Topic 2

Accounting for Upstream

activities 
 Content
1. Introduction
2. Reserve and resources
3. Accounting for exploration and evaluation cost
4. Development cost
5. Provision of IAS 23 and IAS 21 in asset construction
6. Depreciation of upstream assets
7. Revenue recognition in upstream transaction
8. Asset swapping
9. Disclosure
 Introduction
• Basically, oil and gas operations have been classified as being either upstream or
downstream.
• Upstream activities include all the activities involved in finding and producing oil
and gas up to the initial point that the oil or gas is capable of being sold or used.
It include exploration, acquisition, drilling, developing, and producing oil and gas
up to the initial point that the oil or gas is capable of being sold or used.
Upstream activities are generally referred to as exploration and production
(E&P) activities.
• Downstream activities on the other hand generally include refining, processing,
marketing, and distribution.
• Some activities in the oil and gas operations have characteristics of both
upstream and downstream activities are actually referred to as midstream.
Introduction
• Upstream activities are uniquely characterized by the following:
• A high level of risk
• A long time span before a return on investment is received
• A lack of correlation between the magnitude of expenditures and the
value of any resulting reserves
• A high level of regulation
• Complex tax rules
• Unique cost-sharing agreements
• Upstream activities commence with identification of oil resource and reserve
Reserves and resources 
• Resources are volumes of oil and gas that are estimated to be present
in the ground, which may or may not be economically recoverable.
• Reserves are those resources that are anticipated to be commercially
recovered from known accumulations from a specific date. If found by
an entity constitute its most important economic asset. The financial
strength of the entity depends on the amount and quality of reserve it
has the right to extract and sell.
• Reserves may be proved or unproved
Reserves and resources 
• Proved reserves are estimated quantities of reserves that, based on
geological and engineering data, appear reasonably certain to be
recoverable in the future from known oil and gas reservoirs under
existing economic and operating conditions, i.e., prices and costs as of
the date the estimate is made. 
• Proved reserves are further sub-classified into those described as
proved developed and proved undeveloped: 
Reserves and resources  

• Proved developed reserves are those reserves that can be expected to

be recovered through existing wells with existing equipment and
operating methods; 
• proved undeveloped reserves are reserves that are expected to be
recovered from new wells on undrilled proved acreage, or from
existing wells where relatively major expenditure is required before
the reserves can be extracted 
 Reserves and resources 
Unproved reserves are those reserves that technical or other uncertainties preclude
from being classified as proved. Unproved reserves may be further categorised as
probable and possible reserves: 
• probable reserves are those additional reserves that are less likely to be recovered
than proved reserves but more certain to be recovered than possible reserves; 
• possible reserves are those additional reserves that analysis of geoscience and
engineering data suggest are less likely to be recoverable than probable reserves. 

• Identifying or discovering resource and reserves leads to the incurrence of

exploration and evaluation (E&E) cost
 Accounting for Exploration and evaluation 
• There are four basic costs incurred by companies with oil and gas exploration and
producing activities.
• These four basic types of costs are as follows:
1. Acquisition costs. Costs incurred in acquiring property, i.e., costs incurred in
acquiring the rights to explore, drill, and produce oil and natural gas.
2. Exploration and evaluation costs. Costs incurred in exploring property. Exploration
involves identifying areas that may warrant examination and examining specific
areas, including drilling exploratory wells.
3. Development costs. Costs incurred in preparing proved reserves for production, i.e.,
costs incurred to obtain access to proved reserves and to provide facilities for
extracting, treating, gathering, and storing oil and gas.
4. Production costs. Costs incurred in lifting the oil and gas to the surface and in
gathering, treating, and storing the oil and gas.
• Our concentration now is on E&E cost.
Accounting for Exploration and evaluation 
Exploration and evaluation costs
• Exploration costs are incurred to discover hydrocarbon resource
whereas Evaluation costs are incurred to assess the technical
feasibility and commercial viability of the resources found.
• Exploration, per IFRS 6 Exploration and evaluation of mineral
resources, starts when the legal rights to explore have been obtained.
• Thus, expenditure incurred before obtaining the legal right to explore
is expensed except a separately acquired intangible assets such as
payment for an option to obtain legal rights. 
Accounting for Exploration and evaluation 
Accounting for E&E cost
• Nevertheless, the fundamental accounting issue in accounting for E&E cost is whether
to capitalize or expense the incurred costs.
• If capitalized, the costs may be expensed as expiration takes place either through
abandonment, impairment, or depletion as reserves are produced.
• If expensed as incurred, the costs are treated as period expenses and charged against
revenue in the current period.
• In accordance to the GAAP, there are basically two methods applied in accounting for
E&E and subsequent development costs: successful efforts and full cost.
• The primary difference between successful efforts and full cost is in whether a cost is
capitalized or expensed when incurred. In other words, the primary difference
between the two methods is in the timing of the expense or loss charge against
revenue.
 Accounting for Exploration and evaluation 
• Successful efforts
• It is assumed that there is a direct relationship between costs incurred and reserves discovered.
• Consequently, only exploratory drilling costs that are successful, i.e., directly result in the
discovery of proved reserves are considered to be part of the cost of finding oil or gas and thus
are capitalized.
• Costs incurred in finding, acquiring and developing reserves are typically capitalised on a field-by-
field basis.
• Capitalized costs are allocated to commercially viable hydrocarbon reserves. Failure to discover
commercially viable reserves means that the expenditure is charged to expense.
• Unsuccessful exploratory drilling costs do not result in an asset with future economic benefit and
are therefore expensed.
• Specifically, successful efforts treats exploration costs that do not directly find oil or gas as period
expenses, and successful exploration costs as capital expenditures.
• Capitalized costs are depleted on a field-by-field basis as production occurs. 
Accounting for Exploration and evaluation 
• Full cost
• Under this method, it is assumed that, there is no known way to avoid unsuccessful
costs in searching for oil or gas, thus, full cost considers both successful and
unsuccessful costs incurred in the search for reserves as a necessary part of the cost of
finding oil or gas.
• A direct relationship between costs incurred and reserves discovered is not required
under full cost. Hence, both successful and unsuccessful costs are capitalized, even
though the unsuccessful costs have no future economic benefit.
• Thus, under full cost, all exploration costs are capitalized.
• All costs incurred in searching for, acquiring and developing the reserves in a large
geographic cost centre or pool are capitalised. A cost centre or pool is typically a
country. The cost pools are then depleted on a country basis as production occurs. If
exploration efforts in the country or the geological formation are wholly unsuccessful,
the costs are expensed. 
Accounting for Exploration and evaluation 
• Under both methods,
• acquisition and development costs are capitalized and production
costs are expensed.
• Although development costs could include an unsuccessful
development well, all development costs are capitalized under
successful efforts because the purpose of development activities is
considered to be building a producing system of wells and related
equipment and facilities, rather than searching for oil and gas.
• We can compare cost under both methods as follows;
Accounting for Exploration and evaluation 
Successful Efforts Full Cost

Acquisition cost Capitalised Capitalised

Geography & Geological cost Expensed Capitalised

Exploratory dry hole Expensed Capitalised

Exploratory well, successful Capitalised Capitalised

Development dry hole Capitalised Capitalised

Development well, successful Capitalised Capitalised

Production costs Expensed Expensed

Amortization cost center Property, field, or reservoir Country
Illustration - Accounting for Exploration and evaluation 
Excel Oil Company began operations in Ghana on March 3, 2010, with the acquisition
of a lease in Cape three point in the Western Region with an equity capital of
GHS2,660m. During the first year, the following costs were incurred, DD&A
(depreciation, depletion, and amortization) recognized, and the following revenue was
earned:
GHS000
G&G costs. . . . . . . . . . . . . . . . 60,000
Acquisition costs. . . . . . . . . . . .  100,000
Exploratory dry holes . . . . . . . . . . 1,400,000
Exploratory wells, successful. . . . . .  800,000
Development costs.. . . . . . . . . . .  500,000
Production costs. . . . . . . . . . . . . 50,000
DD&A expense (SE). . . . . . . . . . . .   40,000
(FC) 90,000
Revenue.. . . . . . . . . . . . . . . . .  250,000
Prepare income statements and the balance sheets for Excel oil for the first year of
operation on the assumption that the company applies (i) successful efforts (SE) (ii) full
cost (FC) in accounting for upstream transactions.
Accounting for Exploration and evaluation 
Excel Oil Company began operations in Ghana on
Solution March 3, 2010, with the acquisition of a lease in Cape
Income Statements three point in the Western Region with an equity capital
of GHS2,660,000. During the first year, the following
SCM FCM costs were incurred, DD&A (depreciation, depletion,
Revenue. . . . . . . . . .   250,000 250,000 and amortization) recognized, and the following
Expenses: revenue was earned:
GHS
G&G . . . . . . . . . . .   60,000 0 G&G costs. . . . . . . . . . . . . . . . 60,000
Exploratory dry holes . 1,400,000 0 Acquisition costs. . . . . . . . . . . .  100,000
Production costs. . . . . . 50,000 50,000 Exploratory dry holes . . . . . . . . . . 1,400,000
Exploratory wells, successful. . . . . .  800,000
DD&A. . . . . . . . . . . 40,000 90,000 Development costs.. . . . . . . . . . .  500,000
Total expenses. . . . .   1,550,000 140,000 Production costs. . . . . . . . . . . . . 50,000
DD&A expense (SE). . . . . . . . . . . .   40,000
(FC) 90,000
Net income . . . . . . . .  (1,300,000) 110,000 Revenue.. . . . . . . . . . . . . . . . .  250,000
Prepare income statements and the balance sheets for
Excel oil for the first year of operation on the
assumption that the company applies (i) successful
efforts (SE) (ii) full cost (FC) in accounting for
upstream transactions.
Accounting for Exploration and evaluation 
Excel Oil Company began operations in Ghana on
Balance Sheets (Extracts) March 3, 2010, with the acquisition of a lease in Cape
Successful Efforts Full Cost three point in the Western Region with an equity capital
GHS000 GHS000 of GHS2,660,000. During the first year, the following
G&G costs. . . . . . . . . . . - 60,000 costs were incurred, DD&A (depreciation, depletion,
Acquisition costs. . . . . . . . 100,000 100,000 and amortization) recognized, and the following
Exploratory dry holes . . . . . - 1,400,000 revenue was earned:
Exploratory wells, successful. . 800,000 800,000 GHS
Development costs . . . . . . . 500,000 500,000 G&G costs. . . . . . . . . . . . . . . . 60,000
Acquisition costs. . . . . . . . . . . .  100,000
Total assets . . . . . . . . . . 1,400,000 2,860,000
Exploratory dry holes . . . . . . . . . . 1,400,000
Less: Accumulated DD&A. . (40,000) (90,000) Exploratory wells, successful. . . . . .  800,000
Net assets. . . . . . . . . . . 1,360,000 Development costs.. . . . . . . . . . .  500,000
2,770,000 Production costs. . . . . . . . . . . . . 50,000
DD&A expense (SE). . . . . . . . . . . .   40,000
Shareholders Fund (FC) 90,000
Equity 2,660,000. 2,600,000 Revenue.. . . . . . . . . . . . . . . . .  250,000
Earnings (1,300,000). 110,000 Prepare income statements and the balance sheets for
1,360,000 Excel oil for the first year of operation on the
assumption that the company applies (i) successful
2,770,000
efforts (SE) (ii) full cost (FC) in accounting for
upstream transactions.
Accounting for Exploration and evaluation 
Provisions of IASB
• With the introduction of IFRS 6, all upstream petroleum entities are expected to transitioned
to the use of the standards and the IASB Framework to account for the four major cost
identified earlier.
• The successful efforts method is seen as more compatible with the IASB Framework.
• Entities using the successful effort transitioning to IFRS can continue applying their current
accounting policy for E&E. but they should note that, IFRS 6 does not apply to costs incurred
once E&E is completed.
• The principles of IAS 16 and impairment rules of IAS 36 prevent the continuation of full cost in
E&E phase. 
• Specific transition relief has been included in IFRS 1 First-time adoption of IFRSs to help
entities transition from full cost accounting under previous GAAP to successful efforts under
IFRS.
Accounting for Exploration and evaluation 
Accounting for E&E under IFRS 6 
Accounting policy
• In accounting for E&E expenditure, accounting policy developed by the entity should complies
with the IFRS Framework or if not, should be in accordance with the exemption permitted by IFRS
6
• The exemption is "The entity would have selected a policy under previous GAAP of capitalising or
expensing exploration costs. Such entity is allows to continue to apply its existing accounting policy
under national GAAP for E&E. The policy need not be in full compliance with the IFRS Framework”  
• Where an entity has never reported under a previous GAAP (e.g new entity) and is preparing its
initial set of financial statements, it can choose a policy for exploration cost based on the
provisions of IFRS 6 and capitalise such costs.
• This is subject to the requirement to test for impairment if there are indications that the carrying
amount of any assets will not be recoverable.
 Accounting for Exploration and evaluation 
Accounting for E&E under IFRS 6 
Change in Accounting policy
• An entity can change its accounting policy for E&E only if the change
results in an accounting policy that is closer to the principles of the
Framework.
• That is, the change must result in a new policy that is more relevant and
no less reliable or more reliable and no less relevant than the previous
policy.
• The policy, in short, can move closer to the Framework but not further
away. This restriction on changes to the accounting policy includes
changes implemented on adoption of IFRS 6. 
 Accounting for Exploration and evaluation 
Illustration 2
• Excel Oil Ltd has been operating in the upstream oil and gas sector for
many years. It is transitioning to IFRS in 2018 with a transition date of 1
January 2017. Management has decided to adopt IFRS 6 to take advantage
of the relief it offers for capitalisation of exploration costs and the
impairment testing applied. Excel Oil has followed a policy of expensing
geological and geophysical costs under its previous GAAP. The geological
and geophysical studies that Excel Oil has performed do not meet the
Framework definition of an asset in their own right, however management
has noted that IFRS 6 permits the capitalisation of such costs.
Required
a) State the IASB Framework definition of an asset
b) Can Excel Oil management change its accounting policy on transition to
IFRS to capitalise geological and geophysical costs? 
c) Will your answer to (b) change if Excel Ltd is a group of companies?
 Accounting for Exploration and evaluation 
 Solution
• IFRS 6 restricts changes in accounting policy to those which make the
policy more reliable and no less relevant or more relevant and no less
reliable.
• One of the qualities of relevance is prudence. Capitalising more costs
than under the previous accounting policy is less prudent and
therefore is not more relevant.
• On the assumption that Excel Ltd is a single entity, management
should not make the proposed change to the accounting policy. 
• However, if Excel was a group adopting IFRS and at least one entity in
the group had been capitalising exploration and evaluation
expenditures, Excel Ltd as a group could adopt a policy of
capitalisation. 
 Accounting for Exploration and evaluation 
Accounting for E&E under IFRS 6 
Initial recognition of E&E cost
• Where an entity operates on policy based on the exemption under IFRS 6,
the E& E costs can be capitalised as IFRS 6 deems these costs to be assets
except the entity have previously expend it. If not, E&E expenditures
might be capitalised earlier than would otherwise be the case under the
Framework. 
• Note that, the exemption under IFRS 6 only applies to the exploration and
evaluation phase, until the point at which the commercial viability of the
property, positive or negative, has been established. 
 Accounting for Exploration and evaluation 
Accounting for E&E under IFRS 6 
Initial recognition of E&E cost
• However, where the entity recognized E&E expenditures under the IASB framework, all cost
incurred in exploration activities should be expensed unless they meet the definition of an asset.
• An entity recognises an asset when it is probable that economic benefits will flow to the entity as a
result of the expenditure. The economic benefits might be available through commercial
exploitation of hydrocarbon reserves or sales of exploration findings or further development rights.
• Where entities do not adopt IFRS 6 and instead develop a policy under the Framework,
expenditures on an exploration property are expensed until the capitalisation point. 
• The capitalisation point is the earlier of: 
i. the point at which the fair value less costs to sell of the property can be reliably determined as
higher than the total of the expenses incurred and costs already capitalised (such as licence
acquisition costs); and 
ii. an assessment of the property demonstrates that commercially viable reserves are present and
hence there are probable future economic benefits from the continued development and
production of the resource. 
 Accounting for Exploration and evaluation 
Illustration 3
Excel Oil Ltd operates in the upstream oil and gas sector and has chosen to develop accounting
policies for exploration and evaluation expenditures that are fully compliant with the
requirements of the IFRS Framework rather than continue with its previous accounting policies.
It also chooses not to group exploration and evaluation assets with producing assets for the
purposes of impairment testing. 
Excel Oil has acquired a transferable interest in an exploration licence. Initial surveys of the
licence area already completed indicate that there are hydrocarbon deposits present but
further surveys are required in order to establish the extent of the deposits and whether they
will be commercially viable. 
Management are aware that third parties are willing to pay a premium for an interest in an
exploration licence if additional geological and geophysical information is available. This
includes licences where the additional information provides evidence of where further surveys
would be unproductive. 
Required
Can Excel Oil capitalise the costs of the survey? 
 Accounting for Exploration and evaluation 
Solution
• Excel Oil may capitalise the costs of the survey provided that the carrying
amount does not exceed recoverable amount.
• Excel’s management are confident before the survey is undertaken that
the increase in the fair value less costs to sell of the licence interest will
exceed the cost of the additional survey.
• Thus, capitalisation of the costs of the survey meets the accounting policy
criteria set out by the entity, hence, Excel can capitalise the cost of the
survey.
 Accounting for Exploration and evaluation 
How do entity’s recognized E&E? Tangible or Intangible asset?
• In accordance with IFRS 6, Exploration and evaluation assets recognised should be classified as
either tangible or intangible according to their nature.
• The standard however did not provide a basis for classifying E&E as tangible or intangible asset.
• Nevertheless, different approaches are widely seen in practice.
• Some companies will initially capitalise exploration and evaluation assets as intangible and,
when the development decision is taken, reclassify all of these costs to oil and gas properties
within property, plant and equipment.
• Some capitalise exploration expenditure as an intangible asset and amortise this on a straight
line basis over the contractually-established period of exploration.
• Others capitalise exploration costs as tangible within construction in progress or PP&E from
commencement of the exploration. 
• No matter the classification, a clear disclosure of the accounting policy chosen and consistent
application of the policy chosen are important to allow users to understand the entity’s
financial statements. 
 Accounting for Exploration and evaluation 
Subsequent measurement of E&E assets 
• Exploration and evaluation assets can be measured subsequently using
either the cost model or the revaluation model as described in IAS 16 and
IAS 38.
• In practice, most companies use the cost model. 
• Depreciation and amortisation of E&E assets usually does not commence
until the assets are placed in service.
• Some entities choose to amortise the cost of the E&E assets over the term
of the exploration license. 
 Accounting for Exploration and evaluation 
Reclassification out of E&E under IFRS 6 
• When evaluation procedures have been completed, E&E assets for which
commercially-viable reserves have been identified are reclassified to development
assets. E&E assets that are not commercially viable are written down.
• E&E assets are tested for impairment immediately prior to reclassification out of
E&E
• Once an E&E asset has been reclassified from E&E, it is subject to the normal IFRS
requirements. This includes impairment testing at the CGU level and depreciation
on a component basis. The relief provided by IFRS applies only to the point of
evaluation. 
• An E&E asset for which no commercially-viable reserves have been identified
should be written down to its fair value less costs to sell. The E&E asset can no
longer be grouped with other producing properties. 
 Accounting for Exploration and evaluation 
Impairment of E&E assets - IFRS 6 & IAS 36
• When an entity acquire a mineral interest, it is deemed to have a probable
future economic benefit, and hence, the acquisition cost is capitalized and
reported as an asset of the company.
• However, when it becomes unproved, it must be assessed periodically in
order to determine whether they have been impaired
• impairment occurs when there is an indication that a property’s value has
declined to an amount that is less than the purchase price or as reported
on the balance sheet
• IFRS 6 introduces an alternative impairment-testing regime for E&E assets
even though similar to that of IAS 36.
 Accounting for Exploration and evaluation 
Impairment of E&E assets - IFRS 6 & IAS 36
• An entity assesses E&E assets for impairment only when there are indicators that
impairment exists.
• Indicators of impairment include, but are not limited to: 
i. Rights to explore in an area have expired or will expire in the near future without
renewal. 
ii. If there been any dry holes drilled on the lease or on nearby leases, or has any
additional negative G&G information been obtained?
iii. No further exploration or evaluation is planned or budgeted. 
iv. A decision to discontinue exploration and evaluation in an area because of the
absence of commercial reserves. 
v. Sufficient data exists to indicate that the book value will not be fully recovered from
future development and production. 
vi. It is close to the expiration of the primary lease term?
 Accounting for Exploration and evaluation 
Impairment of E&E assets 
• The affected E&E assets are tested for impairment once indicators have been identified.
• In testing for impairment, distinction should be made between properties whose cost is
individually significant and Those properties whose cost is not individually significant
• Impairment of individual unproved properties whose acquisition costs are relatively
significant shall be assessed on a property-by-property basis, and an indicated
impairment loss shall be recognized and charged against profit

• Example
• On January 1, 2015, Excel Oil Company acquired an unproved lease at a total cost of
GHS50,000,000. During the year, Excel Company drilled two dry holes on the property.
As a result of drilling these dry holes, Excel Company decided on December 31, 2015
that the lease was 75% impaired.
• How should Excel reflect it decision in 2015 financial statement
 Accounting for Exploration and evaluation 
Impairment of E&E assets 
• IFRS introduces a notion of larger cash generating units (CGUs) for E&E assets If acquisition costs
are not individually significant.
• Entities are allowed to group E&E assets with producing assets, as long as the policy is applied
consistently and is clearly disclosed. Each CGU or group of CGUs cannot be larger than an
operating segment (before aggregation).
• The grouping of E&E assets with producing assets might therefore enable an impairment to be
avoided for a period of time. 

• Example
• Excel Company groups individually insignificant unproved properties by year of acquisition. During
2018, Excel acquired individually insignificant unproved property costing a total of GHS500,000.
Past experience indicates that 40% of all unproved properties are eventually abandoned without
ever being proved and that it takes Excel an average of four years to determine whether a
property will be proved or surrendered.
• Determine the annual impairment charge for the properties acquired in 2018
 Accounting for Exploration and evaluation 
Side tracks 
• Performing exploratory drilling at a particular location can indicate that
reserves are present in a nearby location rather than the original target.
• In this case, It may be cost-effective to “side track” from the initial drill hole to
the location of reserves instead of drilling a new hole.
• If this side track is successful in locating reserves, the cost previously incurred
on the original target can remain capitalised instead of being written off as a
dry hole.
• The additional costs of the side track are treated in accordance with the
company’s accounting policy which should be followed consistently.
• The asset should be considered for impairment if the total cost of the asset
has increased significantly. If the additional drilling is unsuccessful, all costs
would be expensed. 
 Accounting for Exploration and evaluation 
Suspended wells 
• Exploratory wells may be drilled and then suspended or a well’s success may not be determined
at the point drilling has been completed. The entity may decide to drill another well and
subsequently recommence work on the suspended well at a later date.
• A question arises as to the treatment of the costs incurred on the original drilling: should these
be written off or remain capitalised?
• IFRS does not contain specific guidance on measurement of costs for suspended wells.
Nevetheless, the intention of the entity to recommence the drilling process is critical. If the entity
had decided to abandon the well, the costs incurred should be written off. However, in cases
where there is an intention to recommence work on the suspended well at a later date, the
related costs may remain capitalized provided both of these conditions are met;
1. the well has found a sufficient quantity of reserves to justify its completion as a producing well.
2. sufficient progress is being made in assessing the reserves and the economic and operating
viability of the project is justified.
Both of these criteria must be met. If either criterion is not met, the well is deemed to be impaired,
and its costs, net of any salvage value, are charged to expense.
 Accounting for Exploration and evaluation 
Post balance sheet events 
• This is the time between the end of the financial year and the date on which the financial statements
are actually issued.
• Any events that would have a material effect on an investor’s assessment of a firm’s financial position
should be reflected in the most recent financial statements during this period.
• IAS 10 Events after the reporting period requires an entity to recognise adjusting events after the
reporting period in its financial statements for the period. Adjusting events are those that provide
evidence of conditions that existed at the end of the reporting period. If the condition arose after the
reporting period, these would result in non-adjusting events. 
• In the case of Oil and gas, these may include;

1. Identification of dry holes 

• An exploratory well in progress at the reporting date may be found to be unsuccessful (dry)
subsequent to the balance sheet date.
• If this is identified before the issuance of the financial statements, a question arises whether this is
an adjusting or non-adjusting event. 
 Accounting for Exploration and evaluation 
Post balance sheet events 
• 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
could be viewed as a non-adjusting event.
• However, if the well is determine to be dry before the issuance of the
financial statement, then it is considered as an adjusting event
• These conditions should however be carefully evaluated based on the
facts and circumstances. 
 Accounting for Exploration and evaluation 
Illustration 4
• An entity begins drilling an exploratory well in October 2020. From
October 2020 to December 2020 drilling costs totalling GHS
550,000 are incurred and results to date indicate it is probable there
are sufficient economic benefits. During January 2021 and February
2021, additional drilling costs of GHS250,000 are incurred and
evidence obtained indicates no commercial deposits exist. In the
month of March 2021, the well is evaluated to be dry and
abandoned. Financial statements of the entity for 2020 are issued on
April 2021. 
• Required
• In accordance with IAS 10, how should the entity account for the
exploratory costs? 
 Accounting for Exploration and evaluation 
Solution
• There were no indicators of impairment at period end 31 Dec, 2020,
hence, the subsequent expenditure of GHS250,000 is a non-adjusting
event.
• Hence, all costs incurred up to Dec 2020 amounting to GHS550,000
should continued to be capitalised by the entity in the financial
statements for the year ended 31 December, 2020.
• Disclosure will however be required in the notes to the financial
statements of the additional activity during the subsequent period that
determined the prospect was unsuccessful if material. 
• The asset of GHS550,000 and costs of GHS250,000 incurred
subsequently in the months of January 2021 to February 2021 would
be expensed in the 2021 financial statements. 
 Accounting for Exploration and evaluation 
Illustration 5
• Excel Oil Ltd has an individually significant unproved property on the books
at a cost of GHS1,200,000 as of December 31, 2018. On January 18, 2019,
prior to the issuance of the audited financial statements, a well on an
adjacent lease owned by another party was determined to be dry. Excel
had not taken any impairment on its property prior to December 31, 2018.
Due to the dry hole on the adjacent property, management now estimates
that their property was impaired by 60% at December 31, 2018. Required
• (a) identify whether or not management estimate constitute adjusting or
non adjusting event in accordance with IAS 10.
• (b) Explain how management estimate should be reflected in the financial
statement for the year ended 31 December, 2018.
 Accounting for Exploration and evaluation 
Post balance sheet events 
2. License relinquishment 
• Licences for exploration (and development) usually cover a specified period of time. They may also
contain conditions relating to achieving certain milestones on agreed deadlines.Often, the terms of the
license specify that if the entity does not meet these deadlines, the licence can be withdrawn.
Sometimes, entities fail to achieve these deadlines, resulting in relinquishment of the licence.
• A relinquishment that occurs subsequent to the balance sheet date but before the issuance of the
financial statements, must be assessed as an adjusting or non-adjusting event. 
• If the entity was continuing to evaluate the results of their exploration activity at the end of the
reporting period and had not yet decided if they would meet the terms of the licence, the
relinquishment is a non-adjusting event. The event did not confirm a condition that existed at the
balance sheet date. The decision after the period end created the relinquishment event.
• If the entity had made the decision before the end of the period that they would not meet the terms
of the licence or the remaining term of the licence would not allow sufficient time to meet the
requirements then the subsequent relinquishment is an adjusting event and the assets are impaired at
the period end.
• Appropriate disclosures should be made in the financial statements under either scenario. 
 Accounting for Exploration and evaluation 
Illustration 5 Try questions
On December 31, 2016, Dill Oil Company recognized impairment of GHS100,000
on an individually significant lease. Before the financial statements were issued
early the next year, a well was drilled and proved reserves were found. Dill easily
revised their financial statements so that no impairment was recognized on the
property. Comment on the act of management on discovering the proved reserves

Illustration 6 Try Question

Tharp Energy Company, which uses the successful efforts method of accounting,
owns an individually significant lease, with a cost of GHS200,000. On December
31, 2017, the lease is not considered impaired. However, prior to completion of
the audit, a well on adjacent property is abandoned as a dry hole, and the lease is
now considered to be 40% impaired. Prepare any necessary adjusting entry.
 Content
1. Introduction
2. Reserve and resources
3. Accounting for exploration and evaluation cost
4. Development cost
5. Provision of IAS 23 and IAS 21 in asset construction
6. Depreciation of upstream assets
7. Revenue recognition in upstream transaction
8. Asset swapping
9. Disclosure
 Accounting for Development Expenditure
• Development expenditures are costs incurred to obtain access to proved reserves and to
provide facilities for extracting, treating, gathering and storing the oil and gas.
• An entity should develop an accounting policy for development expenditure based on the
guidance in IAS 16, IAS 38 and the Framework.
• Development expenditures are capitalised to the extent that they are necessary to bring
the property to commercial production.
• Entities should also consider the extent to which abnormal costs have been incurred in
developing the asset. IAS 16 requires that the cost of abnormal amounts of labour or other
resources involved in constructing an asset should not be included in the cost of that asset.
• Entities will sometimes encounter difficulties in their drilling plans and make adjustments
to these There will be a cost associated with this, and entities should develop a policy on
how such costs are assessed as being normal or abnormal. 
• Expenditures incurred after the point at which commercial production has commenced
should only be capitalised if the expenditures meet the asset recognition criteria in IAS 16
or 38. 
 Content
1. Introduction
2. Reserve and resources
3. Accounting for exploration and evaluation cost
4. Development cost
5. Provision of IAS 23 and IAS 21 in asset construction
6. Depreciation of upstream assets
7. Revenue recognition in upstream transaction
8. Asset swapping
9. Disclosure
 Provision of IAS 23 and IAS 21 in asset
construction
IAS 23 Borrowing cost
• The cost of an item of property, plant and equipment may include
borrowing costs incurred for the purpose of acquiring or constructing it.
• Accordingly, IAS 23 Borrowing costs requires that borrowing costs be
capitalised in respect of qualifying assets.
• Qualifying assets are those assets which take a substantial period of time
to get ready for their intended use. 
• Borrowing costs should be capitalised while acquisition or construction is
actively underway.
 Provision of IAS 23 and IAS 21 in asset
construction
IAS 23 Borrowing cost
• The borrowing cost include the costs of specific borrowings for the purpose of
the borrowing is financing the construction of the asset, and those general
borrowings that would have been avoided if the expenditure on the qualifying
asset had not been made.
• The general borrowing costs attributable to an asset’s construction should be
calculated by reference to the entity’s weighted average cost of general
borrowings. 
• Borrowing costs incurred during the exploration and evaluation (E&E) phase
should be capitalised under IFRS 6 as a cost of E&E if they were capitalising
borrowing costs under their previous GAAP.
• Borrowing costs may also be capitalised on any E&E assets that meet the asset
recognition criteria in their own right and are qualifying assets under IAS 23.
 Provision of IAS 23 and IAS 21 in asset
construction
IAS 23 Borrowing cost
• Entities could develop an accounting policy under IFRS 6 to cease
capitalisation of borrowing costs if these were previously capitalised.
• However, the entity would then need to consider whether borrowing
costs relate to a qualifying asset and would therefore require
capitalisation.
• The asset would have to meet the IASB framework definition of an asset
and be probable of generating future economic benefit.  
 Provision of IAS 23 and IAS 21 in asset
construction
• IAS 21 The effects of changes in foreign exchange rates 
• When development is funded by borrowings in a foreign currency, IAS 21
requires that, any foreign exchange gain or loss be recognised in the
income statement unless they are regarded as adjustments to interest
costs, in which case they can be treated as borrowing costs in accordance
with IAS 23. 
• The gains and losses that are an adjustment to interest costs include the
interest rate differential between borrowing costs that would be incurred
if the entity borrowed funds in its functional currency and borrowing costs
actually incurred on foreign currency borrowings. 
 Provision of IAS 23 and IAS 21 in asset
construction
• IAS 21 The effects of changes in foreign exchange rates 
• IAS 23 does not prescribe which method should be used to estimate the
amount of foreign exchange differences that may be included in borrowing
costs.
• Nevertheless, The portion of the foreign exchange movement to capitalise
may be estimated based on two possible methods : 
1. forward currency rates at the inception of the loan. 
2. interest rates on similar borrowings in the entity’s functional currency. 
• Management must use judgement to assess which foreign exchange
differences can be capitalised. The method used is a policy choice which
should be applied consistently to foreign exchange differences whether they
are gains or losses. 
 Provision of IAS 23 and IAS 21 in asset
construction
• IAS 21 The effects of changes in foreign exchange rates 
• Example
• An upstream oil and gas entity operating in Ghana, with GHS
functional currency, has a US$1 million foreign currency loan at the
beginning of the period. The interest rate on the loan is 4% and is
paid at the end of the period. An equivalent borrowing in cedis
would carry an interest rate of 6%. The spot rate at the beginning of
the year is US$ 1 = GHS5.55 and at the end of the year it is US$ 1 =
US$5.70. 
• Required
• What exchange difference could qualify as an adjustment to the
interest cost for capitalisation in accordance to IAS 23? 
 Provision of IAS 23 and IAS 21 in asset
construction • Example
• An upstream oil and gas entity
• IAS 21 The effects of changes in foreign exchange rates  operating in Ghana, with GHS
functional currency, has a US$1 million
• Solution foreign currency loan at the beginning
• Step 1 Compute the expected interest cost in of the period. The interest rate on the
loan is 4% and is paid at the end of the
the functional currency period. An equivalent borrowing in
cedis would carry an interest rate of
$1 million * GHS5.55 * 6% = 333,000 6%. The spot rate at the beginning of
the year is US$ 1 = GHS5.55 and at the
end of the year it is US$ 1 = US$5.70. 
Step 2 compute the actual interest cost • Required
• What exchange difference could qualify
as an adjustment to the interest cost
for capitalisation in accordance to IAS
23? 
 Provision of IAS 23 and IAS 21 in asset
construction • Example
• An upstream oil and gas entity
• IAS 21 The effects of changes in foreign exchange rates 
operating in Ghana, with GHS
• Solution functional currency, has a US$1 million
foreign currency loan at the beginning
• Loan @ the start of the year (1,000,000 @5.55) 5,550 of the period. The interest rate on the
• Loan @ the end of the year(1,000,[email protected]) 5,700 loan is 4% and is paid at the end of the
period. An equivalent borrowing in
• Exchange loss 150 cedis would carry an interest rate of
6%. The spot rate at the beginning of
• Interest paid (1,000,000@4% * 5.7) 228 the year is US$ 1 = GHS5.55 and at the
• Total finance cost 378 end of the year it is US$ 1 = US$5.70. 
• Required
• What exchange difference could qualify
as an adjustment to the interest cost
for capitalisation in accordance to IAS
23? 
 Provision of IAS 23 and IAS 21 in asset
construction • Example
• An upstream oil and gas entity
• IAS 21 The effects of changes in foreign exchange rates 
operating in Ghana, with GHS
• Solution functional currency, has a US$1 million
foreign currency loan at the beginning
• Step 4 Compare the actual interest cost with the expected of the period. The interest rate on the
interest cost. loan is 4% and is paid at the end of the
• if the actual cost of the loan exceeds the expected period. An equivalent borrowing in
cedis would carry an interest rate of
interest cost on equivalent local loan, only the 6%. The spot rate at the beginning of
difference between the exchange loss and the the year is US$ 1 = GHS5.55 and at the
differences computed is eligible for capitalisation end of the year it is US$ 1 = US$5.70. 
• So; • Required
• Actual interest cost 378 • What exchange difference could qualify
as an adjustment to the interest cost
• Expected cost 333 for capitalisation in accordance to IAS
• Difference 45 23? 

• Exchange difference that could be capitalize is;

• 150,000 – 45,000 = 105,000
 Content
1. Introduction
2. Reserve and resources
3. Accounting for exploration and evaluation cost
4. Development cost
5. Provision of IAS 23 and IAS 21 in asset construction
6. Depreciation of upstream assets
7. Revenue recognition in upstream transaction
8. Asset swapping
9. Disclosure
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset

• The accumulated capitalised costs from E&E and development phases are to
be depreciated or amortised in accordance with IAS 16
• The common and appropriate method applicable to depreciate or amortised
over the expected total production using a units of production (UOP) basis as
this reflects the pattern of consumption of the reserves’ economic benefits.
• Other may also apply unit –of-revenue as a basis for computing DD&A
• Nevertheless, straight line amortisation may be appropriate for assets that are
consumed more by the passage of time.
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
The UOP basis 
• IAS 16 do not prescribe what basis should be used for the UOP calculation.
• Thus, the basis of the UOP calculation is an accounting policy choice, and should be applied
consistently.
• Most commonly used basis are use only proved developed reserves; total proved or both
proved and probable. Proved developed reserves are those that can be extracted without
further capital expenditure.
• If an entity does not use proved developed reserves, then an adjustment is made to the
calculation of the amortisation charge to include the estimated future development costs to
access the undeveloped reserves. 
• The estimated production used for DD&A of assets that are subject to a lease or licence should
be restricted to the total production expected to be produced during the licence/lease term.
• Renewals of the licence/lease are only assumed if there is evidence to support probable
renewal at the choice of the entity without significant cost. 
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
The UOP basis 
• Both acquisition costs and the costs of wells and equipment are amortized
using the unit-of-production method, which is as follows:
• Unit-of-production formula:
• Book value end of period/Estimated reserves at beginnning of period *
Production for period
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
Example
• Tyler Oil Company drilled the first successful well on it Lease early in 2020. The
company plans to develop this lease fully over the next several years. Data for
the lease as of December 31, 2020, are as follows:
• Leasehold cost (acquisition costs—proved property) . . . GHS50,000
• Wells and equipment. . . . . . . . . . . . . . . . . 90,000
• Lease and well equipment (wells and equipment) . . . . . 30,000
• Production during 2020. . . . . . . . . . . . . . . . . . . 5,000 bbl
• Estimated proved reserves, December 31, 2020 . . . . . . 895,000 bbl
• Estimated proved reserves recoverable from the well, December 31, 2020 (i.e.,
proved developed reserves). . . 95,000 bbl
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
Solution
• First, reserves as of the beginning of the year are determined.
Proved Reserves (bbl):
• Estimated proved reserves, 12/31/20—end of year 895,000
• Add: Current year’s production 5,000
• Estimated proved reserves, 1/1/20—beginning of year 900,000

Proved Developed Reserves (bbl):

• Estimated proved developed reserves, 12/31/20—end of year 95,000
• Add: Current year’s production 5,000
• Estimated proved developed reserves, 1/1/12—beginning of year 100,000
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
Solution
• DD&A is calculated using the unit-of-production formula

For Leasehold (proved property):

Book value end of period/Estimated reserves at beginnning of period *
Production for period

50,000/900,000bbl * 5,000bbl = GHS278

 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
Solution
• Lease and Well Equipment (wells and equipment):
120,000/100,000 bbl * 5,000bbl = GHS6,000

Accounting entries
DD&A Expense:
Proved Property 278
Wells 6,000
Accumulated DD&A
Proved Property 278
Wells 6,000
 Depletion, depreciation and amortisation
(DD&A) of Upstream Asset
• Data for Tyler Oil Company’s partially developed lease as of December 31, 2013, are as follows:
• Cost Data:
• Lease . . . . . . . . . . . . . . . . . . . . . . . . . . . GHS490,000
• Other capitalized acquisition costs . . . . . . . . . . . . . . 50,000
• Total leasehold costs at year-end. . . . . . . . . . . . . . . . GHS540,000
• Accumulated DD&A on leasehold costs at beginning of year GHS40,000
• IDC at year-end . . . . . . . . . . . . . . . . . . . . . . . . 650,000
• Accumulated DD&A on IDC at beginning of year. . . . . . 120,000
• Lease and well equipment at year-end. . . . . . . . . . . . . 275,000
• Accumulated DD&A on equipment at beginning of year. . 50,000
• Reserve and Production Data:
• Estimated proved developed reserves, 12/31/13. . . . . . . . 1,750,000 bbl
• Estimated proved undeveloped reserves, 12/31/13. . . . . . 2,200,000 bbl
• Production during year. . . . . . . . . . . . . . . . . . . . . 50,000 bbl
Compute the DD&A that should be recorgnised in the 2013 financial statement of Tyler Oil Company