financial-reporting-oil-gas-industry

emission reduction target by the Government which is proportional to the size of their customer base. The current CERT programme runs from April 2008 to March 2011. The target is subject to an annual

adjustment throughout the programme period to take account of changes to a UK-licensed energy supplier’s customer base. Energy suppliers can meet the target through expenditure on qualifying projects which give rise to carbon savings. The carbon savings can

be transferred between energy suppliers. The Group charges the costs of the programme to cost of sales and capitalises costs incurred in deriving carbon savings

in excess of the annual target as inventory, which is valued at the lower of cost and net realisable value and which may be used to meet the carbon emissions reduction target in subsequent periods or sold to third parties. The inventory is carried on a first-in, first-out basis. The carbon emission reduction target for the programme period is allocated to reporting periods on a straight-line basis as adjusted by the annual determination process.

Extract from Annual Report and Accounts 2010, Centrica Plc, see p. 74 for full details

OMV Aktiengesellschaft

Emission allowances received free of cost from governmental authorities (EU Emissions Trading Scheme for greenhouse gas emissions allowances) reduce financial obligations related to CO2 emissions; provisions are recognized only for shortfalls.

Extract from Annual Report and Accounts 2010, OMV Aktiengesellschaft, see p. 83 for full details

10 Joint ventures

10.1 Accounting for joint ventures

BP Plc

A joint venture is a contractual arrangement whereby two or more parties (venturers) undertake an economic activity that is subject to joint control. Joint control exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the venturers. A jointly controlled entity

is a joint venture that involves the establishment of a company, partnership or other entity to engage in

economic activity that the group jointly controls with its fellow venturers.

The results, assets and liabilities of a jointly controlled entity are incorporated in these financial statements using the equity method of accounting. Under the equity method, the investment in a jointly controlled entity is carried in the balance sheet at cost, plus post-

acquisition changes in the group’s share of net assets of the jointly controlled entity, less distributions received and less any impairment in value of the investment.

Loans advanced to jointly controlled entities that have the characteristics of equity financing are also included in the investment on the group balance sheet. The group income statement reflects the group’s share of the results after tax of the jointly controlled entity.

Financial statements of jointly controlled entities are prepared for the same reporting year as the group. Where necessary, adjustments are made to those financial statements to bring the accounting policies used into line with those of the group.

Unrealized gains on transactions between the group and its jointly controlled entities are eliminated to the extent of the group’s interest in the jointly controlled entities. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred.

The group assesses investments in jointly controlled entities for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If any such indication of impairment exists, the carrying amount of the investment is compared with its recoverable amount, being the higher of its fair value less costs to sell and value in use. Where the carrying amount exceeds the

recoverable amount, the investment is written down to its recoverable amount.

The group ceases to use the equity method of accounting on the date from which it no longer has joint control or significant influence over the joint venture or associate respectively, or when the interest becomes held for sale.

Certain of the group’s activities, particularly in the Exploration and Production segment, are conducted through joint ventures where the venturers have a direct ownership interest in, and jointly control, the assets of the venture. BP recognizes, on a line-by-line basis in the consolidated financial statements, its share of the assets, liabilities and expenses of these jointly controlled assets incurred jointly with the other partners, along with the group’s income from the

sale of its share of the output and any liabilities and expenses that the group has incurred in relation to the venture.

Extract from Annual Report and Accounts 2010, BP Plc, see p. 150 for full details

examples disclosure statement Financial – A Appendix

Financial reporting in the oil and gas industry		131

10.2Accounting for jointly controlled operations

BG Group Plc

Most of BG Group’s exploration and production activity is conducted through jointly controlled operations. The Group accounts for its own share of the assets, liabilities and cash flows associated with these

jointly controlled operations using the proportional consolidation method. The results of undertakings acquired or disposed of are consolidated from or to the date when control passes to or from the Company.

Extract from Annual Report and Accounts 2010, BG Group Plc, see p. 79 for full details

evidence of an impairment of the asset transferred. The Group’s investment in associates includes goodwill identified on acquisition, net of any accumulated loss and is tested for impairment as part of the overall balance. Goodwill represents the excess of the cost

of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired associate at the date of acquisition. Accounting policies of associates have been changed where necessary

to ensure consistency with the policies adopted by the Group.

Extract from Annual Report and Accounts 2010, Petrochina Company Limited, see p. 172–173 for full details

Total S.A.

Investments in jointly-controlled entities are consolidated under the equity method. The Group accounts for jointly controlled operations and jointlycontrolled assets by recognising its share of assets, liabilities, income and expenses.

Extract from Annual Report and Accounts 2010, Total S.A., see p. 7 for full details

10.3Equity accounting and investments with less than joint control

Petrochina Company Limited

Associates are entities over which the Group has significant influence but not control, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in associates are accounted for by the equity method of accounting in the consolidated financial statements of the Group and are initially recognised at cost.

Under this method of accounting the Group’s share of the post-acquisition profits or losses of associates is recognised in the consolidated profit or loss and its share of post-acquisition movements in other comprehensive income is recognised in other comprehensive income. The cumulative post-acquisition movements are adjusted against the carrying amounts of the investments. When the Group’s share of losses in an associate equals or

exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate.

Unrealised gains on transactions between the Group and its associates are eliminated to the extent of the Group’s interest in the associates; unrealised losses are also eliminated unless the transaction provides

10.4 Farm Outs

Statoil ASA

For exploration and evaluation asset acquisitions (farm in arrangements) in which Statoil has made arrangements to fund a portion of the selling partners’ (farmor’s) exploration and/or future development expenditures, these expenditures are reflected in the financial statements as and when the exploration

and development work progresses. Exploration and evaluation asset dispositions (farm out arrangements) are accounted for on a historical cost basis with no gain or loss recognition.

Exchanges (swaps) of exploration and evaluation assets are accounted for at the carrying amounts of the assets given up with no gain or loss recognition.

Extract from Annual Report and Accounts 2010, Statoil ASA, see p. 12 for full details

10.5Production Sharing Agreements

OMV Aktiengesellschaft

Exploration and production sharing agreements (EPSAs) are contracts for oil and gas licenses in which production is shared between one or more oil

companies and the host country/national oil company in defined proportions. Under certain EPSA contracts the host country’s/national oil company’s profit share represents imposed income taxes and is treated as such for purposes of the income statement presentation.

Extract from Annual Report and Accounts 2010, OMV Aktiengesellschaft, see p. 79 for full details

Total S.A.

Development costs incurred for the drilling of development wells and for the construction of production facilities are capitalized, together with

132 Financial reporting in the oil and gas industry

borrowing costs incurred during the period of construction and the present value of estimated future costs of asset retirement obligations. The depletion rate is usually equal to the ratio of oil and gas production for the period to proved developed reserves (unit-of- production method).

With respect to production sharing contracts, this computation is based on the portion of production and reserves assigned to the Group taking into account estimates based on the contractual clauses regarding the reimbursement of exploration, development and production costs (cost oil) as well as the sharing of hydrocarbon rights (profit oil).

Extract from Annual Report and Accounts 2010, Total S.A., see p. 9 for full details

11Business Combinations and Goodwill

11.1Allocation of purchase price to assets and liabilities acquired

BP Plc

Business combinations are accounted for using the acquisition method. The identifiable assets acquired and liabilities assumed are measured at their fair values at the acquisition date. The cost of an acquisition is measured as the aggregate of the consideration transferred, measured at acquisition-date fair value, and the amount of any minority interest in the acquiree. Minority interests are stated either at fair value or at the proportionate share of the recognized amounts of the acquiree’s identifiable net assets. Acquisition costs incurred are expensed and included in distribution and administration expenses.

Goodwill is measured as being the excess of the aggregate of the consideration transferred, the amount recognized for any minority interest and the acquisition-date fair values of any previously held interest in the acquiree over the fair value of the identifiable assets acquired and liabilities assumed at the acquisition date.

At the acquisition date, any goodwill acquired is allocated to each of the cash-generating units expected to benefit from the combination’s synergies. For this purpose, cash-generating units are set at one level below a business segment.

Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is reviewed for impairment annually or more frequently if events or changes in circumstances indicate that

the carrying value may be impaired. Impairment is determined by assessing the recoverable amount of the cash-generating unit to which the goodwill relates. Where the recoverable amount of the cash-generating unit is less than the carrying amount, an impairment loss is recognized. An impairment loss recognized for goodwill is not reversed in a subsequent period.

Extract from Annual Report and Accounts 2010, BP Plc, see p. 151 for full details

11.2 Common control transactions

Petrochina Company Limited

An acquisition of a business which is a business combination under common control is accounted for in a manner similar to a uniting of interests whereby the assets and liabilities acquired are accounted for at carryover predecessor values to the other party to the business combination with all periods presented as if the operations of the Group and the business acquired have always been combined. The difference between the consideration paid by the Group and the net assets or liabilities of the business acquired is adjusted against equity.

Extract from Annual Report and Accounts 2010, Petrochina Company Limited, see p. 172 for full details

11.3Goodwill and Bargain Purchases

OAO Gazprom

The excess of the consideration transferred, the amount of any non-controlling interest in the acquiree and the acquisition-date fair value of any previous equity interest in the acquiree over the fair value of the group’s share of the identifiable net assets acquired is recorded as goodwill. If this is less than the fair value of the net assets of the subsidiary acquired in the case of a bargain purchase, the difference is recognized directly in the statement of comprehensive income. Goodwill

is tested annually for impairment as well as when there are indications of impairment. For the purpose of impairment testing goodwill is allocated to the cash generating units that are expected to benefit from synergies from the combination.

Extract from Annual Report and Accounts 2010, OAO Gazprom, see p. 9 for full details

examples disclosure statement Financial – A Appendix

Financial reporting in the oil and gas industry		133

11.4 Asset vs. Business

Statoil ASA

An acquisition of a business, (an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return directly to investors), is a business combination. Determining whether the acquisition meets the definition of a business combination requires judgement to be applied on a case to case basis. Acquisitions are assessed under the relevant criteria to establish whether the transaction represents a business combination or an asset purchase. Depending on the specific facts, acquisitions of exploration and evaluation licences for which a development decision has not yet been made, have largely been concluded to represent asset purchases.

Extract from Annual Report and Accounts 2010, Statoil ASA, see p. 11 for full details

12 Functional Currency

BP Plc

Functional currency is the currency of the primary economic environment in which an entity operates and is normally the currency in which the entity primarily generates and expends cash.

In individual companies, transactions in foreign currencies are initially recorded in the functional currency by applying the rate of exchange ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated into the functional currency at the rate of exchange ruling at the balance sheet date. Any resulting exchange differences are included in the income statement. Non-monetary assets and liabilities, other than those measured at fair value, are not retranslated subsequent to initial recognition.

In the consolidated financial statements, the assets and liabilities of non-US dollar functional currency subsidiaries, jointly controlled entities and associates, including related goodwill, are translated into US dollars at the rate of exchange ruling at the balance sheet date. The results and cash flows of non-US dollar functional currency subsidiaries, jointly controlled entities and associates are translated into US dollars

using average rates of exchange. Exchange adjustments arising when the opening net assets and the profits for the year retained by non-US dollar functional currency subsidiaries, jointly controlled entities and associates are translated into US dollars are taken to a separate component of equity and reported in the statement

of comprehensive income. Exchange gains and losses

arising on long-term intragroup foreign currency borrowings used to finance the group’s non-US dollar investments are also taken to equity. On disposal of a non-US dollar functional currency subsidiary, jointly controlled entity or associate, the deferred cumulative amount of exchange gains and losses recognized

in equity relating to that particular non-US dollar operation is reclassified to the income statement.

Extract from Annual Report and Accounts 2010, BP Plc, see p. 151 for full details

Petrochina Company Limited

Items included in the financial statements of each entity in the Group are measured using the currency of the primary economic environment in which the entity operates (“the functional currency”). Most assets and operations of the Group are located in the PRC (Note 38), and the functional currency of the Company and most of the consolidated subsidiaries is the Renminbi (“RMB”). The consolidated financial statements are presented in the presentation currency of RMB.

Foreign currency transactions of the Group are accounted for at the exchange rates prevailing at the respective dates of the transactions; monetary assets and liabilities denominated in foreign currencies are translated at exchange rates at the date of the statement of financial position; gains and losses

resulting from the settlement of such transactions and from the translation of monetary assets and liabilities are recognised in the consolidated profit or loss.

For the Group entities that have a functional currency different from the Group’s presentation currency, assets and liabilities for each statement of financial position presented are translated at the closing rate at the date of the statement of financial position. Income and expenses for each statement of comprehensive income presented are translated at the average exchange rates for each period and the resulting exchange differences are recognised in other comprehensive income.

Extract from Annual Report and Accounts 2010, Petrochina Company Limited, see p. 173–174 for full details

The extracts from third-party publications that are contained in this document are for illustrative purposes only; the information in these third-party extracts

has not been verified by PricewaterhouseCoopers and does not necessarily represent the views of

PricewaterhouseCoopers; the inclusion of a third-party extract in this document should not be taken to imply any endorsement by PricewaterhouseCoopers of that third-party.

134	Financial reporting in the oil and gas industry

Appendix B –

IFRS/US GAAP differences

There are a number of differences between IFRS and US GAAP. This section provides a summary description of those IFRS/US GAAP differences that are particularly relevant to oil and gas entities. These differences relate to: exploration and evaluation, reserves and resources, depreciation, inventory valuation, impairment, disclosure of resources, decommissioning obligations, financial instruments, revenue recognition, joint ventures and business combinations.

1. Exploration and evaluation

Issue	IFRS
Capitalisation in the exploration	No formal capitalisation models
and evaluation phase	prescribed. IFRS 6 permits
	continuation of previous accounting
	policy for E&E assets but only
	until evaluation is complete.
	Wide range of policies possible
	from capitalisation of all E&E
	expenditures after licence
	acquisition to the expense of all
	such expenditures. However,
	changes to capitalisation polices are
	restricted to those which move the
	policy closer to compliance with the
	IFRS Framework.
Impairment of E&E assets	IFRS 6 provides specific relief for
	E&E assets. Cash-generating units
	(CGUs) may be combined up to the
	level of an operating segment for
	E&E assets.
	Impairment testing is required
	immediately before assets
	are reclassified from E&E
	to development.
	IFRS 6 also provides guidance in
	relation to identifying trigger events
	for an impairment review.
	Impairment charges against E&E
	assets are reversed if recoverable
	amount subsequently increases.
	An exploratory well in progress at
	period end which is determined
	to be unsuccessful subsequent to
	the balance sheet date based on
	substantive evidence obtained
	during the drilling process in that
	subsequent period suggests a non-
	adjusting event. These conditions
	should be carefully evaluated based
	on the facts and circumstances.

US GAAP

Two formal models – successful efforts and full cost, in accordance with FAS 19 and Regulation S-X Rule 4-10. Types of expenditure that may be capitalised are defined.

No similar relief for E&E assets. This is unlikely to result in a GAAP difference when the company uses successful efforts under US GAAP.

A company applying full cost will probably be able to shelter unsuccessful exploration costs in pools with excess net present value until these are depleted through production.

No reversal of impairment charges is permitted.

If an exploratory well is in progress at the end of a period and after the balance sheet date (but before the financial statements for that period are issued) the well is determined not to have found reserves, the exploration costs incurred through the end of the period should be recorded as expense for that period. (ASC 855).

differences GAAP IFRS/US – B Appendix

Financial reporting in the oil and gas industry		135

2. Reserves and Resources

Issue	IFRS
Definitions	No system of reserve classification
	prescribed. No restriction on
	the categories used for financial
	reporting purposes.

US GAAP

Entities must use the definitions of reserves and resources approved by the SEC (see section 2.8). Only proved reserves can be disclosed for financial reporting purposes. Proved and proved developed are used for depletion depending on the nature of the costs.

3. Depreciation of production and downstream assets

Issue

Depletion of production assets

Components of property, plant and equipment

IFRS

The reserve and resource classifications used for the depletion calculation are not specified. An entity should develop an appropriate accounting policy for depletion and apply the policy consistently, e.g., unit of production method. Commonly used categories of reserves include proved, proved developed, or proved and probable.

Significant parts (components) of an item of PPE are depreciated separately if they have different

useful lives. Pool-wide depletion of production assets not permitted.

US GAAP

The definitions of reserves used are those adopted by the SEC. Proved reserves are used for depletion

of acquisition costs and proved developed reserves are used for depletion of development costs.

Cost categories follow major types of assets as required by FAS 19 – individual items are not separated. Production assets held in a full cost pool depleted on a pool-wide basis.

4. Inventory valuation issues

Issue

Impact of changes in market prices after balance sheet date Inventories

IFRS

Inventories measured at the lower of cost and net realisable value. Net realisable value does not reflect changes in the market price of

the inventory after the balance sheet date if this reflects events and conditions that arose after the balance sheet date.

US GAAP

Inventories measured at the lower of cost and market value. When market value is lower than cost at the balance sheet date, a recovery of market value after the balance sheet date but before the issuance of the financial statements is recognised as a type I (adjusting) post balance sheet event.

136 Financial reporting in the oil and gas industry

5. Impairment of production and downstream assets

Issue	IFRS
Impairment test triggers	Assets or groups of assets (cash
	generating units) are tested for
	impairment when indicators of
	impairment are present.

Level at which impairment tested	Assets tested for impairment at the
	cash generating unit (CGU) level.
	CGU is the smallest identifiable
	group of assets that generates
	cash inflows that are largely
	independent of the cash inflows
	from other assets or groups of
	assets. Production assets typically
	tested for impairment at the field
	level. A pool-wide impairment test
	is not permitted.
Measurement of impairment	Impairment is measured as the
	excess of the asset’s carrying
	amount over its recoverable
	amount. The recoverable amount
	is the higher of its value in use and
	fair value less costs to sell.

Reversal of impairment charge	Impairment losses, other than those
	relating to goodwill, are reversed
	when there has been a change in
	the economic conditions or in the
	expected use of the asset.

US GAAP

Long-lived assets, including proved properties, are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset or asset group may not be recoverable. Unproved properties are assessed periodically for impairment based on results of

drilling activity, firm plans, etc. Full cost entities test impairment each period by performing a ceiling test.

Similar to IFRS except that the grouping of assets is based on largely independent cash flows (in and out) rather than just cash inflows. Production assets accounted for under the full cost

method are tested for impairment on a pool-wide basis.

Impairment of proved properties is measured as the excess of the asset’s carrying amount over its fair value. Impairment of unproved properties is based on results of activities. For full cost companies generally impairment equals the excess of net unamortised cost for each pool over the full cost ceiling as defined.

Impairment losses are never reversed.

differences GAAP IFRS/US – B Appendix

Financial reporting in the oil and gas industry		137

6. Disclosure of resources

Issue	IFRS
Disclosure requirements	Disclosure requirements in respect
	of entities in exploration and
	evaluation stage (E&E stage)
	have been laid out in IFRS 6.
	Determination of commercial
	reserves is usually after the E&E
	stage and is accordingly outside the
	scope of IFRS 6.
	There are no specific requirements
	to disclose reserves and resources;
	however, IAS 1 includes general
	requirement to disclose additional
	information necessary for a
	fair presentation.

US GAAP

Detailed disclosures required by ASC 932 and SEC “Final Rule” (see section 2.8).

138 Financial reporting in the oil and gas industry

7. Decommissioning obligations

Issue	IFRS
Measurement of liability	Liability measured at the best
	estimate of the expenditure
	required to settle the obligation.
	Risks associated with the liability
	are reflected in the cash flows or
	in the discount rate. The discount
	rate is updated at each balance
	sheet date.

Recognition of decommissioning	The adjustment to PPE when
asset	the decommissioning liability is
	recognised forms part of the asset
	to be decommissioned.

US GAAP

Range of cash flows prepared and risk weighted to calculate expected values.

Risks associated with the liability are only reflected in the cash flows, except for credit risk, which is reflected in the discount rate.

The discount rate for an existing liability is not updated.

Accordingly, downward revisions to undiscounted cash flows are discounted using the credit adjusted risk-free rate when the liability was originally recognised. Upward revisions, however, are discounted using the current credit adjusted risk-free rate at the time of the revision.

Decommissioning liability need not be recognised for assets with indeterminate life.

Similar to IFRS except consideration should be made to tracking separately due to

potential for adjustments in future periods. This distinction is relevant because of the limits placed on subsequent adjustments to the asset as a result of remeasurement of the decommissioning liability. In particular, the limit that the decommissioning asset cannot be reduced below zero for US GAAP compared with the limit that the asset to be decommissioned cannot be reduced below zero for IFRS.

differences GAAP IFRS/US – B Appendix

Financial reporting in the oil and gas industry		139

8.Financial instruments and embedded derivatives

IFRS and US GAAP take broadly consistent approaches to the accounting for financial instruments; however, many detailed differences exist between the two.

IFRS and US GAAP define financial assets and financial liabilities in similar ways. Both require recognition of financial instruments only when the entity becomes

a party to the instrument’s contractual provisions. Financial assets, financial liabilities and derivatives are recognised initially at fair value under IFRS and transaction price (which is typically equivalent to fair value) under US GAAP. Transaction costs that are directly attributable to the acquisition or issue of a financial asset or financial liability are added to or deducted from its fair value on initial recognition unless the asset or liability is measured subsequently at fair value with changes in fair value recognised in

profit or loss. Subsequent measurement depends on the classification of the financial asset or financial liability. Certain classes of financial assets or financial liabilities are measured subsequently at amortised cost using

the effective interest method and others, including derivative financial instruments, at fair value through profit or loss. The Available For Sale (AFS) class of financial assets is measured subsequently at fair value through other comprehensive income. These general classes of financial assets and financial liabilities

are used under both IFRS and US GAAP, but the classification criteria differ in certain respects.

As explained in section 7, the IASB have a number of ongoing projects relating to Financial Instruments and these should remove some of the differences. Differences between IFRS and US GAAP in the following table are based on IAS 39. Where transition to IFRS 9 or major IASB projects are ongoing, this has been noted.

Issue	IFRS
Definition of a derivative	A derivative is a financial
	instrument:
	ÛÙ o`gk]ÙnYdm]Ù[`Yf_]kÙafÙj]khgfk]Ù
	to a specified variable or
	underlying rate (for example,
	interest rate);
	ÛÙ l`YlÙj]imaj]kÙfgÙgjÙdalld]Ùf]lÙ
	investment; and
	ÛÙ l`YlÙakÙk]lld]\ÙYlÙYÙ^mlmj]Ù\Yl]
	An option contract between an
	acquirer and a seller to buy or
	sell stock of an acquire at a future
	date that results in a business
	combination would be considered
	a derivative under IAS 39 for the
	acquirer; however, the option may
	be classified as equity from the
	seller’s perspective.

US GAAP

Sets out similar requirements, except that the terms of the derivative contract should:

ÛÙ j]imaj]ÙgjÙh]jealÙf]lÙk]lld]e]fl Ù and

ÛÙ a\]fla^qÙYÙfglagfYdÙYegmfl Ù

There are therefore some derivatives that may fall within the IFRS definition, but not the US GAAP definition.

140	Financial reporting in the oil and gas industry