though
they are an expected part of an exploration programme. The goal of
exploration is to add new reserves and management knows that there will be
failures in the process of attaining this goal. Management realises that costs
of the failures must be offset by the results from successful ventures. Thus,
they argue, costs of unsuccessful pre-production projects should be viewed as
part of the cost of reserves obtained through successful exploration projects.
Some argue that successful efforts accounting fails to recognise that all pre-
production costs are incurred to find and develop whatever reserves result
from pre-production activities.

Full Cost Method

Description

27. Under the full cost method, all costs incurred in prospecting, acquiring
mineral interests, exploration, and development, are accumulated in large
cost centres that may not be related to geological factors. The cost centre,
under this method, is not normally smaller than a country except where
warranted by major difference in economic, fiscal or other factors in the
country. The capitalised costs of each cost centre are depreciated as the
reserves in each cost centre are produced.

Arguments in favour of the Full Cost Method

28. The full cost method reflects the way in which enterprises search for,
acquire, and develop mineral resources. These activities are carried out in
diverse locations, using various techniques and it is accepted that some
projects will not result directly in the addition of reserves. However, it is
planned that the value added by the successful ventures in a cost centre will
be greater than the losses resulting from unsuccessful ventures in that cost
centre and will result in an overall profit in the long term. Under the full cost
method, all costs incurred at any time and at any place in a cost centre in an
attempt to add commercial reserves are an essential part of the cost of any
reserves added in that cost centre. As a result they are directly associated
with the enterprise’s reserves in that centre and all the costs should be
treated as part of the cost of the mineral assets in the cost centre.

29. The full cost method provides better matching of income and expenses.
It is argued that there is a better matching of income and expenses if total
costs are depreciated on a pro-rata basis as the total reserves in a large cost
centre are produced than there would be if reserves and costs are matched in
many small cost centres. In periods when an enterprise using successful
efforts accounting incurs large pre-production expenditures in seeking new
reserves, those costs that do not result in new reserves will be charged to
expense, reducing profit and possibly resulting in a loss. The variability in
profit resulting from changes in the expensing of pre-production costs are
eliminated under the full cost method.

30. The full cost method is like absorption costing for manufactured
inventories. Oil and gas reserves are similar to a long-term inventory item.
Generally, inventories are accounted for on an absorption cost basis. The
costs related to unsuccessful efforts are very similar to normal recurring
spoilage occurring in manufacturing operations. It is customary to treat
normal spoilage costs as part of the cost of the good units manufactured.

31. The full cost method avoids distortions of reported earnings Users of
financial statements in the E&P industry are interested primarily in earnings
and changes in earnings from year to year. It is argued that, if successful
efforts accounting is used, distortions are caused by expensing unsuccessful
efforts to find and develop new reserves, which may vary widely from year to
year. Under the full cost method, these annual ‘distortions’ of income
resulting from expensing the charges for unsuccessful pre-production
activities are eliminated.

Arguments against the Full Cost Method

32. Under the full cost method, many costs that are capitalised fail to meet
the definition of ‘asset’ under the ‘Framework for the Preparation and
Presentation of Financial Statements’. Unsuccessful prospecting costs,
unsuccessful exploration costs, the costs of properties that contain no oil and
gas reserves, and many other costs that will be capitalised are known to
provide no future economic benefits. They will not contribute to the
production of goods or services to be sold by the enterprise, they cannot be
exchanged for other assets, they cannot be used to settle a liability, and they
cannot be distributed to the owners of the enterprise. Further, Accounting
Standard (AS) 2, ‘Valuation of Inventories’, requires that “abnormal amounts
of wasted materials, labour, or other production costs” should be excluded
from the cost of inventories and recognised as expenses in the period in
which they are incurred (paragraph 13).

33. The full cost method delays loss recognition. Expenses should be
reported on a timely basis. Costs that do not result directly in future benefits
are costs that are properly charged to expense. Capitalising such costs
results in deferring the effects of expenses.

34. The full cost method impedes measurement of the efficiency and
effectiveness of the enterprise’s exploration and development activities.
Costs of unsuccessful activities are treated in the same way as successful
activities and are matched against future revenues from all of the
enterprise’s successful exploration and development activities. In any given
year, management may conduct exploration and development activities that
are completely unsuccessful, yet the statement of profit and loss would not
reveal this fact.
Recommendation

35. On an overall consideration, the advantages of the successful efforts

method far outweigh its disadvantages particularly keeping in view its
conceptual superiority over the full cost method. Accordingly, the successful
efforts method is recommended to be the preferred method, though an
enterprise is permitted to follow the full cost method. The application of these
methods is discussed hereinafter.

Application of Successful Efforts Method

36. Under the successful efforts method, in respect of a cost centre, the
following costs should be treated as capital work-in-progress when incurred:

i. All acquisition costs;

ii. Exploration costs referred to in paragraph 9 (iv) and (v); and

iii. All development costs.

37. All costs other than the above should be charged as expense when
incurred.

38. When a well is ready to commence commercial production, the costs

referred to in paragraph 36 (ii) and (iii) corresponding to proved developed oil
and gas reserves should be capitalised as ‘completed wells’ from capital
work-in-progress to the gross block of assets. With respect to costs referred to
in paragraph 36 (i), the entire cost should be capitalised from capital work-in-
progress to the gross block of assets. There is a rebuttable presumption that
a well is ready to commence commercial production within two years from
the establishment of proved developed oil and gas reserves. If the well is not
ready for commercial production within the aforesaid period, the relevant
costs included in capital work-in-progress should be capitalised on the expiry
of the aforesaid period of two years.

39. If the cost of drilling exploratory well relates to a well that is determined
to have no proved reserves, then such costs net of any salvage value are
transferred from capital work-in-progress and charged as expense as and
when its status is decided as dry or of no further use. Costs of exploratory
wells-in-progress should not be carried over for more than a period of two
years from the date of completion of drilling unless it could be reasonably
demonstrated that the well has proved reserves and development of the field
in which the well is located has been planned with required capital
investment such as development wells, pipelines, etc., in which case the
costs of the exploratory well can be carried forward without any time limit.

Depreciation (Depletion)
40. Depreciation (Depletion) is calculated, using the unit of production
method. The application of this method results in oil and gas assets being
written off at the same rate as the quantitative depletion of the related
reserve. For the properties or groups of properties containing both oil
reserves and gas reserves, the units of oil and gas used to compute depletion
are converted to a common unit of measure on the basis of their approximate
relative energy content, without considering their relative sales values
(general approximation is 1000 cubic meters of gas is equivalent to 1 metric
tonne of oil). Unit-of-production depletion rates are revised whenever there is
an indication of the need for revision but atleast once a year. These revisions
are accounted for prospectively as changes in accounting estimates, i.e., a
change in the estimate affects the current and future periods, but no
adjustment is made in the accumulated depletion applicable to prior periods.

41. The depreciation charge or the UOP charge for the acquisition cost
within a cost centre is calculated as under:

UOP charge for the period = UOP rate x Production for the period

UOP rate = Acquisition cost of the cost centre / Proved Oil and Gas
Reserves

42. The depreciation charge or the Unit of Production (UOP) charge for all
capitalised costs excluding acquisition cost within a cost centre is calculated
as under:

UOP charge for the period = UOP rate x Production for the period

UOP rate = Depreciation base of the cost centre / Proved Developed Oil and
Gas Reserves

43. Depreciation base of the cost centre should include

a. Gross block of the cost centre (excluding acquisition costs)

b. Estimated dismantlement and abandonment costs net of estimated

salvage values pertaining to proved developed oil and gas reserves

and should be reduced by the accumulated depreciation and any

accumulated impairment charge of the cost centre.

44. ‘Proved Oil and Gas Reserves’ for the purpose of paragraph 41 comprise
proved oil and gas reserves estimated at the end of the period as increased
by the production during the period. ‘Proved Developed Oil and Gas Reserves’
for the purpose of paragraph 42 comprise proved developed oil and gas
reserves estimated at the end of the period as increased by the production
during the period. Additional reserves from advanced recovery techniques are
to be considered as proved developed oil and gas reserves only after the
required investments have been capitalised.
Application of Full Cost Method

45. Under the full cost method, in respect of a cost centre, the following
costs should be treated as capital work-in-progress when incurred:

i. All acquisition costs;

ii. All exploration costs; and

iii. All development costs.

46. All costs other than the above should be charged as expense when
incurred.

47. When any well in a cost centre is ready to commence commercial

production, the costs referred to in paragraph 45 above corresponding to all
the proved oil and gas reserves in that cost centre should be capitalised from
capital work-in-progress to the gross block of assets. In respect of oil and gas
reserves proved subsequently, the capital work-in-progress corresponding to
such reserves should be capitalised at the time when the said reserves are
proved. The expenditure which does not result in discovery of proved oil and
gas reserves should be transferred from capital work-in-progress to the gross
block of assets as and when so determined.

Depreciation (Depletion)

48. The depreciation should be calculated on the capitalised cost according

to the unit of production method as explained in paragraph 40 above. In
case of full cost method, the depreciation charge or the unit of
production (UOP) charge for all costs within a cost centre is calculated
as under:

UOP charge for the period = UOP rate x Production for the period

UOP rate = Depreciation base of the cost centre / Proved Oil and Gas
Reserves

49. The depreciation base of the cost centre should include

a. Gross block of the cost centre;

b. The estimated future expenditure (based on current costs) to be

incurred in developing the proved oil and gas reserves referred to in
paragraph 50;

c. Estimated dismantlement and abandonment costs net of estimated

salvage values for facilities set up for developing the proved oil and
gas reserves referred to in paragraph 50;
and should be reduced by the accumulated depreciation and any
accumulated impairment charge of the cost centre.

50. ‘Proved Oil and Gas Reserves’ for this purpose comprise developed and
undeveloped oil and gas reserves estimated at the end of the period as
increased by the production during the period.

Accounting for Production Costs

51. Production costs, mentioned in paragraph 13 above, become part of the

cost of oil and gas produced, along with depreciation (depletion) of
capitalised acquisition, exploration and development costs.

Accounting for Cost of Support Equipment and facilities

52. The cost of acquiring or constructing support equipment and facilities

used in E&P activities should be capitalised in accordance with Accounting
Standard (AS) 10, ‘Accounting for Fixed Assets’. Depreciation on such
equipment and facilities should be arrived at in accordance with Accounting
Standard (AS) 6, ‘Depreciation Accounting’, and accounted for as exploration
cost, development cost or production cost, as may be appropriate.

ACCOUNTING FOR ABANDONMENT COSTS

53. Abandonment costs are the costs incurred on discontinuation of all

operations and surrendering the property back to the owner. These costs
relate to plugging and abandoning of wells, dismantling of wellheads,
production and transport facilities and to restoration of producing areas in
accordance with license requirements and the relevant legislation.

54. The full eventual liability for abandonment cost net of salvage values
should be recognised at the outset on the ground that a liability to remove an
installation exists the moment it is installed. Thus, an enterprise should
capitalise as part of the cost centre the amount of provision required to be
created for subsequent abandonment. Charge for abandonment costs should
not be discounted to its present value. The provision for estimated
abandonment costs should be made at current prices considering the
environment and social obligations, terms of mining lease agreement,
industry practice, etc.

55. No gain or loss should be recognised if only an individual well or

individual item of equipment is abandoned as long as the remainder of the
wells in the cost centre continue to produce oil or gas. Instead, the asset
being abandoned be deemed to be fully depreciated. When the last well on
the cost centre ceases to produce and the entire cost centre is abandoned,
gain or loss should be recognised.

CAPITALISATION OF BORROWING COSTS

56. Capitalisation of borrowing costs under the full cost method as well as
the successful efforts method should be carried out in accordance with the
Accounting Standard (AS) 16, ‘Borrowing Costs’. For the purpose of AS 16, all
the costs that are classified under capital work-in-progress should be
considered as the qualifying asset.

IMPAIRMENT OF ASSETS

57. Accounting Standard (AS) 28, ‘Impairment of Assets’, is applicable to

E&P enterprises irrespective of the method of accounting used. For the
purpose of AS 28, each cost centre used for depreciation (depletion) purposes
should be treated as a Cash Generating Unit.

Accounting for Interests in Joint Ventures

58. Many E&P enterprises enter into joint venture agreements for oil and
gas exploration, development and production. In case of such arrangements,
the accounting principles prescribed in Accounting Standard (AS) 27,
‘Financial Reporting of Interests in Joint Ventures’, should be applied.

CHANGES IN ACCOUNTING POLICIES

59. An enterprise may change the method of accounting from full cost
method to successful efforts method. The change in the method of
accounting should be carried out with retrospective effect. Such a change is
treated as a change in accounting policy and should be accounted for in
accordance with Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies’.

60. When a change in the method of accounting is made, the effect thereof
is calculated in accordance with the new method as if the enterprise was
always following the new method. The resulting deficiency/surplus should be
charged/credited to the statement of profit and loss in the year in which the
method of accounting is changed.

DISCLOSURE

61. An E&P enterprise should disclose the following in its financial

statements:

i. The method of accounting followed.

ii. Net quantities of an enterprise’s interests in proved reserves and

proved developed reserves of (a) oil (including condensate and natural
gas liquids) and (b) gas as at the beginning and additions, deductions,
production and closing balance for the year.
iii. Net quantities of an enterprise’s interest in proved reserves and proved
developed reserves of (a) oil and (b) gas should also be disclosed on
the geographical basis.

iv. The reporting of reserve quantities should be stated in metric tonnes

for oil reserves and cubic meters for gas reserves.

Appendix
Glossary

1. Abandon

To discontinue attempts to produce oil and gas from a mining lease area or a
well and to plug the reservoir in accordance with regulatory requirements and
salvage all recoverable equipments.

2. Appraisal Well

A well drilled as part of an appraisal drilling programme, which is carried

out to determine the physical extent of oil and gas reserves and likely
production rate of a field.

3. Block

A defined area for purposes of licensing or leasing to an enterprise or

enterprises for exploration, development and production rights.

3. Bottom-Hole Contributions

Money or property paid to an operator for use in drilling a well on property in

which the payer has no property interest. The contributions are payable when
the well reaches a pre-determined depth, regardless of whether the well is
productive or non-productive. The payer may receive proprietary information
on the well’s potential productivity.

5. Condensate

Low vapour pressure hydrocarbons obtained from Natural Gas through

condensation or extraction and refer solely to those hydrocarbons that are
liquid at normal surface temperature and pressure conditions.

6. Dry Hole

A well, which has proved to be non-productive.

7. Dry Hole Contribution

A contribution made by one enterprise to costs incurred by another

enterprise that is drilling a nearby well to obtain information from the
enterprise drilling the well; the contribution is made when the well is
complete and is found to be unsuccessful.

8. Geological and Geophysical Studies

Processes which seek surface or subterranean indications of earth structure

or formation where experience has shown the possibility of existence of
mineral deposits.

9. Geological Survey

An exploratory programme directed to examination of rock and sediments

obtained by boring or drilling, or by inspection of surface outcroppings.

10. Geophysical Survey

A study of the configuration of the earth’s crust in a given area, as

determined by the use of seismic, gravity, magnetic and geo-chemical
procedures.

11. Mining Lease

The license issued for offshore and onshore properties for conducting
development and production activity.

12. Natural Gas Liquids (NGL)

Hydrocarbons (primarily ethane, propane, butane and natural gasoline) which

can be extracted from wet natural gas and become liquid under various
combinations of increasing pressure and lower temperature.

13. Petroleum Exploration License

The license issued for offshore and onshore properties for conducting
exploration activity.

14. Support Equipment and Facilities

Equipment and facilities of the nature of service units, camp facilities,

godowns (for stores and spares), workshops (for equipment repairs),
transport services (trucks and helicopters), catering facilities and drilling and
seismic equipment.

15. Work-Over

Remedial work to the equipment within a well, the well pipework or relating
to attempts to increase the rate of flow.

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