Financial reporting's elements

March 30, 2015
Oil and gas companies are currently preparing their 2014 yearend financial statements that will showcase their operating results to shareholders.

Oil and gas companies are currently preparing their 2014 yearend financial statements that will showcase their operating results to shareholders. Because crude prices during the fourth quarter were much lower than the rest of the year, oil and gas financial reporting will no doubt reflect the downturn.

Markets actually started to see a huge slide in crude oil prices starting about midyear 2014. By August, crude prices started to fall more rapidly, and by December's end, prices were at their lowest in 5 years. In the fourth quarter, West Texas Intermediate crude prices for the month of September averaged $84.43/bbl but ended in December at $59.50/bbl, a decrease of nearly 30%. WTI prices were down 39% from a year ago.

Considering the elements

Accounting firm Hein & Associates LLP believes that oil and gas companies must consider five important elements when reflecting and compiling their 2014 financial statements based on the downward trend of oil prices.

• Impairment of oil and gas properties. A company is required to implement impairment tests on proved oil and gas properties whenever changes in conditions, such as a decline in prices, specify that the carrying value of proved properties may not be recoverable. When such valuations stipulate a drop in the estimated future cash flows of the company's properties, the carrying value may not be recoverable and therefore an impairment charge would be issued to reduce the carrying value of the proved properties to their fair market value.

Depending on which accounting method a company employs-successful efforts or full cost-it will affect the net income and cash flow statements differently based on these new valuations of the oil and gas properties.

• Five-year rule on proved undeveloped properties (PUD). Based on a US Security and Exchange Commission rule, a company must show extensive capability to develop PUD reserves within a 5-year period in order to categorize those reserves as proved. Because of the low crude prices at yearend 2014 and now in 2015, developing those "classified" PUDs may become economically unfeasible. In addition, low crude prices can dampen the resources available to develop the PUD. If this happens and a company must change the classification of the PUD to unproved, creditors may change the amount that they loan out based on the proved reserves a company owns.

• Liquidity concerns. When oil prices drop, a company's reserves values also decline. Since banks typically lend money on the value of reserves, this could change how they award contracts on debt agreements. Due to lower prices, some companies can experience liquidity issues seen by a negative or declining operating cash flow. In addition to that concern, banks could simply stop extending credit while prices are low.

• Collectability of joint interest billings. Companies participating in oil and gas production all face the same dilemmas when prices decline. One must deliberate on any collectability of receivables when prices are down vs. when prices are higher. Companies should have a plan of action to identify any potential issues regarding whether receivables are collectable.

• Derivatives. Huge fluctuations in commodity prices propose risk to oil and gas companies; many companies therefore guard themselves by entering into contracts at a fixed price for oil produced in the future. The current crude oil price decline has led to significant gains on the contract; however, those gains could weaken. As the futures market drops, new contracts will not be as promising.

The drastic change in oil prices during fourth-quarter 2014 made forecasting end-of-year results difficult. Oil and gas producers must reflect modifications to their current business models based on the current market situations.