Oil & Gas Accounting 101 – Joint Interest
Due to the capital intensive, high-risk nature of developing oil and gas properties, companies routinely combine their capital and knowledge in joint operations to share the cost and reduce risk. These sharing arrangements usually involve the transfer an operating interest or non-operating interest by one party to another in exchange for a contribution to the project.
Here’s some of what you need to know for oil & gas accounting…
In order to develop a property, the owner of an operating interest (working interest) may transfer (farm-out) the operating interest. In a farm-out arrangement some of the entire burden for developing the property is transferred to another person. In exchange for assuming the burden, the transferee receives the operating interest in the property.
As a part of the transaction, a non-operating interest is partitioned out of the operating interest and retained by the owner. The retained interest is usually an overriding royalty, but could also be a net profits interest or a production payment. In a farm-out arrangement, the assignor of the mineral interest will transfer any leasehold cost from the operating interest to the non-operating interest.
Joint ventures are a type of sharing arrangement. A joint venture is a nonincorporated association of two or more persons or companies who pool their resources to drill, develop, and operate an oil and gas property or properties.
Each owner has an undivided interest in the property. Joint ventures may be created in several ways, some of the most common being:
- Two or more operators lease a single property as joint lessees.
- A working interest owner assigns an undivided fractional share of the property to another person or company in exchange for cash, property or services contributed to the “pool of capital” necessary to develop the property.
- Working interest is assigned to another operator under a carried interest arrangement.
An operator’s expenses associated with the operation of oil & gas wells could consist of:
Intangible Drilling Costs
Intangible drilling costs (IDCs) include all expenses made by an operator incidental to and necessary in the drilling and preparation of wells for the production of oil and gas, such as survey work, ground clearing, drainage, wages, fuel, repairs, supplies and so on. Broadly speaking, expenditures are classified as IDCs if they have no salvage value.
The following is a nonexhaustive list of potential IDCs incurred in the exploration and development of oil & gas wells.
- Administrative costs in connection with drilling contracts.
- Survey and seismic costs to locate a well site.
- Cost of drilling.
- Grading, digging mud pits, and other dirt work to prepare drill site.
- Cost of constructing roads or canals to drill site.
- Surface damage payments to landowner.
- Crop damage payments.
- Costs of setting rig on drill site.
- Transportation costs of moving rig.
- Technical services of geologist, engineer, and others engaged in drilling the well.
- Drilling mud, fluids, and other supplies consumed in drilling the well.
- Transportation of drill pipe and casing.
Intangible Completion Costs
Similar to IDCs these expenses are related to nonsalvageable completion costs, including labor, completion materials used, ompletion rig time, drilling fluids etc. Intangible completion costs are also almost always deductible in the same year they take place, and usually make up about 15% of the overall well cost.
Tangible Drilling Costs
Expenditures necessary to develop oil or gas wells, including acquisition, transportation and storage costs, which typically are capitalized and depreciated for federal income tax purposes.
Examples of such expenditures include:
- Well casings
- Wellhead equipment
- Water disposal facilities
- Metering equipment
- Gathering lines
- Storage tanks
- Gas compression and treatment facilities
Leasehold Acquisition Costs
The cost and expenses associated with acquiring properties, including:
- Property Rentals
- Lease Bonuses
- Legal Fees
- Right of Ways
Lease Operating Expenses
The costs associated with operating a producing well. Lease operating expenses can include:
- Administrative Fees
- Chart Integration
- Data Processing
As you can see, there are several different types of costs associated with drilling and producing wells and they are treated differently depending on how the joint venture or partnership is setup. Having a good oil and gas accounting software package is critical to keeping track of these expenses.
Source: SherWare Blog