Full Cost Vs. Successful Efforts

We got the following question from one of our clients: “Is there any benefit to switching from full cost to successful efforts?”

Under successful efforts accounting, a company only capitalizes exploration, acquisition, and development costs that directly result in proved reserves. Exploration costs and costs of unsuccessful projects are expensed as incurred.

Full Cost accounting requires a company to capitalize all costs related to the exploration, acquisition, and development of oil and gas reserves. The full cost method allows a company to capitalize these expenditures into a cost center and amortize those costs as the reserves are produced. A “ceiling” is established for these costs centers to ensure that these costs are recoverable through production. Because the primary component of the ceiling calculation is discounted future net revenues at year-end prices, impairment expenses will increase as oil and gas prices decrease.

Full cost accounting results in much larger cost centers, therefore DD&A and impairment expenses will be greater than for companies that utilize the successful efforts method. However, successful efforts companies will record significant exploration expenses as these costs are incurred.

Changing from one method to another would be a change in accounting principle and require a restatement of the prior year financial statements, which becomes more and more difficult the longer a company has owned its properties.  A conversion would require a substantial amount of resources, especially from full cost to successful efforts because of the detail involved. A change of this type should be carefully considered in light of the facts and circumstances specific to your company.