ASC 932: Accounting for Extractive Activities

Accounting Standards Codification (ASC) 932, “Extractive Activities – Oil and Gas,” is a section of U.S. Generally Accepted Accounting Principles (GAAP) that dictates how companies in the oil and gas industry report their financial activities. The objective of ASC 932 is to create a standardized framework for the high-cost and high-risk operations inherent in finding and producing oil and gas. This guidance ensures that investors can compare the financial statements of different energy companies with consistency.

The standard addresses the upstream lifecycle of oil and gas operations, from the initial search for mineral resources to their extraction. It provides a roadmap for how companies should handle the costs associated with exploration and drilling, many of which may not result in commercially viable discoveries.

Scope and Applicability of ASC 932

ASC 932 applies specifically to entities engaged in oil and gas producing activities, which are defined as the acquisition of mineral interests in properties, exploration, development, and production of crude oil and natural gas. The standard’s rules are mandatory for any company involved in the upstream segment of the industry, as the guidance is designed to address the distinct economic characteristics of these operations.

The standard’s reach begins when a company acquires rights to explore for oil and gas and governs the accounting for all subsequent exploration efforts, such as geological studies and drilling exploratory wells. If reserves are found, ASC 932 continues to apply through the development and production phases.

The standard’s applicability ends once the oil and gas are produced and ready for transport. Downstream activities, such as the transportation, refining, and marketing of petroleum products, fall outside the scope of ASC 932 and are accounted for under other sections of U.S. GAAP.

Core Accounting Methods

Under ASC 932, companies must choose between two distinct methods for accounting for their upstream costs: the Successful Efforts (SE) method or the Full Cost (FC) method. This choice is significant as it can alter a company’s reported earnings and the value of assets on its balance sheet.

The Successful Efforts method is the more conservative of the two, aligning costs directly with the discovery of specific reserves. Under this approach, only the costs associated with successfully discovering, acquiring, and developing oil and gas reserves are capitalized as assets. All other exploration costs that do not result in finding proved reserves, such as drilling an unsuccessful exploratory well, are charged to expense in the period they are incurred.

The Full Cost method takes a broader view, allowing companies to capitalize all costs incurred in the exploration for and development of oil and gas reserves within a large geographic cost center, like a country. This includes the costs of both successful and unsuccessful exploration efforts. For example, if a company drills ten exploratory wells in the United States and only one is successful, an FC company would capitalize the costs of all ten wells, whereas an SE company would capitalize the costs of the successful well and expense the costs of the other nine.

Capitalization and Expensing of Costs

The treatment of specific costs under ASC 932 depends on the accounting method chosen and the nature of the expenditure. These costs are categorized into four main types: acquisition, exploration, development, and production.

Acquisition Costs

Acquisition costs are the expenses incurred to obtain the rights to explore for and produce oil and gas from a property. This includes lease bonuses and legal fees. Under both the Successful Efforts and Full Cost methods, these acquisition costs are capitalized when they are incurred and are assessed periodically for impairment.

Exploration Costs

Exploration costs are incurred when identifying areas that may warrant drilling and in the drilling of exploratory wells. This is where the two accounting methods diverge most significantly. Under the Successful Efforts method, costs such as geological and geophysical (G&G) studies are expensed as they are incurred. The costs of drilling an exploratory well are initially capitalized but are then expensed if the well is determined to be a dry hole. In contrast, under the Full Cost method, all exploration costs are capitalized as part of the cost pool for the geographic area, meaning G&G costs and the costs of drilling both successful and unsuccessful exploratory wells are added to the company’s asset base.

Development Costs

Development costs are incurred to create a system for producing discovered reserves. These include the costs of drilling development wells, which are wells drilled in a field where reserves have already been proven, and constructing production facilities. Under both the Successful Efforts and Full Cost methods, all development costs are capitalized and depreciated over the life of the producing field.

Production Costs

Production costs, also known as lifting costs, are the ongoing expenses incurred to operate and maintain the wells and related equipment to extract the oil and gas. These costs include labor, repairs, materials, and property taxes. Under both the Successful Efforts and Full Cost methods, production costs are expensed as they are incurred and matched against the revenues generated in the same period.

Asset Impairment Testing

After costs have been capitalized, companies must periodically assess these assets for impairment. An impairment occurs when the carrying value of an asset on the balance sheet exceeds its estimated future economic benefit. ASC 932 prescribes different impairment testing models for each accounting method.

For companies using the Successful Efforts method, impairment is assessed at the individual property or field level. If an impairment indicator exists, such as a significant drop in oil prices, the company performs a recoverability test by comparing the sum of the estimated future undiscounted cash flows from the property’s proved reserves to its capitalized carrying value. If the undiscounted cash flows are less than the carrying value, the asset is impaired, and the loss is measured as the amount by which the carrying value exceeds its fair value.

Companies using the Full Cost method are subject to a “ceiling test” for each cost center at the end of each reporting period. This test compares the net capitalized costs for the cost pool to a calculated limit, or “ceiling.” This ceiling is the present value of future net revenues from the company’s proved reserves in that cost center, discounted at 10%. If the net capitalized costs exceed this ceiling, the company must write down the excess as an impairment expense.

Required Financial Statement Disclosures

ASC 932 mandates a comprehensive set of disclosures to provide financial statement users with detailed information about a company’s oil and gas activities. The requirements are the same regardless of whether the company uses the Successful Efforts or Full Cost method.

Companies must disclose the aggregate amount of capitalized costs related to their oil and gas producing activities and the related accumulated depreciation, depletion, and amortization. They are also required to report the costs incurred during the year for acquisition, exploration, and development activities, regardless of whether those costs were capitalized or expensed.

A primary requirement of ASC 932 is the disclosure of supplementary information on proved oil and gas reserve quantities. This includes providing a standardized measure of the discounted future net cash flows related to these reserves. Companies must present a reconciliation of the changes in their proved reserve quantities from the beginning to the end of the year, detailing additions from new discoveries, revisions of previous estimates, purchases and sales of reserves, and reductions due to production. This reserve data provides a forward-looking view of the company’s future production potential.