Acquisition Costs under SFAS 19

1
Acquisition Costs under SFAS 19

• Lease bonus
• Option to purchase or lease
• Brokers fees
• Recording fees
• Legal fees
• Entry
• Unproved Property XXX
• Cash or Accounts payable XXX

2
Database of Properties

• Items included in database
• Location and legal description
• Proved or unproved
• Parties to the agreement
• Royalty owners
• Working interest owners
• Used for the following functions
• Revenue distribution
• Joint interest billing

3
More Complex Acquisition Costs

• Purchase in fee Allocate between the surface
  rights and mineral rights based on relative FMVs
• Internal Costs Cost of internal legal and land
  department costs should be allocated to
  properties
• Allocate first between acquisition activities and
  other activities.
• Allocate acquisition costs to properties acquired
  based on acreage acquired or
• Capitalize acquisition cost for properties
  acquired and expense for allocable costs for
  properties not acquired

4
Example Problem 4-8

• Sure Things internal land departments allocable
  costs for acquisition of leases is given as
  150,000.
• Of the 1,000,000 acres of prospects evaluated,
  450,000 acres were leased.
• 45 to unproved properties - 67,500
• 55 expensed 82,500

5
Shooting Rights with Option to Lease

• Shooting rights should be expensed
• Option
• capitalized until it is known whether acreage
  will be acquired
• If acquired, unproved property
• If not acquired, expensed
• Treatment of shooting rights coupled with an
  option to lease in practice
• If acquired, entire amount usually capitalized
• If a portion is acquired, all usually capitalized

6
Example Problem 14

• From Mr. T
• Mabel Oil shooting right _at_ .10/acre for 15,000
  acres 1,500.
• Spent 85,000 on GG.
• Leased 5,000 acres for 35/acre 175,000
• GG expense 1,500
• GG expense 85,000
• Unproved property 175,000

7
Example Problem 14 (Contd)

• From Mr. H
• Shooting rights and option to lease for .25/acre
  on 10,000 acres - 2,500.
• Leased 5,000 acres for 35/acre 175,000.
• Property purchase suspense 2,500
• Unproved property 175,000
• Then move the 2,500 to unproved property

8
Delinquent Taxes and Mortgage Payments

• To get a clear title, lessee may have to pay back
  taxes and mortgage payments.
• Can these payments be recovered from lessor???
• If nonrecoverable, capitalize as part of
  acquisition costs of property
• If recoverable, set up as an account receivable

9
Example of Delinquent Taxes

• If not recoverable
• Unproved property 300
• Cash 300
• If recoverable from delay rentals
• Receivable 300
• Cash 300
• Delay rental expense 400
• Receivable 300
• Cash 100

10
Top Lease

• A top lease is one where the WI owner wants to
  lease the property again and executes a new lease
  prior to expiration of the old lease.
• If execution is prior to expiration of he old
  lease, add the costs of the new lease to the
  costs of the old lease.
• If the old lease has expired, write off the costs
  of the old lease and capitalize the cost of the
  new lease.

11
Impairment of Assets FASB Statement 144 (2001)

• 1. Conduct impairment review when change in
  business environment or way asset is used.
• 2. Recognize impairment loss when undiscounted
  future cash flows is less than book value of
  asset.
• 3. Measure the loss by writing down asset to
  discounted future cash flows.
• 4. If impairment loss is not shown as a line
  item in the income statement, must have footnote
  disclosure.

12
Impairment of Oil Gas Leases

• Is the property Oil or gas lease impaired???
• Dry holes drilled on lease or surrounding leases?
• Is lease about to expire?
• Are there firm plans for drilling?
• Impairment estimation is difficult and subjective
• Impairment loss is recognized by providing a
  valuation allowance

13
Method of Computing Valuation Allowance

• If lease significant, account for valuation
  separately
• If lease 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

14
Impairment Example Significant Property
(Problem 4-3)

• Green 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. And lease is determined
  to be 40 impaired.
• Impairment expense 80,000
• Allowance for impairment 80,000

15
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 from
  ACCT 2113 and 3113.

16
Impairment Methods of Computation

• Balance sheet approach determine the amount
  that should be the ending account balance and
  adjust to get it there
• Income statement approach we will omit this one

17
Impairment Example (from p. 97 in text)

• Lucky Company has a policy of providing 60 as an
  impairment allowance. 60 of 250,000 150,000
• Allowance account
• 70,000
• _________80,000
• 150,000
• Lease impairment expense 80,000
• Allowance for impairment, Texas 80,000

18
Surrender or Abandonment

• Significant property Surrendered lease expense
  is net carrying value of lease (cost less
  allowance for impairment)
• 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.

19
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

20
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

21
Example Problem 4-6

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