08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 1
Energy, Utilities & Mining
Financial reporting in the oil and gas industry* International Financial Reporting Standards April 2008
*connectedthinking 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 2 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 3
Financial reporting in the oil and gas industry 1
Foreword
The move to International Financial Reporting This edition of ‘Financial reporting in the oil & gas Foreword Standards (IFRS) is advancing the transparency industry’ describes the financial reporting and comparability of financial statements around implications of IFRS across a number of areas the world. Many countries now require selected for their particular relevance to oil & gas companies to prepare their financial statements companies. It provides insights into how in accordance with IFRS. National standards in companies are responding to the various other countries are being converged with IFRS. challenges and includes examples of accounting The global trend towards IFRS has gained policies and other disclosures from published significant further momentum with the US financial statements. It examines key Securities and Exchange Commission’s (SEC) developments in the evolution of IFRS in the commitment to the standards, beginning with its industry. The International Accounting Standards decision to drop the requirement for foreign- Board (IASB), for example, has formed an listed companies in the US to reconcile to US Extractive Activities working group. However, GAAP. formal guidance on many issues facing companies is unlikely to be available for some The development of IFRS offers considerable years. Another key development, of course, is long-term advantages for global companies but, convergence with US GAAP and the implications along the way, it brings considerable challenges. of the latest signals from the SEC for the oil & The oil & gas industry is one of the world’s most gas industry. global industries, characterised by the need for big upfront investment, often with great This publication does not describe all IFRSs uncertainty about outcomes over a long-term applicable to oil & gas entities. The ever-changing time horizon. Its geopolitical, environmental, landscape means that management should energy and natural resource supply and trading conduct further research and seek specific challenges, combined with often complex advice before acting on any of the more complex stakeholder and business relationships, has matters raised. PricewaterhouseCoopers has a meant that the transition to IFRS has required deep level of insight into and commitment to some complex judgements about how to helping companies in the sector report implement the new standards. effectively. For more information or assistance, please do not hesitate to contact your local office or one of our specialist oil & gas partners.
Richard Paterson Global Energy, Utilities and Mining Leader 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 4
Contents
Introduction 5
1 Oil & Gas Value Chain & Significant Accounting Issues 7
1.1 Exploration & development 9
1.1.1 Exploration & evaluation 9
1.1.2 Borrowing costs 11
1.1.3 Development expenditures 11
1.2 Production & sales 11
1.2.1 Reserves & resources 11
1.2.2 Depreciation of production and downstream assets 12
1.2.3 Product valuation issues 14
1.2.4 Impairment of production and downstream assets 14
1.2.5 Disclosure of resources 16
1.2.6 Decommissioning obligation 17
1.2.7 Financial instruments and embedded derivatives 18
1.2.8 Revenue recognition issues 21
1.2.9 Royalty and income taxes 22
1.2.10 Emission Trading Schemes 24
1.3 Company-wide issues 25
1.3.1 Production sharing agreements and concessions 25
1.3.2 Joint ventures 26
1.3.3 Business combinations 29
1.3.4 Functional currency 30
2 Developments from the IASB 33
2.1 Extractive activities research project 34
2.2 Borrowing costs 34
2.3 Emissions Trading Schemes 34
2.4 ED 9 Joint Arrangements 35 Contents 3 Financial reporting in the oil and gas industry and the oil in reporting Financial IAS 27, Consolidated and separate financial statements (revised)IAS 27, Consolidated 36 Contact us 62 4.5 Decommissioning obligation 4.5 Decommissioning issues 4.6 recognition Financial instruments and embedded derivatives 4.7 Revenue 4.8 Royalty and income taxes 4.9 Schemes ventures Emission Trading 4.10 Joint 56 combinations 4.11 Business 56 currency 4.12 Functional 57 57 58 60 58 61 3.9 Revenue recognition recognition 3.9 Revenue ventures 3.10 Joint examples Combinations 3.11 Business disclosure 4 Financial 4.1 Exploration & evaluation 4.2 Reserves & resources 4.3 assets and downstream of production Depreciation 4.4 Impairment 51 46 48 54 46 52 53 54 3.1 Exploration & evaluation 3.2 Reserves & resources 3.3 assets and downstream of production Depreciation 3.4 Inventory valuation issues 3.5 assets and downstream Impairment of production 3.6 obligations 41 of resources Disclosure 3.7 Decommissioning 3.8 derivatives Financial instruments and embedded 42 40 41 44 41 43 42 2.5 and IFRS 3, Business combinations (revised) 3 IFRS/US GAAP Differences 39 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 5 Seite Uhr 12:01 10.04.2008 edit final O&G 08PwC0290_IFRS 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 6 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 7
Financial reporting in the oil and gas industry 5
Introduction
What is the focus of this publication? The oil and gas industry has not only Introduction experienced the transition to IFRS, it has also This publication considers the major accounting seen: practices adopted by the oil and gas industry • significant growth in corporate acquisition under International Financial Reporting Standards activity; (IFRS). • increased globalisation; The need for this publication has arisen due to: • continued increase in its exposure to • the absence of an extractive industries sophisticated financial instruments and standard under IFRS; transactions; and • the adoption of IFRS by oil and gas entities • an increased focus on environmental and across a number of jurisdictions, with restoration liabilities. overwhelming acceptance that applying IFRS in this industry will be a continual challenge; This publication has a number of chapters and designed to cover the main issues raised. • ongoing transition projects in a number of PricewaterhouseCoopers’ other jurisdictions, for which companies can draw on the existing interpretations of the experience industry. This publication is based on the experience Who should use this publication? gained from the worldwide leadership position of PricewaterhouseCoopers in the provision of accounting services to the oil and gas industry. This publication is intended for: This leadership position enables • executives and financial managers in the oil PricewaterhouseCoopers’ Global Oil and Gas and gas industry, who are often faced with Industry Group to make recommendations and alternative accounting practices; lead discussions on international standards and practice. The IASB has asked a group of national • investors and other users of oil and gas standard-setters to undertake a research project industry financial statements, so they can that will form the first step towards the identify some of the accounting practices development of an acceptable approach to adopted to reflect unusual features unique to resolving accounting issues that are unique to the industry; and upstream extractive activities. The primary focus • accounting bodies, standard-setting agencies of the research project is on the financial and governments throughout the world reporting issues associated with reserves and interested in accounting and reporting resources. An advisory panel has been practices and responsible for establishing established to provide advice throughout the financial reporting requirements. research project. PwC participates in the advisory panel. We support the IASB’s project to What is included? consider the promulgation of an accounting standard for the extractive industries; we hope Included in this publication are issues that we that this will bring consistency to all areas of believe are of financial reporting interest due to: financial reporting in the extractive industries. The oil and gas industry is arguably one of the • their particular relevance to oil and gas entities; most global industries, and international and/or comparability would be welcomed. • historical varying international practice. We hope you find this publication useful. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 8 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 9
Financial reporting in the oil and gas industry 7
1 Oil & Gas Value Chain & Significant Accounting Issues 1 Oil & Gas Value Chain & Significant Accounting Issues 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 10
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1 Oil & Gas Value Chain & Significant Accounting Issues
The objective of oil and gas operations is to find, extract the hydrocarbons is complex, and includes extract, refine and sell oil and gas, refined a number of significant variables. The industry products and related products. It requires can have a significant impact on the environment substantial capital investment and long lead consequential to its operations and is often times to find and extract the hydrocarbons in obligated to remediate any resulting damage. challenging environmental conditions with Despite all of these challenges, taxation of oil uncertain outcomes. Exploration, development and gas extractive activity and the resultant and production often takes place in joint ventures profits is a major source of revenue for many or joint activities to share the substantial capital governments. Governments are also increasingly costs. The outputs often need to be transported sophisticated and looking to secure a significant significant distances through pipelines, and share of any oil and gas produced on their tankers; gas volumes are increasingly liquefied, sovereign territory. transported by special carriers and then re- This publication examines the accounting issues gasified on arrival at its destination. Gas remains that are most significant for the oil and gas challenging to transport; thus many producers industry. The issues are addressed following and utilities look for long-term contracts to the oil & gas value chain: exploration and support the infrastructure required to develop a development, production and sales of product, major field, particularly off-shore. together with issues that are pervasive to the The industry is exposed significantly to macro- entity. economic factors such as commodity prices, currency fluctuations, interest-rate risk and For published financial disclosure examples, political developments. The assessment of see Section 4 on page 51. commercial viability and technical feasibility to
Oil & Gas Value Chain and Significant Accounting Issues
Exploration & Development Production & Sales
• Exploration & evaluation • Reserves & Resources (incl. depletion, • Borrowing costs depreciation and amortisation) • Development expenditures • Depreciation of production and downstream assets • Product valuation issues • Impairment of production and downstream assets • Disclosure of resources • Decommissioning obligations • Financial instruments and embedded derivatives • Revenue recognition issues • Royalty and income taxes • Emission trading schemes
Company-wide Issues: • Production sharing agreements and concessions • Joint ventures • Business combinations • Functional currency 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 11
Financial reporting in the oil and gas industry 9
1.1 Exploration & development individual fields, are capitalised. Cost centres 1 Oil & Gas Value Chain & Significant Accounting Issues are typically grouped on a country by country 1.1.1 Exploration & evaluation (E&E) basis, although sometimes countries may be grouped together if the fields have similar or Exploration costs are incurred to discover linked economic or geological characteristics. hydrocarbon resources. Evaluation costs are These larger cost pools are then depleted on a incurred to assess the technical feasibility and country basis as production occurs. If exploration commercial viability of the resources found. efforts in the country or geologic formation are Exploration, as defined in IFRS 6 Exploration wholly unsuccessful, the costs are expensed. and Evaluation of Mineral Resources, starts when Full cost, generally, results in a larger deferral of the legal rights to explore have been obtained. costs during exploration and development and Expenditure incurred before obtaining the legal increased subsequent depletion charges. right to explore must be expensed. Debate continues within the industry on the The accounting treatment of exploration and conceptual merits of both methods. IFRS 6 was evaluation expenditures (capitalising or issued to provide an interim solution for E&E expensing) can have a significant impact on the costs pending the outcome of the wider financial statements and reported financial extractive industries project by the IASB. results, particularly for entities at the exploration Entities transitioning to IFRS can continue stage with no production activities. This chapter applying their current accounting policy for E&E. considers the available alternatives for the IFRS 6 provides an interim solution for treatment of such expenditure under IFRS. exploration and evaluation costs, but does not apply to costs incurred once this phase is Successful Efforts and Full Cost Method completed. The period of shelter provided by the Two broadly acknowledged methods have standard is a relatively narrow one, and the traditionally been used under national GAAP to impairment rules make the continuation of full account for E&E and subsequent development cost past the E&E phase a challenge. costs: successful efforts and full cost. Many different variants exist under national GAAP, but Policy choice for E&E under IFRS 6 these are broadly similar. US GAAP has had a An entity accounts for its E&E expenditure by significant influence on the development of developing an accounting policy that complies accounting practice in this area; entities in those with the IFRS Framework or in accordance with countries that may not have specific rules often the exemption permitted by IFRS 6. IFRS 6 follow US GAAP by analogy, and US GAAP has allows an entity to continue to apply its existing influenced the accounting rules in other accounting policy under national GAAP for E&E. countries. The successful efforts method has The policy need not be in full compliance with perhaps been more widely used under national the IFRS Framework. GAAP by integrated oil and gas companies, but is also used by many smaller upstream-only Changes made to an entity’s accounting policy businesses. Costs incurred in finding, acquiring for E&E can only be made if they result in an and developing reserves are capitalised on a accounting policy that is closer to the principles field-by-field basis. Capitalised costs are of the Framework. The change must result in a allocated to commercially viable hydrocarbon new policy that is more relevant and no less reserves. Failure to discover commercially viable reliable or more reliable and no less relevant than reserves means that the expenditure is charged the previous policy. The policy, in short, can to expense. Capitalised costs are depleted on a move closer to the Framework but not further field-by-field basis as production occurs. away. This restriction on changes to the accounting policy includes changes implemented However, some upstream companies under on adoption of IFRS 6. The shelter of IFRS 6 only national GAAP have historically used the full cost covers the exploration and evaluation phase, until method. All costs incurred in searching for, the point at which the reserves’ commercial acquiring and developing the reserves in a large viability has been established. geographic cost centre or pool, as opposed to 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 12
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Initial recognition of E&E under the IFRS 6 only when facts and circumstances suggest that exemption an impairment exists. Indicators of impairment include, but are not limited to: The exemption in IFRS 6 allows an entity to continue to apply the same accounting policy to • Rights to explore in an area have expired or exploration and evaluation expenditures as it did will expire in the near future without renewal. before the application of IFRS 6. The costs • No further exploration or evaluation is planned capitalised under this policy might not meet the or budgeted. IFRS Framework definition of an asset, as the probability of future economic benefits has not • The decision to discontinue exploration and yet been demonstrated. IFRS 6 therefore deems evaluation in an area because of the absence these costs to be assets. E&E expenditures of commercial reserves. might therefore be capitalised earlier than would • Sufficient data exists to indicate that the book otherwise be the case under the Framework. value will not be fully recovered from future development and production. Initial recognition of E&E under the Framework The affected E&E assets should be tested for Expenditures incurred in exploration activities impairment once indicators have been identified. should be expensed unless they meet the IFRS also introduces a notion of larger cash definition of an asset. An entity recognises an generating units (CGUs) for E&E assets. Entities asset when it is probable that economic benefits are allowed to group E&E assets with producing will flow to the entity as a result of the assets, as long as the accounting policy is clear expenditure. The economic benefits might be as to the grouping and such policy is applied available through commercial exploitation of consistently. The only limit is that each CGU hydrocarbon reserves or sales of exploration or or group of CGUs cannot be larger than the further development rights. It is difficult for an segment. The grouping of E&E assets with entity to demonstrate at that stage that the producing assets might therefore enable an recovery of exploration expenditure is probable. impairment to be avoided. As a result, exploration expenditure has to be expensed. Virtually all entities transitioning to Once the decision on commercial viability has IFRS have chosen to use the IFRS 6 shelter been established, E&E assets are reclassified out rather than develop a policy under the of the E&E category. They are tested for Framework. impairment under the IFRS 6 policy adopted by the entity prior to reclassification. However, once Reclassification out of E&E under IFRS 6 assets have been reclassified out of E&E the normal impairment testing guidelines of IAS 36 IFRS 6 requires that E&E assets are reclassified Impairment apply. Successful E&E will be when evaluation procedures have been reclassified to development. Unsuccessful E&E completed. E&E assets for which commercially- must be written down to fair value less costs to viable reserves have been identified are sell, because the shelter afforded by grouping reclassified to development assets. E&E assets these assets with producing assets in a larger are tested for impairment immediately prior to CGU shelter is no longer available. reclassification out of E&E. The impairment testing requirements are described below. Assets reclassified out of E&E are subject to the normal IFRS requirements of impairment testing Impairment of E&E assets at the CGU level and depreciation on a component basis. Impairment testing and IFRS 6 introduces an alternative impairment- depreciation on a pool basis is not acceptable. testing regime for E&E that differs from the general requirements for impairment testing. An entity assesses E&E assets for impairment 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 13
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1.1.2 Borrowing costs production stage is normally larger than the 1 Oil & Gas Value Chain & Significant Accounting Issues individual well. It is appropriate therefore to The cost of an item of property, plant and assess the economic benefits of the development equipment may include borrowing costs incurred dry hole in the context of the field as a whole and for the purpose of acquiring or constructing it. the development plan for that field. The information Such borrowing costs may be capitalised if the provided by a development dry hole is useful asset takes a substantial period of time to get information and is applied through developing ready for its intended use. The capitalisation of the field’s infrastructure more precisely. The costs borrowing costs under IAS 23 Borrowing Costs of a development dry hole should therefore (Issued 1993) is an option, but one which must normally be capitalised. be applied consistently to all qualifying assets. However, amendments to IAS 23 that were 1.2 Production & sales published in 2007 and become effective from 1 January 2009 will require that all applicable 1.2.1 Reserves & Resources borrowing costs be capitalised. The oil and gas natural resources found by an Borrowing costs should be capitalised while entity are its most important economic asset. acquisition or construction is actively underway. The financial strength of the entity depends on These costs include the costs of specific funds the scale and quality of the resources it has the borrowed for the purpose of financing the right to extract and sell. Resources are the construction of the asset, and those general source of future cash inflows from sale of borrowings that would have been avoided if the hydrocarbons, and provide the basis for expenditure on the qualifying asset had not been borrowing and for raising equity finance. made. The general borrowing costs attributable to an asset’s construction should be calculated What are reserves? by reference to the entity’s weighted average cost of general borrowings. Natural resources are outside the scope of IAS 16 Property, Plant and Equipment. The IASB is 1.1.3 Development expenditures considering the accounting treatment for mineral resources and reserves as part of its Extractive Development expenditures are costs incurred to Activities project. Entities record reserves at the obtain access to proved reserves and to provide historical cost of finding and developing reserves facilities for extracting, treating, gathering and or acquiring them from third parties. The cost of storing the oil and gas. finding and developing reserves is not directly Development expenditures should generally be influenced by the quantity of reserves, except capitalised to the extent that they are necessary to the extent that impairment may be an issue. to bring the property to commercial production. The cost of reserves acquired in a business Expenditures incurred after the point at which combination may be more closely associated commercial production has commenced should with the fair value of reserves present. However, only be capitalised if the expenditures meet the reserves and resources have a pervasive impact asset recognition criteria. This will be where the on an oil and gas entity’s financial statements, additional expenditure enhances the productive impacting on a number of significant areas. capacity of the producing property. These include, but are not limited to: • depletion, depreciation and amortisation; Dry holes • impairment and reversal of impairment; Some of the wells drilled in accordance with the development plan for the field may be • the recognition of future decommissioning and unsuccessful (dry), but the results of the restoration obligations; development work as a whole may further • termination and pension benefit cash flows; support the conclusion that the field has commercially viable reserves. The relevant unit of • allocation of purchase price in business account for a field in the development or combinations. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 14
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Resources versus reserves Unproved reserves are those reserves that technical or other uncertainties preclude from Resources are those volumes of oil and gas that being classified as proved. Unproved reserves are estimated to be present in the ground, which may be further categorised as probable and may or may not be economically recoverable. possible reserves: Reserves are those resources that are • probable reserves are those additional reserves anticipated to be commercially recovered from that are less likely to be recovered than proved known accumulations from a specific date. reserves but more certain to be recovered than The geological and engineering data available for possible reserves; specific accumulations will enable an assessment of the uncertainty/certainty of the reserves • possible reserves are those additional reserves estimate. Reserves are classified as proved or that analysis of geoscience and engineering unproved according to the degree of data suggest are less likely to be recoverable certainty/uncertainty associated with their than probable reserves. estimated recoverability. These classifications do not arise from any definitions or guidance in the Estimation of reserves IFRSs. They are commonly and broadly used in Reserves estimates are usually made by the industry. petroleum reservoir engineers, sometimes by Several countries have their own definitions of geologists but, as a rule, not by accountants. reserves, for example China, Russia and Norway. Preparing reserve estimations is a complex Companies that are SEC registrants apply the process. It requires an analysis of information SEC’s own definition of reserves for financial about the geology of the reservoir and the reporting purposes. There are also definitions surrounding rock formations and analysis of the developed by the professional societies, fluids and gases within the reservoir. It also eg, Society of Petroleum Engineers (SPE). requires an assessment of the impact of factors Proved reserves are estimated quantities of such as temperature and pressure on the reserves that, based on geological and recoverability of the reserves, taking account of engineering data, appear reasonably certain to operating practices, statutory and regulatory be recoverable in the future from known oil and requirements, costs and other factors that will gas reserves under existing economic and affect the commercial viability of extracting the operating conditions, ie, prices and costs as of reserves. As an oil and gas field is developed and the date the estimate is made. produced, more information about the mix of oil, gas, water, etc, reservoir pressure, and other Proved reserves are further sub-classified into relevant data is obtained and used to update the those described as proved developed and estimates of recoverable reserves. Estimates of proved undeveloped: reserves are therefore revised over the life of the • proved developed reserves are those reserves field. that can be expected to be recovered There are standards for estimating and auditing through existing wells with existing equipment oil and gas reserves information developed by and operating methods; the Society of Petroleum Engineers. The SPE • proved undeveloped reserves are reserves Standards are not binding on petroleum that are expected to be recovered from new engineers but do provide estimation and wells on undrilled proved acreage, or from reporting guidance. existing wells where relatively major expenditure is required before the reserves 1.2.2 Depreciation of production and can be extracted. downstream assets The accumulated costs from E&E, development and production phases are amortised over expected total production using a unit of production (UOP) basis. UOP is the most 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 15
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appropriate amortisation method because it The significant components of these types of 1 Oil & Gas Value Chain & Significant Accounting Issues reflects the pattern of consumption of the assets must be separately identified, such as the reserves’ economic benefits. However, compressors in a pipeline. It can be a complex straightline amortisation may be appropriate for process, particularly on transition to IFRS, as the some assets. recordkeeping may not have been required to comply with national GAAP. Some components can be identified by Depletion, depreciation and amortisation (DD&A) considering the routine shutdown/turnaround The IFRSs do not prescribe what basis should be schedules and the replacement and maintenance used for the UOP calculation. Many entities use routines associated with these. Consideration only proved developed; others use all proved or should also be given to those components that both proved and probable. The basis of the UOP are prone to technological obsolescence, calculation is an accounting policy choice, and corrosion or wear and tear more severe than that should be applied consistently. of the other portions of the larger asset. If proved and proved undeveloped reserves are Depreciation of components used, then an adjustment should be considered when calculating the amortisation charge to Those identified components that have a shorter reflect the future development costs that need to useful life than the remainder of the asset should be incurred to access the undeveloped reserves. be depreciated to the recoverable amount over that shorter useful life. The remaining carrying The total production used for DD&A of assets amount of the component is derecognised on that are subject to a lease or licence should be replacement and the cost of the replacement part restricted to the total production expected to be is capitalised. A complication can arise where produced during the licence/lease term. upstream assets are largely depreciated on a Renewals of the licence/lease are only assumed UOP basis but specific assets are consumed in a if there is evidence to support probable renewal more straight-line manner. A potential work- without significant cost. around exists if production is stable over time. The production expected during the period can Components be estimated and the components depreciated IFRS has a specific requirement for ‘component’ over that number of units. This method needs to depreciation, as described in IAS 16. Each be periodically assessed to determine that it significant part of an item of property, plant and continues to approximate a straight-line method. equipment is depreciated separately. Significant The calculation of a depreciation charge cannot parts of an asset that have similar useful lives be avoided on the basis that a high level of and pattern of consumption can be grouped maintenance expenditure is incurred that will together. This requirement can create continuously maintain the network’s operating complications for oil & gas entities, as there are capacity. The practice of assuming that the many assets that include components with a maintenance charge approximates the shorter useful life than the asset as a whole. depreciation charge and thus avoiding the Productive assets are often large and complex calculation of depreciation on an asset or installations. Assets are expensive to construct, component basis, known as renewals tend to be exposed to harsh environmental or accounting, is not acceptable under IFRS. operating conditions and require periodic The costs of performing a turnaround/overhaul replacement or repair. Large network or are capitalised as a component of the plant infrastructure assets might comprise a significant provided this provides access to future economic number of components, many of which will have benefits, but turnaround/overhaul costs that do differing useful lives. Examples include gas not relate to the replacement of components or treatment installations, refineries, chemical the installation of new assets should be plants, distribution networks and offshore expensed as incurred. Turnaround/overhaul costs platforms, including the supporting infrastructure should not be accrued over the period between and pipelines. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 16
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the turnarounds/overhauls because there is no 1.2.4 Impairment of production and legal or constructive obligation to perform the downstream assets turnaround/overhaul – the entity could choose to cease operations at the plant and hence avoid The oil and gas industry is distinguished by the the turnaround/overhaul costs. significant capital investment required. The heavy investment in fixed assets leaves the industry 1.2.3 Product valuation issues exposed to adverse economic conditions and therefore impairment charges. Accounting for linefill Oil and gas assets should be tested for Some items of property, plant and equipment, impairment whenever indicators of impairment such as pipelines, refineries and gas storage, exist. The normal measurement rules for require a certain minimum level of product to be impairment apply to assets with the exception of maintained in them in order for them to operate the grouping of E&E assets with existing efficiently. Such product should be classified as producing cash generating units (CGUs) as part of the property, plant and equipment described in section 1.1.1. because it is necessary to bring the PPE to its required operating condition. The product will Impairment indicators therefore be recognised as a component of the PPE at cost and subject to depreciation to Impairment triggers relevant for the petroleum estimated residual value. sector include declining market prices for oil and gas, significant downward reserve revisions, However, product that an entity owns but stores increased regulation or tax changes, in PPE owned by a third party continues to be deteriorating local conditions such that it may classified as inventory, for example all gas in a become unsafe to continue operations and rented storage facility. It does not represent a expropriation of assets. component of the third party’s PPE nor a component of PPE owned by the entity. Such Impairment indicators can also be internal in product should therefore be measured at FIFO or nature. Evidence that an asset or CGU has been weighted average cost. damaged or become obsolete is an impairment indicator; for example a refinery destroyed by fire Determining net realisable value for oil is, in accounting terms, an impaired asset. Other inventories indicators of impairment are a decision to sell or restructure a CGU or evidence that business Oil produced and purchased for use by an entity performance is less than expected. is valued at the lower of cost and net realisable value. Determining net realisable value requires Management should be alert to indicators on a consideration of the estimated selling price in the CGU basis; for example learning of a fire at an ordinary course of business less the estimated individual petrol station would be an indicator of costs to complete the processing of the inventory impairment for that station as a separate CGU. (where appropriate) and less the estimated costs However, generally, management is likely to necessary to sell the inventories. An entity identify impairment indicators on a regional or determines the estimated selling price of the area basis, reflective of how they manage their oil/oil product using the market price for oil at the business. Once an impairment indicator has been balance sheet date, or where appropriate, the identified, the impairment test must be performed forward price curve for oil at the balance sheet at the individual CGU level, even if the indicator date. Movements in the oil price after the balance was identified at a regional level. sheet date typically reflect changes in the market conditions after that date and therefore should Cash generating units not be reflected in the calculation of net A CGU is the smallest group of assets that realisable value. generates cash inflows largely independent of other assets or groups of assets. A CGU in an upstream entity will often be identified as a field and its supporting infrastructure assets. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 17
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Production, and therefore cash flows, can be Value in use (VIU) 1 Oil & Gas Value Chain & Significant Accounting Issues associated with individual wells. However, the VIU is the present value of the future cash flows field investment decision is made based on expected to be derived from an asset or CGU in expected field production, not a single well, and its current condition. Determination of VIU is all wells are typically dependent on the field subject to the explicit requirements of IAS 36. infrastructure. The cash flows are based on the asset that the An entity operating in the downstream business entity has now and must exclude any plans to may own petrol stations, clustered in geographic enhance the asset or its output in the future but areas to benefit from management oversight, includes expenditure necessary to maintain the supply and logistics. The petrol stations, by current performance of the asset. The VIU cash contrast, are not dependent on fixed flows for assets that are under construction and infrastructure and generate largely independent not yet complete (eg, an oil or gas field that is cash inflows. part-developed) should include the cash flows necessary for their completion and the Calculation of recoverable amount associated additional cash inflows or reduced cash outflows. Impairments are recognised if a CGU’s carrying amount exceeds its recoverable amount. Any foreign currency cash flows are projected in Recoverable amount is the higher of fair value the currency in which they will be earned, and less costs to sell (FVLCTS) and value in use (VIU). discounted at a rate appropriate for that currency. The resulting value is translated to the Fair value less costs to sell (FVLCTS) entity’s functional currency using the spot rate at the date of the impairment test. Fair value less costs to sell is the amount that a market participant would pay for the asset or The discount rate used for VIU is always pre-tax CGU, less the costs of sale. The use of and applied to pre-tax cash flows. This is often discounted cash flows for FVLCTS is permitted the most difficult element of the impairment test, where there is no readily available market price as pre-tax rates are not available in the market for the asset or where there are no recent market place. Grossing up the post tax rate does not transactions for the fair value to be determined give the correct answer unless no deferred tax is through a comparison between the asset being involved. Arriving at the correct pre-tax rate is a tested for impairment and a recent market complex mathematical exercise. transaction. However, where discounted cash flows are used, the inputs must be based on Contracted cash flows in VIU external, market-based data. The cash flows prepared for a VIU calculation The projected cash flows for FVLCTS therefore should reflect management’s best estimate of the include the assumptions that a potential future cash flows expected to be generated from purchaser would include in determining the price the assets concerned. Purchases and sales of of the asset. Thus industry expectations for the commodities are included in the VIU at the spot development of the asset may be taken into price at the date of the impairment test, or if account which may not be permitted under VIU. appropriate, prices obtained from the forward However, the assumptions and resulting value price curve at the date of the impairment test. must be based on recent market data and However, management should use the transactions. contracted price in its VIU calculation for any Post-tax cash flows are used when calculating commodities unless the contract is already on FVLCTS using a discounted cash flow model. the balance sheet at fair value. A commodity The discount rate applied in FVLCTS will be a contract that can be settled net in cash and for post-tax market rate based on a typical industry which the own-use exception cannot be claimed, participant’s cost of capital. for example, is recognised separately on the balance sheet at fair value as a derivative. Including the contracted prices of such a 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 18
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contract would double count the effects of the Entities should consider presenting reserve contract. Impairment of financial instruments quantities and changes on a reasonably that are within the scope of IAS 39 Financial aggregate basis. Where certain reserves are Instruments: Recognition and Measurement is subject to particular risks, those risks should addressed by IAS 39 and not IAS 36. be identified and communicated. Reserve disclosures accompanying the financial The cash flow effects of hedging instruments statements should be consistent with those such as caps and collars for commodity reserves used for financial statement purposes. purchases and sales are also excluded from the For example, proven and probable reserves or VIU cash flows. These contracts are also proved developed and undeveloped reserves accounted for in accordance with IAS 39. might be used for depreciation, depletion and amortisation calculations. 1.2.5 Disclosure of resources The categories of reserves used and their A key indicator for evaluating the performance of definitions should be clearly described. Reporting oil and gas entities are their existing reserves and a ‘value’ for reserves and a common means of the future production and cash flows expected measuring that value have long been debated, from them. Some national accounting standards and there is no consensus among national and securities regulators require supplemental standard-setters permitting or requiring value disclosure of reserve information, most notably disclosure. There is, at present, no globally the Statement on Financial Accounting Standards agreed method to ‘value’ disclosures. However, (FAS) 69 and Securities and Exchange there are globally accepted engineering Commission (SEC) regulations. There are also definitions of reserves that take into account recommendations on accounting practices economic factors. These definitions may be a issued by industry bodies – Statements of useful benchmark for disclosing future cash flow Recommended Practice (SORPs) – which cover information about reserves for investors and Accounting for Oil and Gas Exploration, other users of financial statements to evaluate. Development, Production and Decommissioning Activities. However, there are no reserve The disclosure of key assumptions concerning disclosure requirements under IFRS. the future, and other key sources of estimation uncertainty at the balance sheet date, is required IAS 1 Presentation of Financial Statements by IAS 1. Given that the reserves and resources requires that an entity’s financial statements have a pervasive impact, this normally results in should provide additional information that is not entities providing disclosure about hydrocarbon presented on the face of the financial statements resource and reserve estimates, for example: but which is necessary for a fair presentation. IAS 1 allows an entity to consider the • hydrocarbon resource and reserve estimates: pronouncements of other standard-setting • methodology used; and bodies and accepted industry practices in the • key assumptions; absence of specific IFRS guidance when • the sensitivity of carrying amounts of assets developing accounting policies. Many entities and liabilities to the hydrocarbon resource and provide supplemental information with the reserve estimates used; financial statements because of the unique nature of the oil and gas industry and the clear • the range of reasonably possible outcomes desire of investors and other users of the within the next financial year in respect of the financial statements to receive information about carrying amounts of the assets and liabilities reserves. The information is usually supplemental affected; and to the financial statements, and is not covered by • an explanation of changes made to past the independent auditor’s opinion. hydrocarbon resource and reserve estimates, Information about quantities of oil and gas including changes to underlying key reserves and changes therein is essential for assumptions. users to understand and compare oil and gas Other information – for example, potential future companies’ financial position and performance. costs to be incurred to acquire, develop and 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 19
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produce reserves – may help users of financial The cost of the provision is recognised as part of 1 Oil & Gas Value Chain & Significant Accounting Issues statements to assess the entity’s performance. the cost of the asset when it is put in place and Supplementary disclosure of such information depreciated over the asset’s useful life. The total with IFRS financial statements is useful, but it cost of the fixed asset, including the cost of should be consistently reported, the underlying decommissioning, is depreciated on the basis basis clearly disclosed and based on a common that best reflects the consumption of the guideline or practice, such as the Society of economic benefits of the asset. Provisions for Petroleum Engineers definitions. decommissioning and restoration are recognised even if the decommissioning is not expected to Companies already presenting supplementary be performed for a long time, for example 80 to information regarding reserves under their 100 years. This may prove challenging in the national GAAP may want to continue providing downstream business, for example refineries such information until the IASB publishes a when decommissioning is not expected in the comprehensive standard, setting out the short to medium term. supplementary information disclosure requirements under IFRS. The effect of the time to expected decommissioning will be reflected in the 1.2.6 Decommissioning obligations discounting of the provision. The discount rate used is the pre-tax rate that reflects current The oil and gas industry can have a significant market assessments of the time value of money. impact on the environment. Decommissioning or Entities also need to reflect the specific risks environmental restoration work at the end of the associated with the decommissioning liability. useful life of a plant or other installation may be Different decommissioning obligations will, required by law, the terms of operating licences naturally, have different inherent risks, for or an entity’s stated policy and past practice. example different uncertainties associated with An entity that promises to remediate damage, the methods, the costs and the timing of even when there is no legal requirement, may decommissioning. The risks specific to the liability have created a constructive obligation and thus can be reflected either in the pre-tax cash flow a liability under IFRS. There may also be forecasts prepared or in the discount rate used. environmental clean-up obligations for contamination of land that arises during the Revisions to decommissioning provisions operating life of a refinery or other installation. The associated costs of remediation/restoration Decommissioning provisions are updated at each can be significant. The accounting treatment for balance sheet date for changes in the estimates decommissioning costs is therefore critical. of the amount or timing of future cash flows and changes in the discount rate. Changes to Decommissioning provisions provisions that relate to the removal of an asset are added to or deducted from the carrying A provision is recognised when an obligation amount of the related asset in the current period. exists to perform the clean-up. The local legal The adjustments to the asset are restricted, regulations should be taken into account when however. The asset cannot decrease below zero determining the existence and extent of the and cannot increase above its recoverable obligation. Obligations to decommission or amount: remove an asset are created at the time the asset is put in place. An offshore drilling platform, for • if the decrease of provision exceeds the example, must be removed at the end of its carrying amount of the asset, the excess is useful life. The obligation to remove it arises recognised immediately in profit or loss; from its placement. The obligation does not • adjustments that result in an addition to the change in substance if the platform produces cost of the asset are assessed to determine if 10,000 barrels or 1,000,000. Entities recognise the new carrying amount is fully recoverable or decommissioning provisions at the present not. An impairment test is required if there is value of the expected future cash flows that will an indication that the asset may not be fully be required to perform the decommissioning. recoverable. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 20
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The accretion of the discount on a (b) the entity has a practice of settling similar decommissioning liability is recognised as part of contracts net, whether: finance expense in the income statement. • with the counterparty; • by entering into offsetting contracts; or 1.2.7 Financial instruments and embedded • by selling the contract before its exercise or derivatives lapse; The accounting for financial instruments can (c) the entity has a practice, for similar items, of have a major impact on an oil & gas entity’s taking delivery of the underlying and selling it financial statements. Many use a range of within a short period after delivery for the derivatives to manage the commodity, currency purpose of generating a profit from short- and interest-rate risks to which they are term fluctuations in price or dealer’s margin; operationally exposed. Other, less obvious, or sources of financial instruments issues arise (d) the commodity that is the subject of the through both the scope of IAS 39 and the rules contract is readily convertible to cash. around accounting for embedded derivatives. Many entities that are solely engaged in Application of ‘own-use’ producing, refining and selling commodities, may be party to commercial contracts that are either Own-use applies to those contracts that were wholly within the scope of IAS 39 or contain entered into and continue to be held for the embedded derivatives from pricing formulas or purpose of the receipt or delivery of a non- currency. financial item. The practice of settling similar contracts net prevents an entire category of Scope of IAS 39 contracts from qualifying for the own-use treatment (ie, all similar contracts must then be Contracts to buy or sell a non-financial item, recognised as derivatives at fair value). such as a commodity, that can be settled net in cash or another financial instrument, or by A contract that falls into category (b) or (c) above exchanging financial instruments, are within the cannot qualify for own-use treatment. These scope of IAS 39. They are treated as derivatives contracts must be accounted for as derivatives and are marked to market through the income at fair value. Contracts subject to the criteria statement. Contracts that are for an entity’s described in (a) or (d) above are evaluated to see ‘own-use’ are exempt from the requirements of if they qualify for own-use treatment. IAS 39 but these ‘own-use’ contracts may include Many contracts for commodities such as oil and embedded derivatives that may be required to be gas meet criterion (d) above (ie, readily separately accounted for. An ‘own-use’ contract convertible to cash) when there is an active is one that was entered into and continues to be market for the commodity. An active market held for the purpose of the receipt or delivery of exists when prices are publicly available on a the non-financial item in accordance with the regular basis and those prices represent regularly entity’s expected purchase, sale or usage occurring arm’s length transactions between requirements. In other words, it will result in willing buyers and willing sellers. Consequently, physical delivery of the commodity. The ‘net sale and purchase contracts for commodities in settlement’ notion in IAS 39 is quite broad. locations where an active market exists must be A contract to buy or sell a non-financial item can accounted for at fair value unless own-use be net settled in any of the following ways: treatment can be evidenced. An entity’s policies, (a) the terms of the contract permit either procedures and internal controls are therefore party to settle it net in cash or another critical in determining the appropriate treatment financial instrument; of its commodity contracts. Own-use is not an election. A contract that meets the own-use criteria cannot be selectively fair valued unless it otherwise falls into the scope of IAS 39. If an own-use contract contains one or 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 21
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more embedded derivatives, an entity may (b) is consistent with accepted economic 1 Oil & Gas Value Chain & Significant Accounting Issues designate the entire hybrid contract as a financial methodologies for pricing financial asset or financial liability at fair value through instruments; and profit or loss unless: (c) is tested for validity using prices from any (a) the embedded derivative(s) does not observable current market transactions in the significantly modify the cash flows of the same instrument or based on any available contract; and observable market data. (b) it is clear with little or no analysis that The assumptions used to value long-term separation of the embedded derivative is contracts are updated at each balance sheet prohibited. date to reflect changes in market prices, the availability of additional market data and However, the IASB has proposed to restrict the changes in management’s estimates of prices ability to designate the entire hybrid instrument for any remaining illiquid periods of the contract. as a financial asset or financial liability at fair Clear disclosure of the policy and approach, value through profit or loss. The proposal to be including significant assumptions, are crucial to included in the IASB’s 2008 Annual ensure that users understand the entity’s financial Improvements project will restrict this designation statements. to host contracts that are financial instruments in the scope of IAS 39. Day-one profits Further discussion on embedded derivatives is Commodity contracts that fall within the scope of presented in the following section. IAS 39 and fail to qualify for own-use treatment have the potential to create day-one gains. Measurement of long-term contracts that do not A day-one gain is the difference between the fair qualify for ‘own-use’ value of the contract at inception as calculated Long-term commodity contracts are not by a valuation model and the amount paid to uncommon, particularly for purchase and sale of enter the contract. The contracts are initially natural gas. Some of these contracts may be recognised under IAS 39 at fair value. Any such within the scope of IAS 39 as they contain net profits or losses can only be recognised if the fair settlement provisions and do not get own-use value of the contract: treatment. These contracts are measured at fair (1) is evidenced by other observable market value using the valuation guidance in IAS 39 with transactions in the same instrument; or changes recorded in the income statement. There may not be market prices for the entire (2) is based on valuation techniques whose period of the contract. For example, there may variables include only data from observable be prices available for the next three years and markets. then some prices for specific dates further out. Thus, the profit must be supported by objective This is described as having illiquid periods in the market-based evidence. Observable market contract. These contracts are valued using transactions must be in the same instrument (ie, valuation techniques in the absence of an active without modification or repackaging and in the market for the entire contract term. same market where the contract was originated). Valuation is complex and is intended to establish Prices must be established for transactions with what the transaction price would have been on different counterparties for the same commodity the measurement date in an arm’s length and for the same duration at the same delivery exchange motivated by normal business point. considerations. Therefore it: Any day-one profit or loss that is not recognised (a) incorporates all factors that market at initial recognition is recognised subsequently participants would consider in setting a price, only to the extent that it arises from a change in making maximum use of market inputs and a factor (including time) that market participants relying as little as possible on entity-specific would consider in setting a price. Commodity inputs; 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 22
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contracts include a volume component, and oil that may have to be separated and accounted and gas entities are likely to recognise the for under IAS 39 as a derivative. Examples are deferred gain/loss and release it to profit or loss gas prices that are linked to the price of oil or on a systematic basis as the volumes are other products, or a pricing formula that includes delivered, or as observable market prices an inflation component. become available for the remaining delivery An embedded derivative is a derivative period. The recognition of the day-one instrument that is combined with a non-derivative gain/losses may change as the result of the IASB host contract (the ‘host’ contract) to form a single project on Fair Value Measurements. hybrid instrument. An embedded derivative causes some or all of the cash flows of the host Volume flexibility (optionality) contract to be modified, based on a specified Long-term commodity contracts frequently offer variable. An embedded derivative can arise the counterparty flexibility in relation to the through market practices or common contracting quantity of the commodity to be delivered under arrangements. the contract. A supplier that gives a purchaser An embedded derivative is separated from the volume flexibility may have created a written host contract and accounted for as a derivative option. This will often prevent the supplier from if: claiming the own-use exemption. A written option cannot be entered into for the purpose of (a) the economic characteristics and risks of the the receipt or delivery of a non-financial item in embedded derivative are not closely related to accordance with the entity’s expected purchase, the economic characteristics and risks of the sale or usage requirements. A contract host contract; containing a written option must be accounted (b) a separate instrument with the same terms as for in accordance with IAS 39 if it can be settled the embedded derivative would meet the net in cash, eg, when the item that is subject of definition of a derivative; and the contract is readily convertible into cash. (c) the hybrid (combined) instrument is not Contracts may include volume flexibility but not measured at fair value with changes in fair contain a written option if the purchaser did not value recognised in the profit or loss (ie, a pay a premium for the optionality. Receipt of a derivative that is embedded in a financial premium to compensate the supplier for the risk asset or financial liability at fair value through that the purchaser may not take the optional profit or loss is not separated). quantities specified in the contract is one of the distinguishing features of a written option. Embedded derivatives that are not closely related The premium might be explicit in the contract or must be separated from the host contract and implicit in the pricing. It is necessary to consider accounted for at fair value, with changes in fair whether a net premium is received either at value recognised in the income statement. It may inception or over the contract’s life in order to not be possible to measure the embedded determine the accounting treatment. If no derivative. Therefore, the entire combined premium can be identified, other terms of the contract must be measured at fair value, with contract may need to be examined to determine changes in fair value recognised in the income whether it contains a written option; in particular, statement. whether the buyer is able to secure economic An embedded derivative that is required to be value from the option’s presence. separated may be designated as a hedging instrument, in which case the hedge accounting Embedded derivatives rules are applied. Long-term commodity purchase and sale A contract that contains one or more contracts frequently contain a pricing clause (ie, embedded derivatives can be designated as a indexation) based on a commodity other than contract at fair value through profit or loss at the commodity deliverable under the contract. inception, unless: Such contracts contain embedded derivatives 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 23
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(a) the embedded derivative(s) does not expected future cash flows associated with the 1 Oil & Gas Value Chain & Significant Accounting Issues significantly modify the cash flows of the embedded derivative, host contract, or hybrid contract; and contract have significantly changed relative to the previously expected cash flows under the contract. (b) it is clear with little or no analysis that separation of the embedded derivative(s) is A first-time adopter assesses whether an prohibited. embedded derivative is required to be separated from the host contract and accounted for as a Assessing whether embedded derivatives are derivative on the basis of the conditions that closely related existed at the later of the date it first became a party to the contract and the date a All embedded derivatives must be assessed to reassessment is required. determine if they are ‘closely related’ to the host contract at the inception of the contract. The same principles apply to an entity that A pricing formula that is indexed to something purchases a contract containing an embedded other than the commodity delivered under the derivative. The date of purchase is treated as the contract could introduce a new risk to the date when the entity first becomes party to the contract. Some common embedded derivatives contract. that routinely fail the closely-related test are indexation to an unrelated published market price 1.2.8 Revenue recognition issues and denomination in a foreign currency that is Revenue recognition, particularly for upstream not the functional currency of either party and not activities, can present some significant a currency in which such contracts are routinely challenges. Production often takes place in joint denominated in transactions around the world. ventures or through concessions, and entities The assessment of whether an embedded need to analyse the facts and circumstances to derivative is closely related is both qualitative and determine when and how much revenue to quantitative, and requires an understanding of recognise. Crude oil and gas may need to be the economic characteristics and risks of both moved long distances and need to be of a instruments. specific type to meet refinery requirements. Entities may exchange product to meet logistical, In the absence of an active market price for a scheduling or other requirements. This section particular commodity, management should looks at these common issues. Revenue consider how other contracts for that particular recognition in production-sharing agreements commodity are normally priced. It is common for (PSAs) is discussed in section 1.3.1. a pricing formula to be developed as a proxy for market prices. When it can be demonstrated that Overlift and underlift a commodity contract is priced by reference to an identifiable industry ‘norm’ and contracts are Many joint ventures (JV) share the physical regularly priced in that market according to that output (for example crude oil) between the joint norm, the pricing mechanism does not modify venture partners. Each JV partner is then the cash flows under the contract and is not responsible for either using or selling the oil it considered an embedded derivative. takes. The physical nature of the taking (lifting) of oil is Timing of assessment of embedded derivatives such that it is often more efficient for each partner All contracts need to be assessed for embedded to lift a full tanker-load of oil at a time. A lifting derivatives at the date when the entity first schedule identifies the order and frequency with becomes a party to the contract. Subsequent which each partner can lift. At the balance sheet reassessment of embedded derivatives is date the amount of oil lifted by each partner may prohibited unless there is a significant change in not be equal to its equity interest in the field. the terms of the contract, in which case Some partners will have taken more than their reassessment is required. A significant change in share (overlifted) and others will have taken less the terms of the contract has occurred when the than their share (underlifted). 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 24
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Overlift and underlift are in effect a sale of oil at sometimes there are variations in the quality of the point of lifting by the underlifter to the the product, sometimes different products are overlifter. The criteria for revenue recognition in exchanged. Balancing payments are made to IAS 18 Revenue paragraph 14 are considered to reflect differences in the values of the products have been met. Overlift is therefore treated as a exchanged where appropriate. purchase of oil by the overlifter from the The nature of the exchange will determine if it is underlifter. a like-for-like exchange or an exchange of The sale of oil by the underlifter to the overlifter dissimilar goods. A like-for-like exchange doesn’t should be recognised at the market price of oil at give rise to revenue recognition or gains, but an the date of lifting. Similarly the overlifter should exchange of dissimilar goods is accounted for reflect the purchase of oil at the same value. gross, giving rise to revenue recognition and gains or losses. The extent of underlift by a partner is reflected as an asset in the balance sheet and the extent of The exchange of crude oil, even where the overlift is reflected as a liability. An underlift asset qualities of the crude differ, is usually treated as is the right to receive additional oil from future an exchange of similar products and accounted production without the obligation to fund the for at book value. Any balancing payment made production of that additional oil. An overlift or received to reflect minor differences in quality liability is the obligation to deliver oil out of the or location should be adjusted against the entity’s equity share of future production. carrying value of the inventory. There may, however, be unusual circumstances where the The initial measurement of the overlift liability and facts of the exchange suggest that there are underlift asset is at the market price of oil at the significant differences between the crude oil date of lifting, consistent with the measurement exchanged. The transaction should be accounted of the sale and purchase. Subsequent for as a sale of one product and the purchase of measurement depends on the terms of the JV the other at fair values in these circumstances. agreement. JV agreements that allow the net A significant cash element in the transaction is an settlement of overlift and underlift balances in indicator that the transaction may be a sale and cash will fall within the scope of IAS 39 unless purchase of dissimilar products. the own-use exemption applies. Overlift and underlift balances that fall within 1.2.9 Royalty and income taxes the scope of IAS 39 must be remeasured to the Petroleum taxes generally fall into two categories current market price of oil at the balance sheet – those that are calculated on profits earned date. The change arising from this (income taxes) and those calculated on remeasurement is included in the income production or sales (royalty or excise taxes). The statement as other income/expense rather than categorisation is crucial: royalty and excise taxes revenue or cost of sales. do not form part of revenue, while income taxes Overlift and underlift balances that do not fall usually require deferred tax accounting but form within the scope of IAS 39 should be measured part of revenue. at the lower of carrying amount and current market value. Any remeasurement should be Petroleum taxes – royalty and excise included in other income/expense rather than Petroleum taxes that are calculated by applying a revenue or cost of sales. tax rate to a measure of revenue or volume do not fall within the scope of IAS 12 Income Taxes Exchanges and are not income taxes. They do not form part Energy companies exchange crude or refined oil of revenue or give rise to deferred tax liabilities. products with other energy companies to achieve Revenue-based and volume-based taxes are operational objectives. This is often done to save recognised when the production occurs or on transportation costs by exchanging a quantity revenue arises. These taxes are most often of product A in location X for a quantity of described as royalty or excise taxes. They are product A in location Y. Variations on this arise – measured in accordance with the relevant tax 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 25
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legislation and a liability is recorded for amounts regional basis. An IFRS balance sheet and a tax 1 Oil & Gas Value Chain & Significant Accounting Issues due that have not yet been paid to the balance sheet will be required for each area or government. field subject to separate taxation for the calculation of the deferred tax. Royalty and excise taxes are in effect the government’s share of the natural resources The tax rate applied to the temporary differences exploited and are a share of production free of will be the statutory rate for the relevant tax. cost. They may be paid in cash or in kind. If in The statutory rate may be adjusted for certain cash, the entity sells the oil or gas and remits to allowances and reliefs (eg, tax free barrels) in the government its share of the proceeds. certain limited circumstances where the tax is Royalty payments in cash or in kind are excluded calculated on a field-specific basis without the from gross revenues and costs. opportunity to transfer profits or losses between fields. Petroleum taxes based on profits Taxes in PSAs Petroleum taxes that are calculated by applying a tax rate to a measure of profit fall within the Production sharing agreements are discussed in scope of IAS 12. The profit measure used to further detail in Chapter 1.3.1. However, a crucial calculate the tax is that required by the tax question arises about the taxation of PSAs – legislation and will, accordingly, differ from the when are amounts paid to the government as IFRS profit measure. Profit in this context is income tax (and thus form part of revenue) and revenue less costs as defined by the relevant tax when are amounts a royalty and excluded from legislation, and thus might include costs that are revenue. Some PSAs include a requirement for capitalised for financial reporting purposes. the national oil company or another government However it is not, for example, an allocation of body to pay income tax on behalf of the operator profit oil in a PSA. Examples of taxes based on of the PSA. When does tax paid on behalf of an profits include Petroleum Revenue Tax in the UK, operator form part of revenue and income tax Norwegian Petroleum Tax and Australian expense? Resource Rent Tax. The revenue arrangements and tax arrangements Petroleum taxes on income are often ‘super’ are unique in each country and can vary within a taxes applied in addition to ordinary corporate country, such that each major PSA is usually income taxes. The tax may apply only to profits unique. However, there are common features that arising from specific geological areas or will drive the assessment as income tax, royalty sometimes on a field-by-field basis within larger or government share of production. Among the areas. The petroleum tax may or may not be common features that should be considered in deductible when determining corporate income making this determination are: tax; this does not change its character as a tax • whether a well established income tax regime on income. The computation of the tax is often exists; complicated. There may be a certain number of barrels or bcm that are free of tax, accelerated • whether the tax is computed on a measure of depreciation and additional tax credits for profits; and investment. Often there is a minimum tax • whether the PSA requires the payment of computation as well. Each complicating factor in income taxes, the filing of a tax return and the computation must be separately evaluated establishes a legal liability for income taxes and accounted for in accordance with IAS 12. until such liability is discharged by payment Deferred tax must be calculated in respect of all from the entity or a third party. taxes that fall within the scope of IAS 12. The deferred tax is calculated separately for each tax Tax paid in cash or in kind by identifying the temporary differences between Tax is usually paid in cash to the relevant tax the IFRS carrying amount and the corresponding authorities. However, some governments allow tax base for each tax. Petroleum income taxes payment of tax through the delivery of oil instead may be assessed on a field-specific basis or a 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 26
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of cash for income taxes, royalty and excise and does not gross up revenue for the tax paid taxes and amounts due under licences, on its behalf by the government entity. If the production sharing contracts and the like. upstream company retains an obligation for the income tax, it would follow the accounting The accounting for the tax charge and the described above under Tax paid in cash or in kind. settlement through oil should reflect the substance of the arrangement. Determining the 1.2.10 Emission trading schemes accounting is straightforward if it is an income tax (see definition above) and is calculated in The ratification of the Kyoto Protocol by the EU monetary terms. The volume of oil used to settle required total emissions of greenhouse gases the liability is then determined by reference to the within the EU member states to fall to 92% of market price of oil. The entity has in effect ‘sold’ their 1990 levels in the period between 2008 and the oil and used the proceeds to settle its tax 2012. The introduction of the EU Emissions liability. These amounts are appropriately Trading Scheme (EU ETS) on 1 January 2005 included in gross revenue and tax expense. represents a significant EU policy response to the challenge. Under the scheme, EU member states Arrangements where the liability is calculated by have set limits on carbon dioxide emissions from reference to the volume of oil produced without energy intensive companies. The scheme works reference to market prices can make it more on a ‘cap’ and ‘trade’ basis and each member difficult to identify the appropriate accounting. state of the EU is required to set an emissions These are most often a royalty or volume-based cap covering all installations covered by the tax. The accounting should reflect the substance scheme. of the agreement with the government. Some arrangements will be a royalty fee, some will The EU cap and trade scheme is expected to be a traditional profit tax, some will be an serve as a model for other governments seeking appropriation of profits and some will be a to reduce emissions. combination of these and more. The agreement There are also several non-Kyoto carbon markets or legislation under which oil is delivered to a in existence. These include the New South Wales government must be reviewed to determine the Greenhouse Gas Abatement Scheme, the substance and hence the appropriate accounting. Regional Greenhouse Gas Initiative and Western Different agreements with the same government Climate Initiative in the United States and the must each be reviewed as the substance of the Chicago Climate Exchange in North America. arrangement, and hence the accounting may differ from one to another. Accounting for ETS Tax ‘paid on behalf’ (POB) The emission rights permit an entity to emit pollutants up to a specified level. The emission POB arrangements are varied, but generally arise rights are either given or sold by the government when a government entity will pay the income to the emitter for a defined compliance period. tax due by a foreign upstream entity to the government on behalf of the foreign upstream Schemes in which the emission rights are entity. This occurs where the upstream entity is tradable allow an entity to: the operator of fields under a PSA and the • emit fewer pollutants than it has allowances for government entity is usually the national oil and sell the excess allowances; company that holds the government’s interest in the PSA. The crucial issue in accounting for tax • emit pollutants to the level that it holds POB arrangements are if they are akin to a tax allowances for; or holiday or if the upstream entity retains an • emit pollutants above the level that it holds obligation for the income tax. allowances for and either purchase additional POB arrangements that represent a tax holiday allowances or pay a fine. such that the upstream company has no legal tax obligation are accounted for as a tax holiday. The upstream company presents no tax expense 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 27
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IFRIC 3 Emission Rights was published in A provision is recognised for the obligation to 1 Oil & Gas Value Chain & Significant Accounting Issues December 2004 to provide guidance on how to deliver allowances or pay a fine to the extent that account for cap and trade emission schemes. pollutants have been emitted. The allowances The interpretation proved controversial and was reduce the provision when they are used to withdrawn in June 2005 due to concerns over the satisfy the entity’s obligations through delivery to consequences of the required accounting the government at the end of the scheme year. because it introduced significant income However, the carrying amount of the allowances statement volatility. The withdrawal of IFRIC 3 cannot reduce the liability balance until the means there is no specific comprehensive allowances are delivered. accounting for cap and trade schemes. 1.3 Company-wide issues The guidance in IFRIC 3 remains valid, but entities are free to apply variations provided that the 1.3.1 Production sharing agreements and requirements of all relevant IFRS standards are met. Several approaches have emerged in concessions practice under IFRS. The scheme can result in There are as many forms of production sharing the recognition of assets (allowances), expense arrangements (PSA) and concessions as there of emissions, a liability (obligation to submit are combinations of national, regional and allowances) and potentially a government grant. municipal governments in oil producing areas. The allowances are intangible assets and are A PSA is the method whereby governments recognised at cost if separately acquired. facilitate the exploitation of their country’s Allowances that are received free of charge from hydrocarbon resources by taking advantage of the government are recognised either at fair value the expertise of a commercial oil and gas entity. with a corresponding deferred income (liability), Governments, particularly in emerging or poorer or at cost (nil) as allowed by IAS 20 Accounting nations, try to provide a stable regulatory and tax for Government Grants and Disclosure of regime to create sufficient certainty for Government Assistance. commercial entities to invest in an expensive and long-lived development process. An oil and gas The allowances recognised are not amortised entity will undertake exploration, supply the provided residual value is at least equal to capital, develop the resources found, build the carrying value. The cost of allowances is infrastructure and lift the natural resources. recognised in the income statement in line with The government retains title to the hydrocarbon the profile of the emissions produced. resources (whatever the quantity that is ultimately The government grant (if initial recognition at fair extracted) and often the legal title to all fixed value under IAS 20 is chosen) is amortised to the assets constructed to exploit the resources. income statement on a straight-line basis over The government will take a percentage share of the compliance period. An alternative to the the output, which may be delivered in product or straight-line basis can be used if it is a better paid in cash under an agreed pricing formula. reflection of the consumption of the economic The operating entity may only be entitled to benefits of the government grant. recover specified costs plus an agreed profit margin. It may have the right to extract resources The entity may choose to apply the revaluation over a specified period of time. model in IAS 38 Intangible Assets for the subsequent measurement of the emissions A concession agreement is much the same, allowances. The revaluation model requires that although the entity will retain legal title to its the carrying amount of the allowances is restated assets and does not share production with the to fair value at each balance sheet date, with government. The government will still be changes to fair value recognised directly in equity compensated based on production quantities except for impairment, which is recognised in the and prices – this is often described as a income statement. This is the accounting that is concession rent, royalty or a tax. required by IFRIC 3 and is seldom used in PSAs and concessions are not standard even practice. within the same legal jurisdiction. The more 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 28
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significant a new field is expected to be, the PSA rather than the risks of the exploration and more likely that the relevant government will the reserves, it can continue to capitalise E&E write specific legislation or regulations for it. and development costs, but fixed assets are not Each must be evaluated and accounted for in capitalised as such. The entity instead may have accordance with the substance of the a receivable from the government where it is arrangement. The entity’s previous experience allowed to retain oil extracted to the extent of of dealing with the relevant government will also costs incurred plus a profit margin. The accounting be important, as it is not uncommon for applied in these circumstances is therefore in governments to force changes in PSAs or accordance with IAS 39 rather than IAS 16. concessions based on changes in market All assets recognised are then accounted for conditions or environmental factors. An agreement under the usual policies of the entity for may contain a right of renewal with no significant subsequent measurement, depreciation, incremental cost. The government may have a amortisation, impairment testing and de- policy or practice with regard to renewal. These recognition. Assets should be fully depreciated or should be assessed when estimating the amortised on a units of production basis by the expected life of the agreement. date that control passes back to the government or the concession ends. A PSA is almost always Exploration, development and production a separate CGU for impairment testing purposes assets in PSAs once in production. The legal form of the PSA or concession should not impact on the recognition of exploration and Revenue and costs of PSAs and concessions evaluation (E&E) assets or production assets. The entity should record only its share of oil Costs that meet the criteria of IFRS 6, IAS 38 or under a PSA as revenue. Oil extracted on behalf IAS 16 should be recognised in accordance with of a government is not revenue or a production the usual criteria where the entity is exposed to cost. The entity acts as the government’s agent the majority of the economic risks and has to extract and deliver the oil or sell the oil and access to the probable future economic benefits remit the proceeds. Many PSAs specify that of the assets. The period of the PSA or income taxes owed by the entity are paid in concession should be longer than the expected delivered oil rather than cash. ‘Tax oil’ is recorded useful life of the majority of the constructed as revenue and as a reduction of the current tax assets. The probable hydrocarbon resources and liability to reflect the substance of the current prices should provide evidence that E&E, arrangement where the entity delivers oil to the development and fixed asset investment will be value of its current tax liability. Any volume-based recovered during the concession period. Assets tax is accounted for as royalty or excise tax are appropriately recorded on the balance sheet within operating results. of the entity beyond the E&E phase, if both conditions are present. Assets subject to depreciation, depletion or amortisation should be expensed in a manner A PSA that is shorter than the expected useful that reflects the consumption of their economic life of the related production assets or is a cost benefits. The units of production basis is usually plus arrangement can represent an arrangement the appropriate method. whereby the government compensates the entity for exploration activities and the development 1.3.2 Joint ventures and construction of fixed assets. The entity should assess the arrangement to determine to Joint ventures and other similar arrangements what extent it is bearing the risks associated with are frequently used by oil & gas companies as a the exploration, the reserves, etc, and to what way to share the high risks associated with the extent it is instead bearing the risks of industry or as a way of bringing in specialist contractual performance under the contract. skills to a particular project on an equity basis. Under arrangements where the entity is largely The legal basis for a joint venture or the bearing the risks of its performance under the description of it may take various forms; establishing a joint venture might be achieved 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 29
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through a formal joint venture contract, or controlled entity is usually, but not necessarily, 1 Oil & Gas Value Chain & Significant Accounting Issues alternatively the governance arrangements set a legal entity, such as a company. The key to out in a company’s constitution might give the identifying the presence of an entity is to same result. The feature that distinguishes a joint determine whether the joint venture can perform venture from other forms of cooperation between the functions associated with an entity, such as parties is the presence of joint control. An entering into contracts in its own name, incurring arrangement without joint control is not a joint and settling its own liabilities and holding a bank venture. account in its own right.
Joint control Accounting for jointly controlled operations Joint control is the contractually-agreed sharing Joint operations are often found where one party of control. It requires that an identified group of controls hydrocarbon rights and has production venturers must unanimously agree on all key facilities and another party has transport facilities financial and operating decisions. Put another and/or processing capacity. The parties to the way – each of those parties that share the joint joint operation will share the revenue and control have a veto right: they can each block expenses of the jointly produced end product. key decisions if they do not agree. Not all parties Each will retain title and control of its own assets. to the joint venture need to share joint control – it The venturer should recognise 100% of the is possible for a small number of key venturers to assets it controls and the liabilities it incurs as share joint control, and for other investors to well as its own expenses and its share of income account for their interest either as an investment from the sale of goods or services from the JV. in an associate (if they have significant influence) or as an available for sale financial asset in Accounting for jointly controlled assets accordance with IAS 39. A venturer to a jointly controlled assets A key test when identifying if joint control exists arrangement recognises: is to identify how disputes between ventures are resolved. If joint control exists, resolution of • its share of the jointly controlled asset, disputes will usually require eventual agreement classified according to the nature of the asset; between the venturers, independent arbitration • any liabilities the venturer has incurred; or, as a last resort, dissolution of the joint venture. • its proportionate share of any liabilities that arise from the jointly controlled assets; The nomination of one of the venturers as operator of the joint venture does not prevent • its share of expenses from the operation of the joint control. The operator’s powers are usually assets; and limited to day-to-day operational decisions – all • its share of any income arising from the key strategic financial and operating decisions operation of the assets (for example, ancillary remain with the joint venture partners collectively. fees from use by third parties). Types of joint venture Jointly controlled assets tend to reflect the sharing of costs and risk rather than the sharing Joint ventures are analysed into three classes; of profits. An example is a joint venture interest in jointly controlled operations, jointly controlled an oil field where each venturer receives its share assets and jointly controlled entities. Jointly of the oil produced. controlled assets are common in the upstream industry and jointly controlled entities in the Accounting for jointly controlled entities downstream sector. Jointly controlled assets exist when the venturers jointly own and control Jointly controlled entities can be accounted for the assets used in the joint venture. Jointly either by proportionate consolidation or using controlled entities arise when the venturers equity accounting. The choice between these jointly control an entity which, in turn holds the two methods is a policy choice, and must be assets and liabilities of the joint venture. A jointly applied consistently to all jointly controlled 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 30
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entities. A key practical issue will sometimes be arise when a super majority, for example an 80% ensuring that the results of the joint venture are majority, is required but where the threshold can incorporated by the venturer on the same basis be achieved with a variety of combinations of as the venturer’s own results – ie, using the same shareholders and no venturers are able to GAAP (IFRS) and the same accounting policy individually veto the decisions of others. choices. The growing use of IFRS is helping Accounting for these arrangements will depend reduce the adjustments required but doesn’t on the way they are structured and the rights that eliminate them. each venturer has. Companies should be aware, however, that the When the arrangement is organised in an entity, IASB is proposing to eliminate the choice of each investor will account for its investment proportionate consolidation in certain either using equity accounting in accordance with circumstances. Further details are included in IAS 28 Investments in Associates (if it has section 2. significant influence) or at fair value as a financial asset in accordance with IAS 39. When the Contributions to joint ventures investors have an undivided interest in the tangible or intangible assets, they will typically It is common for venturers to contribute assets to have a right to use a share of the operative a joint venture when it is created. This may be in capacity of that asset. An example is when a the form of cash or a non-monetary asset. number of investors have invested in an oil Contributions of assets are a part disposal by the pipeline and an investor with, say, a 20% interest contributing party, in return receiving a share of has the right to use 20% of the capacity of the the assets contributed by the other venturers. pipeline. Industry practice is for an investor to Accordingly the contributor should recognise a recognise its undivided interest at cost less gain/loss on the part disposal measured as the accumulated depreciation and any impairment difference between its share of the fair value of charges. the assets contributed by the other venturers and the other venturers’ share of the book value of An undivided interest in an asset is normally the asset it contributed. accompanied by a requirement to incur a proportionate share of the asset’s operating and The venturer recognises its share of an asset maintenance costs. These costs should be contributed by other venturers at its share of recognised as expenses in the income statement the fair value of the asset contributed. This is when incurred and classified in the same way as classified in the balance sheet according to equivalent costs for wholly-owned assets. the nature of the asset in the case of jointly controlled assets or when proportionate Accounting within the joint venture consolidation is applied to a jointly controlled entity. The equivalent measurement basis is The preceding paragraphs describe the achieved when equity accounting is applied; accounting by the investor in a joint venture. however, the interest in the asset forms part of The joint venture itself will normally prepare its the equity accounted investment balance. own financial statements for reporting to the joint venture partners, for tax compliance or for other The same principles apply when one of the other reasons. It is increasingly common for these venturers contributes a business to a joint financial statements to be prepared in venture; however, in this case one of the assets accordance with IFRS. Joint ventures are recognised will be goodwill, calculated in the typically created by the venturers contributing same way as in a business combination. assets and businesses to the joint venture in exchange for their equity interest in the JV. Investments with less than joint control Assets received by a joint venture in exchange Some co-operative arrangements may appear to for issuing shares to a venturer is a transaction be joint ventures but fail on the basis that within the scope of IFRS 2 Share-based unanimous agreement between venturers is not Payment. Such assets are therefore recognised required for key strategic decisions. This may at fair value. However, the accounting for the 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 31
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receipt of a business contributed by a venturer is deferred tax. The consideration in an asset 1 Oil & Gas Value Chain & Significant Accounting Issues not described within the IFRS literature. Two transaction is allocated to individual assets policies have developed. One is to recognise the acquired and liabilities assumed based on assets and liabilities of the business, including relative fair values. goodwill, at fair value, similar to the accounting Allocation of the cost of the combination to for an asset contribution and the accounting for a assets and liabilities acquired business combination. The second is to recognise the assets and liabilities of the IFRS 3 requires all identifiable assets and business at the same book values as used in the liabilities (including contingent liabilities) acquired contributing party’s IFRS financial statements. to be recorded at their fair value. These include The policy followed must be disclosed and assets and liabilities that may not have been consistently applied. previously recorded by the entity acquired eg, acquired reserves and resources – proved, 1.3.3 Business combinations probable and possible. Acquisition of assets and businesses are IFRS 3 also requires recognition separately of common in oil and gas. Entities seek to secure intangible assets if they arise from contractual or access to reserves or replace depleting reserves. legal rights, or are separable from the business. These may be business combinations or The standard includes a list of items that are acquisitions of groups of assets. IFRS 3 Business presumed to satisfy the recognition criteria. Combinations provides guidance on both types The items that should satisfy the recognition of transactions, and the accounting can differ criteria include trademarks, trade names, service significantly. and certification marks, Internet domain names, customer lists, customer contracts, use rights All business combinations are accounted for by (such as drilling, water, hydrocarbon, etc), applying the purchase method. The purchase patented/unpatented technology, etc, many of method is summarised as follows: which may apply to oil and gas companies. a) identify the acquirer; Fair values of assets are often determined using b) measure the cost of the combination; and discounted cash flow models. These models should include the tax amortisation benefit (TAB) c) record the fair value of assets acquired and available to the typical market participant. liabilities assumed. The TAB represents the value associated with the tax deductibility for an asset. Asset values Definition of a business obtained through direct market observations A business is an integrated set of activities rather than the use of discounted cash flows managed together to provide a return to (DCFs) already reflect the general tax benefit investors or other economic benefits. The key associated with the asset. Differences between element of the definition is ‘integration’. the general tax benefit of each asset and the Upstream activities in production will typically specific tax benefits for the acquirer are included represent a business, whereas those at the within goodwill because these are entity-specific. exploration stage will typically represent a collection of assets. Projects that lie in the Goodwill development stage will require consideration of Past practice in upstream transactions the stage of development and other relevant accounted for under national GAAP or previous factors. versions of IFRS seldom resulted in the The accounting for a business combination and recognition of significant amounts of goodwill. a group of assets can be substantially different. The consideration paid was allocated to proved, A business combination will usually result in the probable and possible reserves. recognition of goodwill and deferred tax. An asset IFRS 3 requires that the fair value of the assets transaction qualifies for the initial recognition acquired and liabilities assumed are recognised. exemption and therefore there is usually no The difference between consideration and the fair 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 32
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value of net assets gives rise to positive or Exchange differences can arise for two reasons: negative goodwill. This residual approach to the when a transaction is undertaken in a currency calculation of goodwill required by IFRS 3 is likely other than the entity’s functional currency; or to result in the goodwill in upstream business when the presentation currency differs from the combinations. Any goodwill is likely to represent functional currency. the value paid for assets that do not qualify for separate recognition on the balance sheet (such Determining the functional currency as an assembled workforce), synergies paid for Identifying the functional currency for an oil and by the acquirer and, occasionally, overpayments. gas entity can be complex because there are However, IFRS 3 requires certain assets and often significant cash flows in both the US dollar liabilities acquired in a business combination to and local currency. be recognised on a basis other than fair value. Determining the functional currency, Examples include pension liabilities and deferred management should take into account primarily tax. Deferred tax is calculated after the fair values the currency that dominates the determination of of the other identifiable assets and liabilities have the sales prices and that most influences been determined by comparing the fair value operating costs. recognised for accounting purposes with the tax base of each asset and liability. Consequently, The currency in which selling prices are the mechanics of the deferred tax calculation and denominated and settled is often the currency the goodwill calculation might result in goodwill that mainly dominates the determination of sales being recognised solely as a result of the prices, but this is not necessarily the case. recognition of the deferred tax. That is, goodwill Many sales within the oil and gas industry are might be recognised when there is no expectation conducted either in, or with reference to, the US of goodwill because there are no unrecognised dollar. However, the US dollar may not always assets, no synergies and no overpayments. be the main influence on these transactions. This anomaly will persist until the IASB revises For many of the commodities sold by oil and gas the deferred tax standard, expected in 2009. entities, it is difficult to identify a single country whose competitive forces and regulations mainly 1.3.4 Functional currency determine the selling prices. Oil and gas entities commonly undertake If the primary indicators do not provide an transactions in more than one currency, as obvious answer to what the functional currency commodity prices are often denominated in US is, the currency in which an entity’s finances are dollars and costs are typically denominated in denominated should be considered ie, the the local currency. Determination of the functional currency in which funds from financing activities currency can require significant analysis and are generated and the currency in which receipts judgement. from operating activities are retained. An entity’s functional currency is the currency of A typical oil and gas entity in the production the primary economic environment in which it stage receives its revenue predominantly in US operates. This is the currency in which the entity dollars with most of its costs denominated in the measures its results and financial position. local currency and only some in US dollars. An entity’s presentation currency is the currency Management may conclude that the US dollar is in which it presents its accounts. Reporting the functional currency, as the majority of the entities may select any presentation currency cash flows are denominated and settled in the (subject to the restrictions imposed by local US dollar. regulations or shareholder agreements). Oil and gas entities at different stages of However, the functional currency must reflect the operation may reach a different view about their substance of the entity’s underlying transactions, functional currency. Functional currency is not a events and conditions; it is unaffected by the free choice, and an entity’s functional currency choice of presentation currency. does not change unless there are changes in its operations and transaction flows. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 33
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Determining the functional currency of holding 1 Oil & Gas Value Chain & Significant Accounting Issues companies and treasury companies may present some unique challenges; these have largely internal sources of cash although they may pay dividends, make investments, raise debt and provide risk management services. The underlying source of the cash flows to such companies is usually the appropriate basis for determining the functional currency. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 34 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 35
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2 Developments from the IASB
2.1 Extractive activities research The changes to the standard were made as part project of the IASB’s and FASB’s short-term convergence project. The elimination of the The extractive activities project at the IASB is a option to expense borrowing costs does not comprehensive research project and the first step achieve full convergence with US GAAP, as some towards a standard focused on upstream technical differences remain (for example, extractive activities. Any new standard is definitions of borrowing costs and qualifying expected to supersede IFRS 6 Exploration for assets). and Evaluation of Mineral Resources. The effective date of IAS 23R is 1 January 2009, The project was approved in 2004 and is with earlier adoption permitted. The amendments considering the unique issues associated with are to be applied prospectively; comparatives will accounting for upstream activities. This involves not need to be restated. The Board has provided researching: additional relief by allowing management to designate a particular date on which it can start • financial reporting issues associated with oil & applying the amendments. For example, gas reserves and resources (including the management can decide to designate 1 October exploration for reserves and resources) – in 2008 as a starting date, because the company particular whether and how to define, starts a project for which management would like recognise, measure and disclose reserves and to capitalise interest when it applies IAS 23R in resources; and 2009. • considering other issues related to extractive activity accounting as identified in the IASC’s 2.3 Emissions Trading Schemes Extractive Industries Issues Paper. The IASB added the emissions trading topic to A Discussion Paper is due in late 2008. Despite its agenda after the withdrawal of IFRIC 3 the scope of the project including ‘other issues’ Emission Rights in 2005. The project was and referring to the previous Issues Paper, it is temporarily deferred (due to deferral of the expected to focus almost exclusively on the project relating to government grants) and again reserves and resources recognition questions. activated in December 2007 with the increasing The Issues Paper spanned a wide range of international interest in emission trading schemes issues relevant to the industry including and the diversity in practice that has arisen. The decommissioning and restoration, revenue Board decided to limit the scope of the project to recognition, joint ventures and impairment. The the issues that arise in accounting for emissions IASB’s discussions to date have raised the trading schemes, rather than addressing broadly possibility of recognising and measuring reserves the accounting for all government grants (which on the balance sheet at fair value. This will likely would have involved re-activating the IAS 20 be given consideration as one of the possible project). accounting models during the Board’s The purpose of the project is to comprehensively deliberations and its public consultations. address the accounting for emissions trading 2.2 Borrowing costs schemes. It will cover the following issues: • whether the emissions allowances are an asset The IASB issued amendments to IAS 23 (considering different ways of acquiring the Borrowing Costs in March 2007. IAS 23R asset) and what its nature is; removes the policy choice of either capitalising or • recognition and measurement of allowances; expensing borrowing costs and requires • whether liability exists, what its nature is and management to capitalise borrowing costs how it should be measured. attributable to qualifying assets. Qualifying assets The project is in the research phase, with the are assets that take a substantial time to get Board gathering information on the characteristics ready for their intended use or sale. An example of various emissions trading schemes. This will is self-constructed assets such as power plant, be the basis for preparation of a comprehensive buildings, machinery. package that outlines the alternative models that 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 37
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could be used to account for emissions trading Switching from proportionate consolidation to 2 Developments from the IASB schemes. The timing of an initial due process equity accounting has the following impacts: document and the estimated project completion • Revenues are reduced: the venturer cannot date is not yet determined. present its share of the joint venture’s revenue 2.4 ED 9 Joint Arrangements as part of its own revenue. • Tangible and intangible assets are reduced: The IASB published in September 2007 the the gross presentation of the venturer’s share exposure draft ED 9 Joint Arrangements, which of the JV’s tangible assets, intangible assets, sets out proposals for the recognition and other assets and liabilities is replaced by a disclosure of interests in joint arrangements. It is single net amount, classified as part of its intended to replace IAS 31 Interests in Joint investments. Ventures and it is another step towards the goals of the Memorandum of Understanding between Although the information about these gross the IASB and the FASB on the convergence of amounts is included in the notes to the financial IFRS and US GAAP. The changes proposed are statements, removing them from the primary to IFRS only; there are no changes proposed to statements diminishes their prominence. Moving US GAAP. to equity accounting for an E&P joint venturer also raises the question about the presentation of ED 9’s core principle is that parties to a joint reserves. Some regulators require that the arrangement recognise their contractual rights reserves presented reflect only those that will and obligations arising from the arrangement. result in revenue when produced. This The ED therefore focuses on the recognition of accounting change would – in those assets and liabilities by the party to the joint circumstances – require a restatement of the arrangement. reserves reported. The scope of the ED is broadly the same as that of IAS 31. That is, unanimous agreement is The ‘dual approach’ to joint arrangements required between the key parties that have the The second change is the introduction of a ‘dual power to make the financial and operating policy approach’ to the accounting for joint arrangements. decisions for the joint arrangement. ED 9 carries forward with modification from IAS There are two principal changes proposed by 31, the three types of joint arrangement; each ED 9. The first is the elimination of proportionate type having specific accounting requirements. consolidation for a jointly controlled entity. The The first two types are Joint Operations and second change is the introduction of a ‘dual Joint Assets. The description of these types and approach’ to the accounting for joint the accounting for them is consistent with Jointly arrangements. Controlled Operations and Jointly Controlled Assets in IAS 31. The third type of joint Elimination of proportionate consolidation arrangement is a Joint Venture, which is accounted for using equity accounting. A Joint Eliminating proportionate consolidation will have Venture is identified by the party having rights a fundamental impact on the income statement only to a share of the outcome of the joint and balance sheet for some entities. Entities that arrangement, for example a share of the profit currently use proportionate consolidation to or loss of the joint arrangement. The key change account for jointly controlled entities may need to is that a single joint arrangement may contain account for many of these using the equity more than one type; for example Joint Assets method. These entities will replace the line-by- and a Joint Venture. The party to such a joint line proportionate consolidation of the income arrangement accounts first for the assets and statement and balance sheet by a single net liabilities of the Joint Assets arrangement and result and a single net investment balance. then uses a residual approach to equity accounting for the Joint Venture part of the joint arrangement. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 38
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The introduction of the dual approach will require accordance with the ED proposals. The all companies to review each of their joint venture accounting described in the examples may agreements. They will need to determine whether require some entities to modify their accounting each joint arrangement exhibits the properties practices in these areas. and characteristics of joint assets/joint operations (typically a direct use of Timetable assets/obligation for liabilities) and/or the The IASB expects to publish a new IFRS for joint characteristics of a Joint Venture (an interest in arrangements in quarter 4 of 2008. The the outcome of the JV, eg, a share of profit implementation date has not been decided yet generated by the Joint Venture). An interest in the but might be as early as 2010. Those companies outcome/net result will more commonly arise that conduct a significant amount of their when the joint arrangement is incorporated; business through joint ventures may want to however, unincorporated joint arrangements are follow the development of this standard carefully. capable, in some circumstances, of returning a net result/profit to the partners, and so should 2.5 IFRS 3, Business combinations also be analysed. (revised) and IAS 27, Other considerations Consolidated and separate The results presented in financial statements will financial statements (revised) reflect the cumulative impact of all relevant The IASB issued two revised standards in factors. For example, if a company has an January 2008: IFRS 3R Business Combinations interest in the net result of an E&P joint venture it and IAS 27R Consolidated and Separate will account for its interest in the joint venture Financial Statements. The revised standards are using equity accounting. However, if it also effective for annual periods beginning on or after purchases (its share of) oil from the joint venture 1 July 2009. The standards result in more fair and sells it to a third party, it will record revenue value changes being recorded through the for those third-party sales in addition to equity income statement and cement the ‘economic accounting for its interest in the joint venture, entity’ view of the reporting entity. after appropriate eliminations. The key differences between IFRS 3R and IAS A company that finds itself moving from 27R and the previous standards are as follows: proportionate consolidation to equity accounting may also want to consider the impact of its • Business combinations achieved by contract internal management reporting. IFRS 8 Operating alone and business combinations involving Segments requires disclosure of segmental only mutual entities are accounted for under information on the same basis as is provided to the revised IFRS 3. the company’s chief operating decision-maker • Minor changes in the definition of a business (CODM). The accounting basis used for providing with more significant changes in the information to the CODM is used to present the application guidance. segment information in accordance with IFRS 8. Accordingly, if the CODM is presented with • Transaction costs incurred in connection with information prepared using proportionate the business combination are expensed when consolidation, then this is the basis that should incurred and are no longer included in the cost be presented in the segment information and of the acquiree. reconciled to the primary financial statements. • An acquirer recognises contingent The ED includes a number of illustrative consideration at fair value at the acquisition examples, including a farm-in arrangement and a date. Subsequent changes in the fair value of unitisation. These examples describe the such contingent consideration will often affect expected accounting for these arrangements in the income statement. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 39
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• The acquirer recognises either the entire • All purchases of equity interests from and 2 Developments from the IASB goodwill inherent in the acquiree, independent sales of equity interests to non-controlling of whether a 100% interest is acquired (full interests are treated as treasury share goodwill method), or only the portion of the transactions. Any difference between the total goodwill that corresponds to the amount of consideration received or given and proportionate interest acquired (as currently the amount of non-controlling interest is the case under IFRS 3). recorded in equity. Entities will no longer be able to report gains on the partial disposal of a • Any previously-held non-controlling interest (as subsidiary. a financial asset or associate, for example) is remeasured to its fair value at the date of • Additional disclosure requirements. obtaining control, and a gain or loss is Several of the requirements may be of interest to recognised in the income statement. oil and gas entities. The slight changes in the • There are new provisions to determine whether definition of a business and the related a portion of the consideration transferred for application guidance may push transactions the acquiree or the assets acquired and into business combination accounting sooner in liabilities assumed are part of the business the development process. The requirement to combination or part of another transaction to re-assess all contracts and arrangements for be accounted for separately under the embedded derivatives may also result in more applicable IFRS. classified as derivatives with subsequent income statement volatility. Contingent consideration is • There is new guidance on classification and more common in mining, with selling shareholders designation of assets, liabilities and equity seeking to profit from previously undiscovered instruments acquired or assumed in a business resources or favourable price movements. These combination on the basis of the conditions that arrangements are less common in oil and gas but exist at the acquisition date, except for leases do exist. All such arrangements will be captured and insurance contracts. This guidance by the contingent consideration guidance and includes reassessment of embedded recognised as liabilities of the acquirer whether derivatives. or not payment is probable at the date of the • Intangible assets are recognised separately transaction. All subsequent changes are income from goodwill if they are identifiable – ie, if statement items. they are separable or arise from contractual or other legal rights. The reliably-measurable criterion is presumed to be met. • Recognition of the acquiree’s deferred tax assets after the initial accounting for the business combination leads to an adjustment of goodwill only if the adjustment is made within the measurement period (not exceeding one year from the acquisition date) and the adjustment results from new information about facts and circumstances that already existed at the acquisition date. Otherwise, it must be reflected in the income statement with no change to goodwill. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 40
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3 IFRS/US GAAP Differences
There are a number of differences between IFRS and US GAAP. This section provides a summary description of those IFRS/US GAAP differences that are particularly relevant to oil & gas entities. These differences relate to: exploration and evaluation, reserves & resources, depreciation, inventory valuation, impairment, disclosure of resources, decommissioning obligations, financial instruments, revenue recognition, joint ventures and business combinations.
3.1 Exploration and evaluation
Issue IFRS US GAAP
Capitalisation in No formal capitalisation models Two formal models – successful the exploration & prescribed. IFRS 6 permits efforts and full cost, in accordance evaluation phase continuation of previous accounting with FAS 19 and Regulation S-X policy for E&E assets but only until Rule 4-10. Types of expenditure that evaluation is complete. Wide range of may be capitalised are defined. policies possible from capitalisation of all E&E expenditures after licence acquisition to the expense of all such expenditures. However, changes to capitalisation polices are restricted to those which move the policy closer to compliance with the IFRS Framework.
Impairment of E&E IFRS 6 provides specific relief for No similar relief for E&E assets. assets E&E assets. Cash-generating units This is unlikely to result in a GAAP (CGUs) may be combined up to the difference when the company uses level of a segment for E&E assets. successful efforts under US GAAP. Impairment testing is required A company applying full cost will immediately before assets are probably be able to shelter reclassified from E&E to unsuccessful exploration costs in development. larger pools until these are depleted through production. IFRS 6 also provides guidance in relation to identifying trigger events No reversal of impairment charges for an impairment review. is permitted. Impairment charges against E&E Evaluation of exploration activity that assets are reversed if recoverable is completed after the balance sheet amount subsequently increases. date and that concludes that the exploration has been unsuccessful, Evaluation of exploration activity that is classified as a type I (adjusting) is completed after the balance sheet post-balance sheet event (FIN 36). date and that concludes that the exploration has been unsuccessful, is classified as a non-adjusting (type II) post-balance sheet event. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 43
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3.2 Reserves & resources 3 IFRS/US GAAP Differences
Issue IFRS US GAAP
Definitions No system of reserve classification Entities must use the definitions of prescribed. No restriction on the reserves and resources approved by categories used for financial reporting the SEC. Only proved reserves can be purposes. disclosed for financial reporting purposes. Proved and proved developed are used for depletion depending on the nature of the costs.
3.3 Depreciation of production and downstream assets
Issue IFRS US GAAP
Depletion of The reserve and resource The definitions of reserves used production assets classifications used for the depletion are those adopted by the SEC. calculation are not specified. An Proved reserves are used for entity should develop an appropriate depletion of acquisition costs and accounting policy for depletion and proved developed reserves are used apply the policy consistently, eg, unit for depletion of development costs. of production method. Commonly used categories of reserves include proved developed, or proved developed and undeveloped or proved and probable.
Components of Significant parts (components) of an Cost categories follow major types property, plant and item of PPE are depreciated of assets as required by FAS 19 – equipment separately if they have different useful individual items are not separated. lives. Pool-wide depletion of Production assets held in a full cost production assets not permitted. pool depleted on a pool-wide basis.
3.4 Inventory valuation issues
Issue IFRS US GAAP
Impact of changes Inventories measured at the lower of Inventories measured at the lower of in market prices cost and net realisable value. Net cost and market value. When market after balance sheet realisable value does not reflect value is lower than cost at the date changes in the market price of the balance sheet date, a recovery of inventory after the balance sheet date market value after the balance sheet if this reflects events and conditions date but before the issuance of the that arose after the balance sheet financial statements is recognised as date. a type I (adjusting) post balance sheet event. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 44
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3.5 Impairment of production and downstream assets
Issue IFRS US GAAP
Impairment test Assets or groups of assets (cash Long-lived assets are tested for triggers generating units) are tested for impairment only if indicators are impairment when indicators of present and an undiscounted cash impairment are present. flow test suggests that the carrying amount of an asset will not be recovered from its use and eventual disposal. Unproved properties are assessed periodically for impairment based on results of drilling activity, firm plans, etc.
Level at which Assets tested for impairment at the Similar to IFRS except that the impairment tested cash generating unit (CGU) level. grouping of assets is based on CGU is the smallest identifiable group largely independent cash flows (in of assets that generates cash inflows and out) rather than just cash that are largely independent of the inflows. cash inflows from other assets or Production assets accounted for groups of assets. under the full cost method are tested Production assets typically tested for for impairment on a pool-wide basis. impairment at the field level. A pool- wide impairment test is not permitted.
Measurement of Impairment is measured as the Impairment of proved properties is impairment excess of the asset’s carrying measured as the excess of the amount over its recoverable amount. asset’s carrying amount over its fair The recoverable amount is the higher value. Impairment of unproved of its value in use and fair value less properties is based on results of costs to sell. activities.
Reversal of Impairment losses, other than those Impairment losses are never impairment charge relating to goodwill, are reversed reversed. when there has been a change in the economic conditions or in the expected use of the asset.
3.6 Disclosure of resources
Issue IFRS US GAAP
Disclosure No specific requirements to disclose Detailed disclosures required by FAS requirements reserves and resources; however, IAS 69 and SEC Regulation S-X. 1 includes general requirement to disclose additional information necessary for a fair presentation. 3 IFRS/US GAAP Differences 43 Range of cash flows prepared and Range of cash flows prepared expected risk weighted to calculate values. the liability are Risks associated with in the cash flows, only reflected risk, which is except for credit in the discount rate. reflected The discount rate for an existing liability is not updated. Accordingly, to undiscounted revisions downward using the discounted cash flows are rate when adjusted risk-free credit the liability was originally recognised. are however, revisions, Upward credit discounted using the current rate at the time of adjusted risk-free the revision. Decommissioning liability need not assets with for be recognised indeterminate life. of a in respect The asset recognised decommissioning obligation is a the asset to be separate asset from decommissioned. because This distinction is relevant of the limits placed on subsequent adjustments to the asset as a of the of remeasurement result In decommissioning liability. the limit that the particular, decommissioning asset cannot be for US GAAP below zero reduced with the limit that the compared asset to be decommissioned cannot for IFRS. below zero be reduced Financial reporting in the oil and gas industry and the oil in reporting Financial The adjustment to PPE when the decommissioning liability is forms part of the asset recognised to be decommissioned. Liability measured at the best Liability measured required estimate of the expenditure to settle the obligation. the liability are Risks associated with the in the cash flows or in reflected discount rate. at each The discount rate is updated balance sheet date. Recognition of decommissioning asset Measurement of Measurement liability Issue IFRS US GAAP 3.7 Decommissioning obligations 3.7 Decommissioning 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 45 Seite Uhr 12:01 10.04.2008 edit final O&G 08PwC0290_IFRS 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 46
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3.8 Financial instruments and embedded derivatives IFRS and US GAAP take broadly consistent approaches to the accounting for financial instruments; however, many detailed differences exist between the two. IFRS and US GAAP define financial assets and financial liabilities in similar ways. Both require recognition of financial instruments only when the entity becomes a party to the instrument’s contractual provisions. Financial assets, financial liabilities and derivatives are recognised initially at fair value under IFRS and US GAAP. Transaction costs that are directly attributable to the acquisition or issue of a financial asset or financial liability are added to its fair value on initial recognition unless the asset or liability is measured subsequently at fair value with changes in fair value recognised in profit or loss. Subsequent measurement depends on the classification of the financial asset or financial liability. Certain classes of financial asset or financial liability are measured subsequently at amortised cost using the effective interest method and others, including derivative financial instruments, at fair value through profit or loss. The Available For Sale (AFS) class of financial assets is measured subsequently at fair value through equity (other comprehensive income). These general classes of financial asset and financial liability are used under both IFRS and US GAAP, but the classification criteria differ in certain respects. Selected differences between IFRS and US GAAP are summarised below.
Issue IFRS US GAAP
Definition of a A derivative is a financial instrument: Sets out similar requirements, derivative except that the terms of the • whose value changes in response derivative contract should: to a specified variable or underlying rate (for example, • require or permit net settlement; interest rate); and • that requires no or little net • identify a notional amount. investment; and There are therefore some derivatives • that is settled at a future date. that may fall within the IFRS definition, but not the US GAAP definition.
Continued on next page 3 IFRS/US GAAP Differences 45 Similar to IFRS except that there are are that there Similar to IFRS except of what is some detailed differences meant by ‘closely related’. if a hybrid Under US GAAP, embedded instrument contains an and derivative that is not clearly to the host contract closely related to required at inception, but is not the embedded be bifurcated, derivative is continuously for bifurcation. reassessed and normal The normal purchases sales exemption cannot be claimed for a contract that contains a separable embedded derivative – even if the host contract would otherwise qualify for the exemption. Similar to IFRS, contracts that qualify to be classified as for normal sales do not and normal purchases need to be accounted for as financial instruments. The conditions under which the normal purchase and normal sales exemption is available is similar to IFRS but exist. detailed differences Application of the normal purchases and normal sales exemption is an election. Financial reporting in the oil and gas industry and the oil in reporting Financial risks of the embedded derivatives risks of the embedded to the not closely related are and risks economic characteristics of the host contract; same terms as the embedded derivative would meet the definition of a derivative; and value through at fair measured or loss. profit Derivatives embedded in hybrid Derivatives embedded separated when: contracts are • the economic characteristics and • a separate instrument with the • the hybrid instrument is not of whether Under IFRS, reassessment an embedded derivative needs to be separated is permitted only when in the terms of the is a change there contract that significantly modifies the cash flows that would otherwise under the contract. be required which an A host contract from embedded derivative has been separated, qualifies for the own-use exemption if the own-use criteria are met. Contracts to buy or sell a non- financial item that can be settled net in cash or another financial for as accounted instrument are financial instruments unless the into and contract was entered continues to be held for the purpose or delivery of of the physical receipt the non-financial item in accordance purchase, expected with the entity’s sale or usage requirements. Application of the own-use an – not exemption is a requirement election. Own-use exemption IssueSeparation of embedded derivatives IFRS US GAAP 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 47 Seite Uhr 12:01 10.04.2008 edit final O&G 08PwC0290_IFRS 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 48
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3.9 Revenue recognition
Issue IFRS US GAAP
Overlift/underlift Revenue is recognised in US GAAP permits a choice of the overlift/underlift situations on a sales/liftings method or the modified entitlements basis. entitlements method for revenue recognition.
3.10 Joint ventures
Issue IFRS US GAAP
Definition A joint venture is a contractual A corporate joint venture is a agreement that requires all significant corporation owned and operated by decisions to be taken unanimously by a small group of businesses as a all parties sharing control. separate and specific business or project for the mutual benefit of the members of the group.
Types of joint IFRS distinguishes between three Refers only to jointly controlled venture types of joint venture: entities, where the arrangement is carried on through a separate • jointly controlled entities – the corporate entity. arrangement is carried on through a separate entity (company or partnership); • jointly controlled operations – each venturer uses its own assets for a specific project; and • jointly controlled assets – a project carried on with assets that are jointly owned.
Continued on the next page 3 IFRS/US GAAP Differences 47 Prior to determining the accounting Prior to determining the model, an entity first assesses is a Variable whether the joint venture Entity (VIE). If the joint venture Interest is a VIE, the primary beneficiary joint venture should consolidate. If the assessis not a VIE, venturers the voting interest accounting using the does not exist then model. If control typically the arrangement will meet the criteria to apply the equity method in the the investment to measure Proportionate entity. jointly controlled consolidation is generally not permitted except for unincorporated entities operating in certain industries, such as the oil & gas industry. Common practice is for an investor contributions to to record (venturer) cost (ie, the at a joint venture amount of cash contributed and the book value of other non-monetary assets contributed). However, non-cash sometimes, appreciated to a newly contributed assets are in exchange for formed joint venture when others have an equity interest invested cash or other financial-type market value. assets with a ready in this Practice and existing literature have been put Arguments vary. area forth that assert that the investor non-cash contributing appreciated part realised assets has effectively of as a result of the appreciation to which in the venture its interest others have contributed cash. can be Immediate gain recognition The specific facts and appropriate. gain will affect circumstances careful and require recognition, analysis. Financial reporting in the oil and gas industry and the oil in reporting Financial the contributed assets have not to the jointly been transferred entity; controlled contributed cannot be measured or reliably; substance. commercial A venturer that contributes non- that contributes A venturer or monetary assets, such as shares to a jointly assets, non-current exchange for an entity in controlled the jointly controlled in equity interest in its consolidated entity recognises income statement the portion of the gain or loss attributable to the equity venturers, of the other interests except when: • of the significant risks and rewards • the gain or loss on the assets • lacks the contribution transaction Either the proportionate consolidation Either the proportionate method is method or the equity consolidation allowed. Proportionate of the share the venturer’s requires and assets, liabilities, income combined on a expenses to be either similar items in line-by-line basis with statements, or financial the venturer’s in the as separate line items reported financial statements. venturer’s Contributions to a jointly controlled entity Issue Jointly controlled entities IFRS US GAAP 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 49 Seite Uhr 12:01 10.04.2008 edit final O&G 08PwC0290_IFRS 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 50
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3.11 Business Combinations The following summary reflects differences between the requirements of IFRS 3 (Issued 2004) and FAS 141 (Issued 2001).
Issue IFRS US GAAP
Purchase method Assets, liabilities and contingent There are specific differences from – fair values on liabilities of acquired entity are IFRS. acquisition recognised at fair value where fair Contingent liabilities of the acquiree value can be measured reliably. are recognised if, by the end of the Goodwill is recognised as the allocation period: residual between the consideration paid and the percentage of the fair • their fair value can be determined, value of the net assets acquired. or In-process research and • they are probable and can be development is generally capitalised. reasonably estimated. Liabilities for restructuring activities Specific rules exist for acquired are recognised only when the in-process research and acquiree has an existing liability at development (generally expensed). acquisition date. Liabilities for future Some restructuring liabilities relating losses or other costs expected to be solely to the acquired entity may be incurred as a result of the business recognised if specific criteria about combination cannot be recognised. restructuring plans are met.
Purchase method Included in cost of combination at Generally, not recognised until – contingent acquisition date if adjustment is contingency is resolved and the consideration probable and can be measured amount is determinable. reliably.
Purchase method Stated at minority’s share of the fair Stated at minority’s share of pre- – minority interests value of acquired identifiable assets, acquisition carrying value of net at acquisition liabilities and contingent liabilities. assets.
Purchase method Capitalised but not amortised. Similar to IFRS, although the level of – intangible assets Goodwill and indefinite-lived impairment testing and the with indefinite intangible assets are tested for impairment test itself are different. useful lives and impairment at least annually at either goodwill the cash-generating unit (CGU) level or groups of CGUs, as applicable.
Purchase method The identification and measurement Any remaining excess after – negative goodwill of acquiree’s identifiable assets, reassessment is used to reduce liabilities and contingent liabilities are proportionately the fair values reassessed. Any excess remaining assigned to non-current assets (with after reassessment is recognised in certain exceptions). Any excess is the income statement immediately. recognised in the income statement immediately as an extraordinary gain. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 51
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The revisions made to FAS 141 in 2007 and to IFRS 3 in 2008 remove some of the differences 3 IFRS/US GAAP Differences between IFRS and US GAAP. The following table identifies those aspects of business combinations accounting from the table above which will become consistent between IFRS and US GAAP as a result of the revisions to the standards.
Issue IFRS and US GAAP
Acquisition method Assets and liabilities of the acquired entity are recognised at fair value. – fair values on This includes acquired in-process research and development. acquisition Liabilities for restructuring activities are recognised only when the acquiree has an existing liability at the acquisition date.
Acquisition method Contingent consideration recognised at fair value. – contingent consideration
Acquisition method The identification and measurement of acquiree’s identifiable assets, – negative goodwill liabilities and contingent liabilities are reassessed. Any excess remaining after reassessment is recognised in the income statement immediately. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 52
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The following summary reflects differences between the requirements of IFRS 3 (Revised 2008) and FAS 141 (Revised 2007).
Issue IFRS US GAAP
Assets and Recognise contingent liabilities at fair Liabilities and assets subject to liabilities arising value if fair value can be measured contractual contingencies are from contingencies reliably. If not within the scope of IAS recognised at fair value. Recognise 39, measure subsequently at higher liabilities and assets subject to other of amount initially recognised and contingencies only if more likely best estimate of amount required to than not that they meet definition of settle (under IAS 37). asset or liability at acquisition date. After recognition, retain initial Contingent assets are not recognised. measurement until new information is received, then measure at the higher of amount initially recognised and amount under FAS 5 for liabilities subject to contingencies, and lower of acquisition date fair value and the best estimate of a future settlement amount for assets subject to contingencies.
Employee benefit Measure in accordance with IFRS 2 Measure in accordance with FAS arrangements and and IAS 12, not at fair value. 123 and FAS 109, not at fair value. deferred tax
Non-controlling Measure at fair value or at NCI share Measure at fair value. interest (NCI) – of fair value of identifiable net assets. formerly Minority Interest
Contingent If not within scope of IAS 39, account Measure subsequently at fair value, consideration for subsequently under IAS 37. with changes recognised in earnings Measure financial asset or liability if classified as asset or liability. contingent consideration at fair value, with changes recognised in earnings or other comprehensive income.
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4 Financial disclosure examples
4.1 Exploration & evaluation Initial recognition and reclassification out Successful Efforts Method of E&E under IFRS6
BG Group plc BP plc Exploration expenditure Licence and property acquisition costs “BG Group uses the ‘successful efforts’ method “Exploration licence and leasehold property of accounting for exploration expenditure. acquisition costs are capitalized within intangible Exploration expenditure, including licence fixed assets and amortized on a straight-line acquisition costs, is capitalised as an intangible basis over the estimated period of exploration. asset when incurred and certain expenditure, Each property is reviewed on an annual basis to such as geological and geophysical exploration confirm that drilling activity is planned and it is costs, is expensed. A review of each licence or not impaired. If no future activity is planned, field is carried out, at least annually, to ascertain the remaining balance of the licence and whether proved reserves have been discovered. property acquisition costs is written off. Upon When proved reserves are determined, the determination of economically recoverable relevant expenditure, including licence acquisition reserves (‘proved reserves’ or ‘commercial costs, is transferred to property, plant and reserves’), amortization ceases and the remaining equipment and depreciated on a unit of costs are aggregated with exploration production basis. Expenditure deemed to be expenditure and held on a field-by-field basis as unsuccessful is written off to the income proved properties awaiting approval within other statement. Exploration expenditure is assessed intangible assets. When development is for impairment when facts and circumstances approved internally, the relevant expenditure is suggest that its carrying amount exceeds its transferred to property, plant and equipment.” recoverable amount. For the purposes of impairment testing, exploration and production Exploration expenditure assets may be aggregated into appropriate cash “Geological and geophysical exploration costs generating units based on considerations are charged against income as incurred. Costs including geographical location, the use of directly associated with an exploration well are common facilities and marketing arrangements.” capitalized as an intangible asset until the drilling of the well is complete and the results have Annual Report and Accounts 2007, BG Group plc, p. 74 been evaluated. These costs include employee remuneration, materials and fuel used, rig costs, Royal Dutch Shell plc delay rentals and payments made to contractors. Exploration costs If hydrocarbons are not found, the exploration “Shell follows the successful efforts method of expenditure is written off as a dry hole. If accounting for oil and natural gas exploration hydrocarbons are found and, subject to further costs. Exploration costs are charged to income appraisal activity, which may include the drilling when incurred, except that exploratory drilling of further wells (exploration or exploratory-type costs are included in property, plant and stratigraphic test wells), are likely to be capable equipment, pending determination of proved of commercial development, the costs continue reserves. Exploration wells that are more than to be carried as an asset. All such carried costs 12 months old are expensed unless (a) proved are subject to technical, commercial and reserves are booked, or (b) (i) they have found management review at least once a year to commercially producible quantities of reserves, confirm the continued intent to develop or and (ii) they are subject to further exploration or otherwise extract value from the discovery. appraisal activity in that either drilling of When this is no longer the case, the costs are additional exploratory wells is under way or firmly written off. When proved reserves of oil and planned for the near future or other activities are natural gas are determined and development is being undertaken to sufficiently progress the sanctioned, the relevant expenditure is assessing of reserves and the economic and transferred to property, plant and equipment.” operating viability of the project.” Annual Report and Accounts 2007, BP plc, p. 102 Annual Report and Accounts 2007, Royal Dutch Shell plc, p. 118 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 55
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Dry Holes and decommissioning and restoration provisions) 4 Financial disclosure examples that are based on proved reserves are also Hydro ASA subject to change. Exploration and development costs of oil and gas reserves Proved reserves are estimated by reference to “Hydro uses the successful efforts method of available reservoir and well information, including accounting for oil and gas exploration and production and pressure trends for producing development costs, and is in accordance with reservoirs and, in some cases, subject to IFRS 6 Exploration for and Evaluation of Mineral definitional limits, to similar data from other Resources. Exploratory costs, excluding the cost producing reservoirs. Proved reserves estimates of exploratory wells and acquired exploration are attributed to future development projects only rights, are charged to expense as incurred. where there is a significant commitment to Drilling costs for exploratory wells are capitalized project funding and execution and for which pending the determination of the existence of applicable governmental and regulatory proved reserves. If reserves are not found, the approvals have been secured or are reasonably drilling costs are charged to operating expense.” certain to be secured. Furthermore, estimates of proved reserves only include volumes for which Annual Report and Accounts 2007, Hydro ASA, p. F12 access to market is assured with reasonable certainty. All proved reserves estimates are subject to revision, either upward or downward, 4.2 Reserves & resources based on new information, such as from Estimation of reserves development drilling and production activities or from changes in economic factors, including Royal Dutch Shell plc product prices, contract terms or development Estimation of oil and gas reserves plans. In general, changes in the technical “Oil and gas reserves are key elements in Shell’s maturity of hydrocarbon reserves resulting from investment decision-making process which is new information becoming available from focussed on generating value. They are also an development and production activities have important element in testing for impairment. tended to be the most significant cause of annual Changes in proved oil and gas reserves will also revisions. affect the standardised measure of discounted cash flows and changes in proved oil and gas In general, estimates of reserves for undeveloped reserves, particularly proved developed reserves, or partially developed fields are subject to greater will affect unit-of-production depreciation uncertainty over their future life than estimates charges to income. of reserves for fields that are substantially developed and depleted. As a field goes into Proved oil and gas reserves are the estimated production, the amount of proved reserves will quantities of crude oil, natural gas and natural be subject to future revision once additional gas liquids that geological and engineering data information becomes available through, for demonstrate with reasonable certainty to be example, the drilling of additional wells or the recoverable in future years from known reservoirs observation of long-term reservoir performance under existing economic and operating under producing conditions. As those fields are conditions, i.e., prices and costs as of the date further developed, new information may lead to the estimate is made. Proved developed reserves revisions. are reserves that can be expected to be recovered through existing wells with existing Changes to Shell’s estimates of proved reserves, equipment and operating methods. Estimates of particularly proved developed reserves, also oil and gas reserves are inherently imprecise, affect the amount of depreciation, depletion and require the application of judgement and are amortisation recorded in the Consolidated subject to future revision. Accordingly, financial Financial Statements for property, plant and and accounting measures (such as the equipment related to hydrocarbon production standardised measure of discounted cash flows, activities. These changes can for example be the depreciation, depletion and amortisation charges, result of production and revisions. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 56
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A reduction in proved developed reserves will Depreciation of components increase depreciation, depletion and amortisation charges (assuming constant production) and Hydro ASA reduce income.” “Hydro depreciates separately any component of an item of property, plant and equipment when Annual Report and Accounts 2007, Royal Dutch Shell plc, p. 122 that component has a useful life and cost that is significant in relation to the total PP&E cost and PP&E useful life. At each financial year-end Disclosure of resources Hydro reviews the residual value and useful life of our assets, with any estimate changes accounted BG Group plc for prospectively over the remaining useful life of (A) Proved reserves the asset.” “Proved reserves are the estimated quantities of gas and oil which geological and engineering Annual Report and Accounts 2007, Hydro ASA, p. F10 data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating 4.4 Impairment conditions. Proved developed reserves are those reserves which can be expected to be recovered BP plc through existing wells with existing equipment Impairment of intangible assets and property, and operating methods. Proved undeveloped plant and equipment reserves are those quantities that are expected “The group assesses assets or groups of assets to be recovered from new wells on undrilled for impairment whenever events or changes in acreage or from existing wells where relatively circumstances indicate that the carrying value of major expenditure is required for completion. an asset may not be recoverable. If any such Proved undeveloped reserves comprise total indication of impairment exists, the group makes proved reserves less total proved developed an estimate of its recoverable amount. Individual reserves.” assets are grouped for impairment assessment purposes at the lowest level at which there are Annual Report and Accounts 2007, BG Group plc, p. 121 identifiable cashflows that are largely independent of the cashflows of other groups of assets. An asset group’s recoverable amount is 4.3 Depreciation of production and the higher of its fair value less costs to sell and downstream assets its value in use. Where the carrying amount of an Depletion, depreciation and amortisation asset group exceeds its recoverable amount, the asset group is considered impaired and is written BP plc down to its recoverable amount. In assessing “Oil and natural gas properties, including related value in use, the estimated future cash flows are pipelines, are depreciated using a unit-of adjusted for the risks specific to the asset group production method. The cost of producing wells and are discounted to their present value using a is amortized over proved developed reserves. pre-tax discount rate that reflects current market Licence acquisition, field development and future assessments of the time value of money.” decommissioning costs are amortized over total proved reserves. The unit-of-production rate for Annual Report and Accounts 2007, BP plc, p. 103 the amortization of field development costs takes into account expenditures incurred to date, together with approved future development expenditure required to develop reserves. Other property, plant and equipment is depreciated on a straight-line basis over its expected useful life.”
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Value in use Contracted cash flows in VIU 4 Financial disclosure examples
BP plc Royal Dutch Shell plc “Given the nature of the group’s activities, “Estimates of future cash flows used in the information on the fair value of an asset is usually evaluation for impairment of assets related to difficult to obtain unless negotiations with hydrocarbon production are made using risk potential purchasers are taking place. assessments on field and reservoir performance Consequently, unless indicated otherwise, the and include outlooks on proved reserves and recoverable amount used in assessing the unproved volumes, which are then riskweighted impairment charges described below is value in utilising the results from projections of geological, use. The group generally estimates value in use production, recovery and economic factors. using a discounted cash flow model. The future cashflows are usually adjusted for risks specific Estimates of future cash flows are based on to the asset and discounted using a pre- tax management estimates of future commodity discount rate of 11% (2006 10% and 2005 10%). prices, market supply and demand, product This discount rate is derived from the group’s margins and, in the case of oil and gas post-tax weighted average cost of capital. In properties, the expected future production some cases the group’s pre-tax discount rate volumes. Other factors that can lead to changes may be adjusted to account for political risk in in estimates include restructuring plans and the country where the asset is located.” variations in regulatory environments. Expected future production volumes, which include both Annual Report and Accounts 2007, BP plc, p. 121 proved reserves as well as volumes that are expected to constitute proved reserves in the future, are used for impairment testing because Calculation of recoverable amount – Fair Shell believes this to be the most appropriate value less costs to sell indicator of expected future cash flows, used as a measure of value in use. Estimates of future Royal Dutch Shell plc cash flows are risk-weighted to reflect expected “Other than properties with no proved reserves cash flows and are consistent with those used in (where the basis for carrying costs in the subsidiaries’ business plans. A discount rate Consolidated Balance Sheet is explained under based on Shell’s marginal cost of debt is used in “Exploration costs”), the carrying amounts of impairment testing. Expected cash flows are then major property, plant and equipment are risk-adjusted to reflect specific local reviewed for possible impairment annually, while circumstances or risks surrounding the cash all assets are reviewed whenever events or flows. Shell reviews the discount rate to be changes in circumstances indicate that the applied on an annual basis although it has been carrying amounts for those assets may not be stable in recent years.” recoverable. If assets are determined to be impaired, the carrying amounts of those assets Annual Report and Accounts 2007, Royal Dutch Shell plc, are written down to their recoverable amount, p. 118 and 123 which is the higher of fair value less costs to sell and value in use determined as the amount of estimated risk adjusted discounted future cash flows. For this purpose, assets are grouped based on separately identifiable and largely independent cash flows. Assets held for sale are recognised at the lower of the carrying amount and fair value less cost to sell. No further provision for depreciation is charged on such assets.”
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4.5 Decommissioning obligation the non-current asset as an element of its cost. Revisions to decommissioning provisions The effect of the passage of time on the liability is recognized as an accretion expense, included BG Group plc in Financial expense, and the costs added to the Decommissioning costs carrying value of the asset are subsequently “Where a legal or constructive obligation has depreciated over the assets’ useful life. been incurred, provision is made for the net Measurement of an asset retirement obligation present value of the estimated cost of requires us to evaluate legal, technical and decommissioning at the end of the producing economic data to determine which activities or lives of fields. sites are subject to asset retirement obligations, as well as the method, cost and timing of such When this provision gives access obligations.” to future economic benefits, an asset is recognised and then subsequently depreciated in Annual Report and Accounts 2007, Hydro ASA, p. F18 line with the life of the underlying producing field, otherwise the costs are charged to the income statement. The unwinding of the discount on the 4.6 Financial instruments and embedded provision is included in the income statement derivatives within finance costs. Any changes to estimated Scope of IAS 39 costs or discount rates are dealt with prospectively. BG Group plc Commodity instruments The estimated cost of decommissioning at the “Within the ordinary course of business the end of the producing lives of fields is reviewed at Group routinely enters into sale and purchase least annually and engineering estimates and transactions for commodities. The majority of reports are updated periodically. Provision is these transactions take the form of contracts that made for the estimated cost of decommissioning were entered into and continue to be held for the at the balance sheet date, to the extent that purpose of receipt or delivery of the commodity current circumstances indicate BG Group will in accordance with the Group’s expected sale, ultimately bear this cost. The payment dates of purchase or usage requirements. Such contracts total expected future decommissioning costs are are not within the scope of IAS 39. uncertain but are currently anticipated to be between 2010 and 2047.” Certain long-term gas sales contracts operating in the UK gas market have terms within the Annual Report and Accounts 2007, BG Group plc, p. 74 and 109 contract that constitute written options, and accordingly they fall within the scope of IAS 39. In addition, commodity instruments are used to Decommissioning provisions manage certain price exposures in respect of optimising the timing and location of its physical Hydro ASA gas and LNG commitments. These contracts are Asset retirement obligations and similar liabilities recognised on the balance sheet at fair value “Hydro accounts for asset retirement obligations, with movements in fair value recognised in the including decommissioning, restoration and income statement, see Presentation of results similar liabilities related to the retirement of above, note 2, page 82, and note 10, page 96. noncurrent assets under IAS 37 Provisions, Contingent Liabilities and Contingent Assets The Group uses various commodity based which prescribes the accounting for obligations derivative instruments to manage some of the associated with the retirement of non-current risks arising from fluctuations in commodity assets, and IAS 16 Property, plant and prices. Such contracts include physical and net equipment. The fair value of the asset retirement settled forwards, futures, swaps and options. obligation is recognized as a liability when it is Where these derivatives have been designated as incurred, and added to the carrying amount of cash flow hedges of underlying commodity price 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 59
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exposures, certain gains and losses attributable characteristics are not closely related to those of 4 Financial disclosure examples to these instruments are deferred in equity and the host contract. Contracts are assessed for recognised in the income statement when the embedded derivatives when the group becomes underlying hedged transaction crystallises. a party to them, including at the date of a business combination. Embedded derivatives are All other commodity contracts within the scope measured at fair value at each balance sheet of IAS 39 are measured at fair value with gains date. Any gains or losses arising from changes in and losses taken to the income statement. fair value are taken directly to profit or loss.”
Gas contracts and related derivative instruments Annual Report and Accounts 2007, BP plc, p. 105 associated with the physical purchase and resale of third-party gas are presented on a net basis within other operating income.” 4.7 Revenue recognition issues Revenue recognition – Exchanges Annual Report and Accounts 2007, BG Group plc, p. 75 BP plc “Revenues associated with the sale of oil, natural Measurement of long-term contracts that gas, natural gas liquids, liquefied natural gas, do not qualify for ‘own use’ petroleum and chemicals products and all other items are recognized when the title passes to the BG Group plc customer. Physical exchanges are reported net, Valuation as are sales and purchases made with a “The Group calculates the fair value of interest common counterparty, as part of an arrangement rate and currency exchange rate derivative similar to a physical exchange. Similarly, where instruments by using market valuations where the group acts as agent on behalf of a third party available or, where not available, by discounting to procure or market energy commodities, any all future cash flows by the market yield curve at associated fee income is recognized but no the balance sheet date. purchase or sale is recorded.”
The fair value of commodity contracts and Annual Report and Accounts 2007, BP plc, p. 107 commodity related derivatives is based on forward price curves, where available. Where observable market valuations are unavailable, the 4.8 Royalty and income taxes fair value on initial recognition is the transaction Petroleum taxes price and is subsequently determined using quotes from thirdparties or the Group’s forward Centrica plc planning assumptions for the price of gas, other Petroleum revenue tax (PRT) commodities and indices. “The definitions of an income tax in IAS 12, Income Taxes, have led management to judge One of the assumptions underlying the fair value that PRT should be treated consistently with of long-term UK gas contracts is that the gas other income taxes. The charge for the year is market in the UK is liquid for two years.” presented within taxation on profit from continuing operations in the Income Statement. Annual Report and Accounts 2007, BG Group plc, p. 105 Deferred amounts are included within deferred tax assets and liabilities in the Balance Sheet.”
Embedded derivatives Annual Report and Accounts 2007, Centrica plc, p. 68
BP plc “Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 60
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4.9 Emission Trading Schemes strategic financial and operating decisions Accounting for ETS relating to the activity require the unanimous consent of the venturers. A jointly controlled Centrica plc entity is a joint venture that involves the EU Emissions Trading Scheme and renewable establishment of a company, partnership or other obligations certificates entity to engage in economic activity that the “Granted CO2 emissions allowances received in group jointly controls with its fellow venturers. a period are initially recognised at nominal value (nil value). Purchased CO2 emissions allowances The results, assets and liabilities of a jointly are initially recognised at cost (purchase price) controlled entity are incorporated in these within intangible assets. A liability is recognised financial statements using the equity method of when the level of emissions exceed the level of accounting. Under the equity method, the allowances granted. The liability is measured at investment in a jointly controlled entity is carried the cost of purchased allowances up to the level in the balance sheet at cost, plus postacquisition of purchased allowances held, and then at the changes in the group’s share of net market price of allowances ruling at the balance assets of the jointly controlled entity, less sheet date, with movements in the liability distributions received and less any impairment in recognised in operating profit. Forward contracts value of the investment. Loans advanced to for the purchase or sale of CO2 emissions jointly controller entities are also included in the allowances are measured at fair value with investment on the group balance sheet. gains and losses arising from changes in fair The group income statement reflects the group’s value recognised in the Income Statement. share of the results after tax of the jointly The intangible asset is surrendered at the end of controlled entity. The group statement of the compliance period reflecting the consumption recognized income and expense reflects the of economic benefit. As a result no amortisation group’s share of any income and expense is recorded during the period. recognized by the jointly controlled entity outside profit and loss. Purchased renewable obligation certificates are initially recognised at cost within intangible Financial statements of jointly controlled entities assets. A liability for the renewables obligation is are prepared for the same reporting year as the recognised based on the level of electricity group. Where necessary, adjustments are made supplied to customers, and is calculated in to those financial statements to bring the accordance with percentages set by the UK accounting policies used into line with those of Government and the renewable obligation the group. certificate buyout price for that period. The intangible asset is surrendered at the end of the Unrealized gains on transactions between the compliance period reflecting the consumption of group and its jointly controlled entities are economic benefit. As a result no amortisation is eliminated to the extent of the group’s interest in recorded during the period.” the jointly controlled entities. Unrealized losses are also eliminated unless the transaction Annual Report and Accounts 2007, Centrica plc, p. 62 provides evidence of an impairment of the asset transferred.
4.10 Joint ventures The group assesses investments in jointly Accounting for joint ventures controlled entities for impairment whenever events or changes in circumstances indicate BP plc that the carrying value may not be recoverable. Interests in joint ventures If any such indication of impairment exists, the “A joint venture is a contractual arrangement carrying amount of the investment is compared whereby two or more parties (venturers) with its recoverable amount, being the higher of undertake an economic activity that is subject to its fair value less costs to sell and value in use. joint control. Joint control exists only when the 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 61
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Where the carrying amount exceeds the Accounting for jointly controlled or owned 4 Financial disclosure examples recoverable amount, the investment is written assets down to its recoverable amount. Hydro ASA The group ceases to use the equity method of Jointly controlled assets or operations accounting on the date from which it no longer “Hydro accounts for jointly controlled assets or has joint control over, or significant influence in operations using the proportional method of the joint venture, or when the interest becomes accounting. In some instances Hydro participates held for sale. in arrangements, where Hydro and the other partners have a direct ownership in specifically Certain of the group’s activities, particularly in identified assets or direct participation in certain the Exploration and Production segment, are operations of another entity. These jointly conducted through joint ventures where the controlled assets or operations are accounted venturers have a direct ownership interest in for by including Hydro’s percentage ownership and jointly control the assets of the venture. share of the assets, liabilities, income and The income, expenses, assets and liabilities of expense on a line-by-line basis in the group these jointly controlled assets are included in the financial statements (the proportional method).” consolidated financial statements in proportion to the group’s interest.” Jointly owned assets or operations “Hydro accounts for jointly owned assets or Annual Report and Accounts 2007, BP plc, p. 100 operations using the proportional method of accounting. Based on a contractual commitment, Hydro and the other parties to the contract have Accounting for jointly controlled operations direct ownership in specifically identified assets or direct participation in certain operations. BG Group plc These jointly owned assets or operations are Basis of consolidation accounted for by including Hydro’s percentage “The Financial Statements comprise a ownership share of the assets, liabilities, income consolidation of the accounts of the Company and expense on a line-by-line basis in the group and its subsidiary undertakings and incorporate financial statements (the proportional method).” the results of its share of jointly controlled entities and associates using the equity method of Annual Report and Accounts 2007, Hydro ASA, p. F8 accounting. Consistent accounting policies have been used to prepare the consolidated Financial Statements.
Most of BG Group’s Exploration and Production activity is conducted through jointly controlled operations. BG Group accounts for its own share of the assets, liabilities and cash flows associated with these jointly controlled operations using the proportional consolidation method.”
Annual Report and Accounts 2007, BG Group plc, p. 73 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 62
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Investments with less than joint control Allocation of the cost of the combination to assets and liabilities acquired Hydro ASA Investments in associates and joint ventures BP plc “Associates Hydro accounts for associates using Business combinations and goodwill the equity method. The definition of an associate “Business combinations are accounted for using is based on Hydro’s ability to exercise significant the purchase method of accounting. The cost influence, which is the power to participate in the of an acquisition is measured as the cash paid financial and operating policies of the entity. and the fair value of other assets given, equity Significant influence is assumed to exist if Hydro instruments issued and liabilities incurred or owns between 20 to 50 percent of the voting assumed at the date of exchange, plus costs rights. However, exercise of judgment may lead directly attributable to the acquisition. The to the conclusion of significant influence at acquired identifiable assets, liabilities and ownership levels less than 20 percent or a lack of contingent liabilities are measured at their fair significant influence at ownership percentages values at the date of acquisition. Any excess of greater than 20 percent. Hydro uses the equity the cost of acquisition over the net fair value of method for a limited number of investees where the identifiable assets, liabilities and contingent Hydro owns less than 20 percent of the voting liabilities acquired is recognized as goodwill. rights, based on an evaluation of the governance Any deficiency of the cost of acquisition below structure in each investee.” the fair values of the identifiable net assets acquired (i.e. discount on acquisition) is credited Annual Report and Accounts 2007, Hydro ASA, p. F8 to the income statement in the period of acquisition. Where the group does not acquire 100% ownership of the acquired company, the 4.11 Business combinations interest of minority shareholders is stated at the Goodwill minority’s proportion of the fair values of the assets and liabilities recognized. Subsequently, BG Group plc any losses applicable to the minority “Business combinations and goodwill shareholders in excess of the minority interest on In the event of a business combination, fair the group balance sheet are allocated against the values are attributed to the net assets acquired. interests of the parent. Goodwill, which represents the difference At the acquisition date, any goodwill acquired is between the purchase consideration and the fair allocated to each of the cash-generating units value of the net assets acquired, is capitalised expected to benefit from the combination’s and subject to an impairment review at least synergies. For this purpose, cash-generating annually, or more frequently if events or changes units are set at one level below a business in circumstances indicate that the goodwill may segment. be impaired. Goodwill is treated as an asset of the relevant entity to which it relates, including Following initial recognition, goodwill is measured foreign entities. Accordingly, it is re-translated at cost less any accumulated impairment losses. into pounds Sterling at the closing rate of Goodwill is reviewed for impairment annually or exchange at each balance sheet date.” more frequently if events or changes in circumstances indicate that the carrying value Annual Report and Accounts 2007, BG Group plc, p. 73 may be impaired.
Impairment is determined by assessing the recoverable amount of the cash-generating unit to which the goodwill relates. Where the recoverable amount of the cash-generating unit is less than the carrying amount, an impairment loss is recognized. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 63
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Goodwill arising on business combinations prior 4 Financial disclosure examples to 1 January 2003 is stated at the previous carrying amount under UK generally accepted accounting practice.
Goodwill may also arise upon investments in jointly controlled entities and associates, being the surplus of the cost of investment over the group’s share of the net fair value of the identifiable assets. Such goodwill is recorded within investments in jointly controlled entities and associates, and any impairment of the goodwill is included within the earnings from jointly controlled entities and associates.”
Annual Report and Accounts 2007, BP plc, p. 101
4.12 Functional currency Determining the functional currency
Royal Dutch Shell plc “The functional currency for most upstream companies and for other companies with significant international business is the US dollar, but other companies usually have their local currency as their functional currency. Foreign exchange risk arises when certain transactions are denominated in a currency that is not the entity’s functional currency. Typically these transactions are income/expense or non-monetary item related.”
Annual Report and Accounts 2007, Royal Dutch Shell plc, p. 145
The extracts from third-party publications that are contained in this document are for illustrative purposes only; the information in these third-party extracts has not been verified by PricewaterhouseCoopers and does not necessarily represent the views of PricewaterhouseCoopers; the inclusion of a third-party extract in this document should not be taken to imply any endorsement by PricewaterhouseCoopers of that third-party. 08PwC0290_IFRS O&G final edit 10.04.2008 12:01 Uhr Seite 64
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