If you are new to oil and gas exploration, there are essential things that you must understand. The oil and gas industry is the largest sector in the world with regard to dollar value, generating billions of dollars worldwide every year. To capitalize on operating expenses, financial reporting is vital.
Moreover, oil and gas accounting has two standard methods, such as the following:
- Successful Efforts or SE.
- Full Cost or FC.
These two things represent conflicting views in the industry about how oil and natural gas businesses can most transparently present their revenues. Continue reading this post to understand each concept better.
Successful Efforts Method
A successful efforts method is utilized to account for specific operating costs. Through this, the entrepreneur regards the operating expenses as an asset rather than an expense. This is known as capitalizing. In other words, you are utilizing your money and pay them in exchange for goods or services.
Having tight controls over expenditures is necessary to dodge incurring losses. Most businesses have a capitalization limit for categorizing expenditures. Moreover, the term “expenditure” is distinct from “expense” because it indicates the gaining of an asset, rather than a decrease in value of an asset.
Expenditures are recorded in a balance sheet instead of an income statement. Things are considered as expenditures when they meet these two things: beyond the cap limit and should have a useful life within one year.
To give you a clearer understanding of the concept of what expenditure is, here are two explanations:
- Not-expenditure: You purchased some ink cartridges for printing purposes. There’s a possibility that they can last for more than a year, especially if there are only a few to print. You might think that it’s expenditure. But, when you purchased them, the total cost did not go beyond the capitalization limit. So, they can’t be considered as expenditures.
- Expenditure: Say, for example, one of your business premises required you to purchase a router for networking for $3,000. This router is expected to last for years to come. This unit is considered as expenditure because it exceeds the useful life of one year. Also, if your cap limit is $1,000, the cost of the router meets the criteria.
Full Cost Method
The full cost method is a cost bookkeeping practice utilized in the business, wherein all property procurements, explorations and development expenses are combined and capitalized into a nationwide cost pool by the entrepreneur. In other words, capitalization happens whether or not the project becomes fruitful.
With the full cost method, the cost of the impairment is regarded as an expense at once. Because risks are always associated with oil and natural gas explorations, most companies stay away from this kind of method. Instead, they find the “successful efforts method” more useful.
They capitalize only those costs it incurs that directly result in an asset that has future advantage measured in terms of future cash flows.
Why an Oil and Gas Company Needs Accounting
The IRS or Internal Revenue Service emphasizes that businesses linked to oil and gas must match their revenues and expenses under their chosen accounting method. Now, when you choose an accounting process, you should always seek help from an expert accounting firm to guarantee that your method is acceptable and satisfy all IRS necessities.
To free yourself from the hassle brought by financial reporting, get help from professionals. You will realize its importance come financial reporting season.
