Oil Gas Accounting 101 PDF
Oil Gas Accounting 101 PDF
Oil Gas Accounting 101 PDF
&
Gas
Accoun.ng
101
3 Introduction
4 Terminology
10 Division of Interests
11 Accounting Methods
12 Chart of Accounts
13 Revenue Accounting
17 Expense Accounting
21 Reporting
22 Title&of
Oil Gas
theAccounting
book 101
Introduction
O il & Gas accounting isn’t that difficult to understand. You may have heard the
term “Accounting is Accounting”, and that’s true. Oil & Gas Accounting is still
accounting, but with it’s own terminology and twists.
This eBook will help you to gain a better understanding of what Oil & Gas accounting
is and what it isn’t. We’ll start by going over some of the terminology unique to the oil
& gas industry so understanding the concepts will be easier when you encounter
terms that may not have been familiar to you.
Then, we’ll look at the unique relationship between the wells that are drilled and the
people that must be paid for any oil & gas production the well produces.
Next we’ll cover revenue and how it is paid out and accounted for and then we’ll
cover well expenses, amounts held in suspense.
Lastly we’ll cover reporting. This includes profit and loss (financials) as well as year-
end reporting.
Authorization for Expenditure (AFE): A document shown to investors in a well that will
estimate drilling and completion costs. An AFE can then be used as drilling occurs to show
actual costs versus estimated costs.
Barrel (BBL) – The basic unit for measuring oil. A barrel is equal to 42 U.S. gallons.
Crude Oil – Liquid petroleum as it comes out of the ground. Crude oil varies radically in its
properties, such as specific gravity and viscosity.
Delay Rental: Paid to the lessee (person or company who leased the land to be drilled upon)
to retain concession if production is not taking place on the land.
Intangible Drilling Costs (IDC): All costs incurred in drilling a well other than equipment or
leasehold.
Intangible Completion Costs (ICC): Costs incurred with completing a well that are non-
salvageable if the well is dry or not including labor, materials, rig time, etc.
Joint Interest Billing Statement: The monthly statement sent from the operator to all the
working interest holder’s within an oil and gas property detailing the expenses charged each
month.
Leasehold Costs – The costs associated with obtaining and keeping a lease on a parcel of
land on which a well is drilled.
Legal Suspense – Amounts held in suspense instead of being paid to an owner. Reasons for
holding the suspense could be they moved with no forwarding address, a title dispute on the
lease or they haven’t reached the minimum check amount set by the operator.
MCF – Thousand Cubic Feet. The standard unit for measuring the volume of natural gas.
Payout: When the costs of drilling, producing and operating a well have been recouped from
the sale of the products of the well
Revenue Statement: The monthly statement sent from either the purchaser or operator to all
the interest holder’s within an oil and gas property detailing the expenses and revenue
charged or received each month.
Severance Tax – A tax on the removal of minerals from the ground. The tax can be levied
either as a tax on volume or a tax on value. In Louisiana oil is taxed at 10 cents per BBL and
Natural gas is taxed at 5 cents per MCF.
Spudding In – The first boring of the hole in the drilling of an oil well.
Tangible Completion Costs: Lease and well equipment costs incurred from completing a
well.
Well – A hole drilled in the earth for the purpose of finding or producing crude oil or natural gas
or providing services related to the production of crude oil or natural gas.
Working Interest: An interest in an oil and gas well that shares the expense associated with
drilling, completing or operating a well, as well as the share in the revenue made on the well
Historically, we know the tales of eternal fires where oil and gas seeps
ignited and burned. One example is the site where the famous oracle of
Delphi was built around 1,000 B.C. Written sources from 500 B.C. describe
how the Chinese used natural gas to boil water.
It was not until 1859 that "Colonel" Edwin Drake drilled the first successful oil
well, with the sole purpose of finding oil. The Drake Well was located in the
middle of quiet farm country in northwestern Pennsylvania, and sparked the
international search for an industrial use for petroleum.
So how does a well get drilled? How do they determine where to drill the well? How are
they sure where oil & gas will be found?
An oil & gas operator will research different areas where oil & gas has been found in the
past. But before they can begin drilling, they have to have permission to drill from the
landowner and/or mineral owner where the well is to be drilled. They will need to get a
Lease from the landowner and/or mineral owner in order to drill on their property. A lease
is a legal document that spells out what the operator or owner of the lease will do for the
landowner for the permission or right to drill wells on their property. There are also
payments involved in order to get the lease. These payments consist of a lease bonus of
so many $ per acre being leased.
Usually, in order to keep the lease until a well is drilled, the operator has to pay Delay
Rental Payments to the landowner of so much per acre per year.
Production from the well will be paid to the landowner (hereinafter called the Royalty
owner). The amount paid is typically 12.5% - 25% of the production before expenses.
Sometimes, the person who found the lease and did all the work in getting it signed, called
the Land Man, is paid by giving them a percentage of the production from the wells on the
lease. This is called an Overriding Royalty. This percentage usually varies from 1% - 5%.
The people who provide the money to drill the well are called Working Interest owners.
Their percentage is based on the amount of money they invested. Working interest owners
share in the expenses incurred during the drilling and production phases of a well.
The lessor’s share of the production is known as the royalty or landowner’s royalty. It is
common for the share to be stated as a fraction of the oil and gas produced, for example
1/8. The lessee acquires the right to the oil and gas produced less the landowner’s
royalty.
The lessee does not take on a specific obligation to develop the property or to pay delay
rentals, but does agree that the lease will expire if the property is not developed or rentals
are not paid. Normally the lessee can abandon the lease without penalty.
Landowner Royalties
The owner of the minerals in place generally retains a royalty interest, which is specified
in the lease as a fraction or percentage of the total value of the oil and gas production.
This royalty is commonly known as a landowner royalty.
Overriding Royalties
An overriding royalty is created out of the working interest. Since it is created out of
working interest, its life cannot exceed that of the working interest. The interest can
either be “carved out” or “retained”. The working interest owner sometimes “carves
out” a non-operating interest in exchange for services related to the acquisition and
development of the property. An overriding royalty interest is also created when a
working interest owner, under a “farmout” arrangement, transfers the working interest to
another party and retains an overriding royalty.
Production Payments
A production payment is a right to receive a share of production until a specific amount
has been received. It is either carved out or retained from the working interest, and bears
none of the development or operating costs.
Under Internal Revenue Code Section 636, a production payment is generally treated as
a mortgage loan on the property. Payments received are loan payments. Production
payments treated as mortgage loans are not considered to be an economic interest.
EXAMPLE:
Assume a well has a 12.5% royalty and an overriding Distribution Example
royalty of 3.0%. The royalties are paid first so this
would leave 84.5% for the working interest owners. Gas Revenue $5,000.00
Revenue
Owner Type Expenses Revenue
Royalty: $5,000 * .125 = $ 625.00
Pct Pct
Override: $5,000 * .03 = $ 150.00
Royalty 12.500%
WI Owner 1:$5,000 * .63375 = $3,168.75
Overriding Royalty 3.000% WI Owner 2:$5,000 * .21125 = $1,056.25
Working Owner 1: 75.00% * 84.50% = 63.375% Total Disbursed: $5,000.00
Working Owner 2: 25.00% * 84.50% = 21.125%
Well Totals: 100.00% 100.000% Expenses
WI Owner 1:$2,500 * .75 = $1,875.00
WI Owner 2:$2,500 * .25 = $ 625.00
Total Billed: $2,500.00
The accounting method used must clearly reflect income and be consistently applied.
Treas. Reg. Sec. 1.446-1 states:
Balance Sheet accounts consist of categories such as Assets, Liabilities and Equity.
Assets are items of value owned by the company. Liabilities are obligations of the
company to transfer something of value, like an Asset, to another party. Equity is the
value of the assets contributed by the owners of the company.
Before we get into debits and credits, let’s talk about the challenges of accounting
for revenue in the oil & gas industry. In most other industries, the product is made,
the price is set, then it’s sold and cash is received. The transaction is booked as a
simple two-sided accounting entry debiting cash and crediting revenue.
In the oil & gas industry, we have to manage booking revenue for a product who’s
price is a moving target and who’s inventory is mostly unknown. Oil and gas
producers’ main assets are the minerals in place on the developed and
undeveloped properties it holds. Most of these properties have been leased by the
producers. These minerals in place are known as reserves. The accounting for oil
and gas reserves requires the use of estimates made by petroleum engineers and
geologists. Reserves estimation is a complex, and imprecise process.
Once properties are producing, the oil and gas reserves related to the producing
properties will deplete resulting in a decline in production from the properties.
Operating revenue
Some operators generate income from operating wells, supervising
drilling, transporting gas, hauling and disposing salt water, and other
activities incidental to their operations.
Hedging transactions
Some exploration and production companies use derivatives in their
operations to hedge risk associated with oil and gas prices. Derivatives
are financial instruments whose values are derived from the value of an
underlying asset. Typically, oil and gas companies use futures, options
and swaps.
Here’s a posting example using the cash method: On February 1st, 2015 you receive
$25,500 of oil revenue. Your operating company owns a 25% net revenue interest in the
wells that produced the oil.
Farm-out
In order to develop a property, the owner of an operating interest (working interest)
may transfer (farm-out) the operating interest. In a farm-out arrangement some of
the entire burden for developing the property is transferred to another person. In
exchange for assuming the burden, the transferee receives the operating interest in
the property.
• Intangible Drilling Costs - Intangible drilling costs (IDCs) include all expenses
made by an operator incidental to and necessary in the drilling and preparation of
wells for the production of oil and gas, such as survey work, ground clearing,
drainage, wages, fuel, repairs, supplies and so on. Broadly speaking, expenditures
are classified as IDCs if they have no salvage value. The following is a non-
exhaustive list of potential IDCs incurred in the exploration and development of oil
& gas wells.
– Administrative costs in connection with drilling contracts.
– Survey and seismic costs to locate a well site.
– Cost of drilling.
– Grading, digging mud pits, and other dirt work to prepare drill site.
– Cost of constructing roads or canals to drill site.
– Surface damage payments to landowner.
– Crop damage payments.
– Costs of setting rig on drill site.
– Transportation costs of moving rig.
– Technical services of geologist, engineer, and others engaged in
– drilling the well.
– Drilling mud, fluids, and other supplies consumed in drilling the
– well.
– Transportation of drill pipe and casing.
• Intangible Completion Costs - Similar to IDCs these expenses are related to non-
salvageable completion costs, including labor, completion materials used,
completion rig time, drilling fluids etc. Intangible completion costs are also almost
always deductible in the same year they take place, and usually make up about
15% of the overall well cost.
• Leasehold Acquisition Costs - The cost and expenses associated with acquiring
properties, including:
– Property Rentals
– Lease Bonuses
– Legal Fees
– Right of Ways
Here’s some examples of expense posting when a $1,400 bill for pumping is
received.
The reason that only $1,050 posted to the JIB receivable account is that your
company owned 25% of the well so it got 25% of the expense. This portion, or
$350, posts to the Pumping expense account so it affects your P&L.
For more information on Expense Accounting and oil & gas accounting as a whole,
check out the Council of Petroleum Accounting Societies or COPAS for short. They
are the standardizing body for oil & gas accounting and set the guidelines for how to
account for revenue and expenses. (www.copas.org)
Balance Sheet
The balance sheet provides detailed information about a company’s assets,
liabilities and stockholder’s (owner’s) equity.
Assets are things a company owns that have value. Typically this means they can
either be sold or used by the company to produce products or provide services.
Liabilities are the amounts of money that a company owes to others. The difference
between the total assets and the total liabilities is the equity of the owners. A
company’s assets have to equal or “balance”, the sum of its liabilities and owner’s
equity.
Operating Company
Balance Sheet
As of 12/31/2014
ASSETS
Current Assets
Cash – Checking 99,500
Cash – Savings 101,500
201,000
Accounts Receivable 249,300
Inventory 105,200
Drilling In Progress 450,000
Total Current Assets 804,500
Stockholders Equity
Common Stock 5,000
Retained Earnings 3,255,200
Current Earnings 1,355,930
Total Stockholders Equity 4,616,130
Also known as the "profit and loss statement" or "statement of revenue and
expense."
The income statement is divided into two parts: the operating and non-operating
sections.
The portion of the income statement that deals with operating items is interesting to
investors and analysts alike because this section discloses information about
revenues and expenses that are a direct result of the regular business operations.
For example, for an oil & gas producing company the operating items section would
talk about the revenues and expenses involved with the production of oil & gas.
The non-operating items section discloses revenue and expense information about
activities that are not tied directly to a company's regular operations. For example, if
the oil & gas company sold an old field office and some old equipment, then this
information would be in the non-operating items section.
Revenues
Oil Sales 1,899,500
Gas Sales 1,101,500
Royalties 11,000
Operating Income 22,700
Total Revenues 3,234,700
Cost of Operations
Lease Operating Expense 71,300
Severance Tax 8,700
Dry Hole Costs 100,000
Depreciation, Depletion & Amortization 250,000
Intangible Drilling Costs 450,000
Total Current Assets 780,000
Cash flow statements report a company’s inflows and outflows of cash. While the
income statement tells whether a company made a profit, a cash flow statement
tells whether the company generated cash. The cash flow statement uses and
reorders the information from a company’s balance sheet and income statement.
The bottom line of the cash flow statement shows the net increase or decrease in
cash for the reporting period. In arriving at the bottom line, the statement reports
cash flow from: (1) operating activities; (2) investing activities; and (3) financing
activities.
The Cash Flow Statement is especially useful for companies using the accrual
method of account since a big sale would be recorded as revenue even though the
cash may not have been received yet.
The oil and gas industry is highly regulated, and a significant burden is placed upon
producers to comply with laws and regulations of various federal, state and local
agencies. Good accounting practices and systems enable companies to comply
with the various agencies’ reporting requirements.
Summary
Oil & Gas Accounting is just accounting but it helps to know some of the
terminology and where the numbers are coming from that affect your accounting
system. This guide gave you the basics. Now you can start digging deeper, if you
want.
There are a lot of tax consequences associated with how transactions are posted
for oil & gas companies. Stay tuned…. We will be coming out with an Oil & Gas
Accounting 201 guide that will take the concepts in this manual a little further.