IFRS Oil and Gas Update: The Critical Differences Between U.S. and International Standards
By Jake Vossen
Published in Oil and Gas 360 on Aug 10, 2012
Extractive industries, particularly oil and gas, would be significantly affected by the U.S. adoption of international accounting standards. A lack of industry specific guidance in international financial reporting standards (IFRS) is one factor that had some influence on the reluctance of the SEC staff to wholeheartedly back international adoption. Although there is an IFRS standard on exploration and evaluation costs, there is otherwise limited industry specific guidance for oil and gas in IFRS.
The summer of 2012 has proven to be a deciding point for the so-called roadmap to convergence of global accounting standards. In July, the SEC staff released its long-awaited, 127-page report on adopting IFRS, set by the International Accounting Standards Board (IASB). Although the report painstakingly avoided an outright recommendation on how commissioners should vote, it raised enough issues to be interpreted in the financial community as a collective SEC raspberry. Many corporate constituents have expressed a negative reaction to adopting IFRS due to the added expense and investor confusion that adoption would bring.
Accounting Today editor Michael Cohn called an SEC vote on IFRS “pointless.” CFO Magazine characterized the report as putting convergence further back on the shelf and stating that the SEC made it clear that it would not relinquish any of its rulemaking authority over U.S. reporting. Then, only days later, there were reports of squabbling between the FASB and the IASB on other issues.
Wholesale international accounting convergence might be stalled for now, but there are parts of the convergence plan that have already been adopted. Because oil and gas companies operate in an international environment, it is important that the industry realize the differences between U.S. GAAP and international accounting treatment. This knowledge will not only further the understanding of financial statements belonging to Canadian and other international energy companies, but also increase informed participation in the adoption debate.
No full cost concept. Although certain aspects of the evaluation and exploration phase are similar between IFRS and the U.S. full cost method, there is no full cost concept in IFRS. All assets are capitalized by major component and there is no pooling of assets.
No two-step impairment. IFRS uses a single-step method for impairment write-downs rather than the two-step method used in U.S. GAAP, making write-downs more likely.
In the U.S., for successful efforts companies, undiscounted cash flows from the asset are used as a “first step” to determine if additional impairment tests are needed. If the “first step” is failed, the fair value of the asset is compared to its book value to determine how much (if any) impairment must be recorded.
The first step does not exist in IFRS. In IFRS, if the fair value of the asset is less than the book value, an impairment must be recorded. Without first considering recoverability though undiscounted cash flows, impairments are much more likely.
Impairments can be reversed under IFRS, not in U.S. GAAP. IFRS gives companies the ability to reverse an impairment if facts and circumstance change from the time it was initially recorded. All impairments in U.S. GAAP are permanent. As a result, earnings are likely to be more volatile under IFRS due to impairments being recorded more often (and reversed) as compared to U.S. GAAP.
IFRS and depletion: No prescribed reserve base. In U.S. GAAP, under successful efforts, depletion is calculated using various sub-categories of proved reserves. Under IFRS, a company elects which reserve base to use in its calculation and may consider probable (or even possible) reserves as long as the future development costs for those categories are also used. The election in IFRS must be applied consistently and disclosed.
The other depletion calculation difference is the period of time you apply the quarterly revised depletion rate. Under GAAP, the revised depletion rate is calculated at the end of the quarter, but the new rate is applied retrospective to the beginning of the quarter. Under IFRS, it is calculated at the end of the quarter and the new rate is applied prospectively to the next quarter, and no adjustments are made to the current quarter.
There is no standardized measure type reserve disclosures required under IFRS, nor are there prescribed definitions of proved, probable or possible reserves. Most companies follow their home country rules, or U.S. rules for reserve definitions and disclosures. Here again, disclosure of the policy used is critical.
Exploration and Evaluation. Although there is some flexibility for companies initially converting to IFRS, in general, the costs of unproved or unevaluated oil and gas properties ― from the time a lease is acquired until it is evaluated ― are capitalized.
If your company is considering making the move, you should familiarize yourself with these five IFRS standards:
- IFRS #6 – Accounting for exploration costs
- IFRS #11 – Joint Arrangements
- IAS #16 – Property, plant and equipment
- IAS # 36 – Impairment of assets
- IAS # 38 – Intangibles
I believe that it is unlikely that U.S. companies and regulators would give up sovereignty over accounting standards. In the U.S., accounting standards boards are funded privately, partly to avoid political influence. The funding mechanism for the IASB is less certain, opening up the process to potential political pressure.
It appears that the most likely result of the “path to convergence” may be the “condorsement” approach, wherein the current convergence projects are finished, the U.S. retains its independence, and future accounting rules are endorsed by the FASB or converged into U.S. GAAP to the extent acceptable.
For public and private companies in the oil and gas industry, there isn’t an urgent need to do anything right now, but there is an urgent need to understand the differences between the two sets of standards in order to understand your competitors and have a voice in the ongoing IFRS debate.