Accounting for Conveyances SEC Adopted the SFAS 19 Rules

1
Accounting for Conveyances SEC Adopted the SFAS
19 Rules

• Generally, no gain or loss recognized where
• Exchange of Oil Gas assets for Oil Gas assets
• Pooling of assets in joint undertaking

2
Exchange of OG Assets for Other OG Assets

• Farm-ins/Farm-outs Owner of the WI assigns all
  or part of the WI to another party in return for
  exploration and development of the property
• WI to farmee and retain ORI
• Farmor assigns all costs to retained (unproved)
  ORI then to proved ORI if reserves found
• Farmee accounts for drilling and development
  costs as per previous chapters

3
Farm-ins/Farm-outs Retention of Reversionary WI

• Farmor may retain ORI with reversion to a WI at
  payout (when farmee has recouped all costs to
  drill and operate through payout).
• The reversionary WI percentage must be agreed
  upon at the time of the farmout.
• Issues related to costs and DDA can get very
  involved.
• Costs for farmor in productive ORI will be
  transferred to producing WI.

4
Retention of Reversionary WI Example Spring
2007 exam

• J.R. Oil Company owns a 100 WI in the unproved
  Ewing lease for which it paid 80,000, subject to
  a 1/8 royalty. J.R. Oil farmed out the WI to
  Dallas Oil Company and retained a 1/7 ORI in
  return for Dallas Oil agreeing to drill, develop,
  and operate the property. After payout, J.R.s
  ORI converts to a 50 WI. During 2006, Dallas
  spent 300,000 in IDC and 150,000 in equipping
  the well. During 2006, the well produced 25,000
  barrels of oil at 58 per barrel. The price of
  the oil is expected to remain constant. As of
  December 31, 2006, the total proved reserves are
  500,000 barrels of oil and the total proved
  developed reserves are 200,000 barrels. Lease
  operating expenses were 7 per barrel. Ignore
  severance tax.

5
Determine when payout will occur (in bbls).

• Dallas completed well at a cost of 450,000
• Estimated gross reserves
• proved reserves - 500,000 bbls
• proved developed reserves - 200,000 bbls
• (7/8 x 6/7 x 58X) - 7X 450,000
• 36.5 X/bbl 450,000
• Payout 12,329 bbls

6
Compute DDA for 2006 for J.R. Oil Co. for the
Ewing lease.

• J.R.s 80,000 depleted over proved reserves
• J.R.s share of proved reserves
• Before payout 1/7 x 7/8 x 12,329 1,541
• After payout 50 x 7/8 x 487,671 213,356
• J.R.s bbls 1,541 5,544 7,085
• DDA 80,000/214,897 X 7,085 2,638

7
Compute DDA for 2006 for Dallas Oil Company for
the Ewing lease

• Dallas 450,000 depleted over PDR
• Dallas share of PDR
• Before payout 6/7 x 7/8 x 12,329 9,247
• After payout 50 x 7/8 x 187,671 82,106
• Dallas bbls 9,247 5,544 14,791
• DDA 450,000/91,353 X 14,791 72,860

8
Conveyances Free Well

• The WI owner assigns a percentage of the WI (for
  example 25) in exchange for a well to be
  drilled.
• Differs from farm-out/farm-in in that no payout
  involved
• Agreement may require the well to be a producer
  to earn the WI
• Assignor generally has leasehold cost
• Assignee records the IDC and equipment costs

9
Conveyances Carried Interest

• Carried interest situations
• Non consent
• Farm-out/farm-in
• Carrying party has 100 of WI until payout is
  achieved
• Carrying party bears all costs until payout (or
  including penalty for nonconsent)
• Be careful in DDA computation
• Carrying party allocated all WI reserves during
  payout
• Carried party allocates leasehold cost over
  Proved reserves while carrying party allocates
  IDC Eqpt over proved developed reserves

10
Conveyance Exchange of WI

• Owner of WI in Lease A exchanges a portion of the
  WI for a WI in Lease B
• No gain or loss recognized and cost allocated
  between the leases
• Example Lucky acquires WI in Lease A for
  80,000. Lucky assigns 50 WI in lease A for 30
  WI in Lease B.
• Oil gas properties Lease A 40,000
• Oil gas properties Lease B 40,000

11
Conveyances Unitizations

• Usually refer to combining of producing
  properties for secondary or tertiary project
• Participation factors may include share of
  contributed reserves
• The numbers often get messy because participants
  are treated as paying or receiving cash to
  proportionalize the IDC and equipment.
• Receipts of cash are treated as reductions in IDC
  equipment

12
Unitizations Problem 13-18

• Partici- Factor x
• pation Total Agreed Individual Receive
  Pay
• Co Factor Value Agreed Value Cash Cash
• A 10 96,000 330,000 234,000
• B 40 384,000 190,000 194,000
• C 20 192,000 440,000 248,000
• D 30 288,000 0
  ______ 288,000
• 100 960,000 960,000 482,000 482,000

13
Sale of Oil Gas Property

• See Figure 13-1
• (Note, I will give you Figure 13-1 for final
  exam)

14
Sale of Unproved Property Complete Interest

• If individually impaired, recognize gain or loss
• Example Cost 80,000, 30,000 impairment, SP
  60,000
• Cash 60,000
• Allowance for impairment 30,000
• Unproved property 80,000
• Gain 10,000
• If impaired on a group basis, recognize gain only
  if SP gt Cost, and dont recognize loss
• Example Cost 80,000, SP 60,000
• Cash 60,000
• Allowance for impairment 20,000
• Unproved property 80,000

15
Sale of Unproved Property Partial Interest,
Individually Impaired

• Special treatment because substantial uncertainty
  exists about recoverability of costs and SP
  should be treated as recovery of cost
• If individually impaired and SP exceeds entire
  cost less impairment, recognize a gain
• Example Cost 100,000, 20,000 impairment, SP
  10,000 for 25
• Cash 10,000
• Unproved property 10,000
• What if SP is 110,000 for 25
• Cash 110,000
• Allowance for impairment 20,000
• Unproved property 99,990
• Gain 30,010
• Leave 10 in cost

16
Sale of Unproved Property Partial Interest,
Group Impaired

• Special treatment because substantial uncertainty
  exists about recoverability of costs and SP
  should be treated as recovery of cost
• If impaired on a group basis, recognize gain only
  if exceeds original cost of entire interest
• Example Cost 100,000, SP 40,000 for 25
• Cash 40,000
• Unproved property 40,000
• What if SP is 110,000 for 25
• Cash 110,000
• Unproved property 99,990
• Gain 10,010
• Leave 10 in cost

17
Sale of Proved Property Complete Interest

• This sale results in gain or loss being reported
• Credit the asset accounts and debit the
  accumulated DDA account. The difference is gain
  or loss.
• Example Sale 100 WI for 300,000
• LHC 60,000
• IDC 200,000
• Eqpt 75,000
• Accumulated DDA (50,000)
• Net 285,000
• If sold for 300,000, gain of 15,000
• If sale of partial interest, allocate costs and
  compute gain or loss

18
Conveyances Production Payments

• We covered only PPIs payable in money
• Retained PPI the owner of the WI transfers the
  WI and retains the PPI
• Reasonably assured
• Not reasonably assured
• Carved out PPI The WI owner needs cash and
  transfers the PPI to generate cash

19
Retained PPI Reasonably Assured

• Treated as a sale and gain or loss recognized
• Seller records a receivable of the present value
  of the PPI
• Purchaser of WI records cost as cash paid
  present value of PPI
• For present values, seller and purchaser use
  their respective cost of capital (these will
  usually be different!!)

20
Retained PPI Not Reasonably Assured

• This looks more like an ORI since it is payable
  only while the property produces and it is likely
  it will not all be paid
• Allocate cost in WI to retained PPI and
  transferred WI
• It is an economic interest in the property so
  compute DDA

21
Problem from Spring 2007 Exam

• Baker Oil owns a 100 WI in a lease in Clay
  County, Texas, subject to a 1/8 royalty interest.
  On January 1, 2006, Baker Oil transferred the WI
  to Charlie Oil Company for 150,000 and retained
  a production payment for 300,000 payable out of
  60 of the WI share of the revenue. The present
  value of the production payment is 260,000 using
  Bakers cost of capital and 280,000 using
  Charlies cost of capital. Baker Oil Company is
  reasonably assured of payout. Bakers
  capitalized costs in the lease are 400,000 and
  its Accumulated DDA for the lease is 150,000.
  During 2006, 8,000 barrels of oil were sold for
  50 per barrel.

22
How much gain or loss does Baker record on the
transfer?

• Cash received 150,000
• Value of production payment is 260,000
• Total value received 410,000
• Less cv (400,000- 150,000) 250,000
• Gain 160,000

23
How much does Charlie capitalize as the cost of
its WI?

• Cash paid 150,000
• Value of production payment is 280,000
• Capitalized cost as Wells Rel EF 430,000

24
Record Charlies journal entry to make the
payment to Baker

• During 2006, 8,000 barrels of oil were sold for
  50 per barrel for a total of 400,000
• Payable out of 60 of the WI share of the
  revenue.
• Cash payment 7/8 x 60 x 400,000 210,000
• Lets say interest rate is 5
• Interest is 280,000 x 5 14,000
• Journal entry
• PPI Payable 196,000
• Interest expense 14,000
• Cash 210,000