Acquisition Costs

1
Acquisition Costs

• Incur acquisition costs
• Periodically assess properties
• If impaired, record/adjust allowance
• If surrendered, write off costs
• If successful well drilled, transfer to proved
  property account
• See Fig. 4-1 and 4-2 in text

2
SFAC 7 Using Cash Flow Information

• Use cash flows for fair value computations
• How to measure cash flows for unproved properties
  where there are no proved reserves?

3
Impairment of Unproved Property

• Is the unproved lease impaired???
• Dry holes drilled on lease or surrounding leases?
• Is lease about to expire?
• Are there firm plans for drilling?
• Experience of company

4
Method of Computing Valuation Allowance

• If lease is significant, account for valuation
  separately
• If lease is not significant, account for lease
  along with other insignificant leases
• Significance
• Many companies consider lease significant if
  costs exceed 10 - 20 of capitalized costs of
  unproved leases
• Other companies set dollar amount for
  significance
• Each WI owner makes the impairment decision
  separately

5
Impairment Example Significant Property
(Problem 4-3)

• Tharp Energy Company has an individually
  significant lease with cost of 200,000. Prior
  to the issuance of the financial statements, a
  well on adjacent property is dry. Lease is
  determined to be 40 impaired.
• Impairment expense 80,000
• Allowance for impairment 80,000

6
Impairment Insignificant Properties

• Impairment for insignificant properties is
  computed for the group
• An allowance account for the group is established
• A company may establish more than one group
  account, for example, grouping by state
• The allowance account works in a manner similar
  to a computation of allowance for bad debts.

7
Impairment Methods of Computation

• Income statement approach Estimate the cost of
  leases that will be surrendered and charge over
  the average holding period.
• Balance sheet approach determine the amount
  that should be the ending account balance and
  adjust to achieve that balance.

8
Impairment Example (from p. 110 in text)

• Tyler Company has a policy of providing 40 as an
  impairment allowance. 40 of 100,000 40,000
• Allowance account
• 10,000 Beginning balance
• _________30,000 Current year entry
• 40,000 Ending balance
• Lease impairment expense 30,000
• Allowance for impairment, group 30,000

9
Surrender or Abandonment

• Significant property Surrendered lease expense
  is net carrying value of lease (cost less
  allowance for impairment) see p. 112.
• Insignificant property
• The charge is to allowance for impairment and the
  credit is to unproved property
• If the allowance account is not large enough,
  charge surrendered lease expense for an amount to
  bring the allowance account back to zero.

10
Reclassification of an Unproved Property to
Proved Property

• Significant properties Transfer the net amount
  to proved property
• Example- Lease has an acquisition cost of 100,000
  and an allowance for impairment of 25,000
• Proved property 75,000
• Allowance for impairment 25,000
• Unproved property 100,000

11
Reclassification of an Unproved Property to
Proved Property

• Insignificant properties Transfer the full
  amount to proved property
• Example- Lease has an acquisition cost of
  100,000. No specific allowance account.
• Proved property 100,000
• Unproved property 100,000

12
Example Problem 4-6

• Lease impairment expense 365,000
• Allowance for impairment, group 365,000
• Allowance for impairment, group 300,000
• Unproved property - lease 300,000
• Proved property 50,000
• Unproved property - lease 50,000
• Unproved property - lease 310,000
• Cash 310,000

13
Example Problem 4-6 (Contd)

• Lease impairment expense 278,000
• Allowance for impairment, group 278,000
• Allowance for impairment, group 428,000
• Unproved property 428,000
• Surrendered lease expense 10,000
• Allowance for impairment, group 10,000

14
Impairment Expense for ConocoPhillips

• Statement of operations (p. 59)
• 1,686 million for other impairment expense
• Footnote 1 on PPE (p. 65)
• Footnote 10 on impairment (p. 76)
• Can we determine impairment on unproved
  properties?